Larry Swedroe

Expected Returns to Green Stocks

The past decade has seen a dramatic growth in sustainable investing—applying environmental, social and governance (ESG) criteria to investment strategies. Investments considered environmentally friendly are often referred to as “green,” while “brown” denotes the opposite. Important questions for investors are: What are the expected returns to green stocks? What does their past performance tell us about their future expected returns? We begin by looking at what economic theory tells us our expectations should be.

The Performance of Multi-Factor Long-Short Portfolios in Various Economic Regimes

To determine if a multi-factor approach has provided diversification benefits in terms of exposure to economic cycle risks, the research team at Counterpoint evaluated returns to multifactor long-short strategies, stocks, and 1-month T-bills in a variety of economic conditions (recession or no recession, high or no high inflation, and stagflation) over the period July 1963-August 2022.

The “Resurrected” Size Effect and Monetary Policy

Given that tightening monetary policy increases economic risks, Simpson and Grossman provided compelling evidence of a risk explanation for the size factor. For those investors who engage in tactical asset allocation strategies (market timing), their evidence suggests that it might be possible to exploit the information. Before jumping to that conclusion, I would caution that because markets are forward-looking, they should anticipate periods of Fed tightening and the heightened risks of small stocks.

Trend Following and Relative Sentiment: Complementary Factors

Since it is likely that both the Relative Sentiment and Trend Following strategies will underperform at some points in the future, “a 50-50 combination of TF and RS might reduce the emotional volatility an investor may experience from holding only the underperforming strategy.”

Active Managers are Subject to the Same Biases as Individual Investors

Are active managers victims of the same bias as individual investors? That is the question we’ll explore in this paper.

The Role of the Secular Decline in Interest Rates in Asset Pricing Anomalies

Jules van Binsbergen, Liang Ma and Michael Schwert, authors of the September 2022 study “The Factor Multiverse: The Role of Interest Rates in Factor Discovery,” posed an interesting question: Are the findings of at least some of the reported anomalies the direct result of the 40-year secular decline in global interest rates and thus not really anomalies?

Market Risk and Speculative Factors

Soroush Ghazi and Mark Schneider authors of the August 2022 study “Market Risk and Speculation Factors” decomposed the excess market return (the equity risk premium) into speculative (in the simple sense that it is negative, reflecting a premium investors pay to hold assets that are more subject to speculative demand) and non-speculative, or risk (in the simple sense that it is positive, a necessary characteristic for a factor to reflect compensation for risk) components.

Mind the Momentum Gap to Improve Performance

This article discusses the academic research about the Momentum Gap and the role that its predictive potential may have in reducing momentum crashes, hence possibly improving performance.

The Effect of Indexing on Price Discovery and Limits to Arbitrage

We discuss the academic research about the causal effect of indexing on arbitrage conditions and price discovery.

Lottery Demand and the Asset Growth Anomaly

It is well documented in the literature that over the long term, low-investment firms have outperformed high-investment firms—with the negative relation between asset growth (AG) and future stock returns particularly featured by the overvaluation of high AG stocks.

Momentum Everywhere, Including Emerging Markets

Atilgan et al. contribute to the momentum literature with “Momentum and Downside Risk in Emerging Markets.”

The Relationship Between the Demand for Leverage and Management Fees

This article discusses what academic research says about the relationship between the demand for leverage and management fees.

High-Frequency Consumer Spending Data and the Cross-Section of Stock Returns

Consumer demand drives the cash flows of consumer-oriented companies. Thus, they should serve as a reliable source of information to predict future fundamentals above and beyond the information contained in financial statements and readily available market data.

The Short-Duration Equity Premium

We examine the short-duration premium using pre-scheduled economic, monetary policy, and earnings announcements. We provide high-frequency evidence that duration premia associated with revisions of economic growth and interest rate expectations are consistent with asset pricing models but cannot explain the short-duration premium. Instead, we show that the trading activity of sentiment-driven investors raises prices of long-duration stocks, which lowers their expected returns, and results in the short-duration premium. Long-duration stocks have the lowest institutional ownership, exhibit the largest forecast errors at earnings announcements, and show the highest mispricing scores.

Brand Values and Long-Term Stock Returns

An equal-weighted portfolio of Best Brands (BBs) in the U.S. earns an excess return of 25 to 35 bps per month during the period 2000-2020. This result is remarkably robust across various factor models and therefore is not driven by exposure to common (risk) factors. The excess returns of the BB portfolio are not due to firm characteristics, industry composition, or small-cap stocks. We provide evidence suggesting that expensing investments in brands (instead of capitalizing them) and the tendency to underestimate the effect of brand name on generating future earnings are two mechanisms contributing to the excess returns.

How You Sort Matters in Sorting Factor Portfolios

Non-standard errors capture uncertainty due to differences in research design choices. We establish substantial variation in the design choices made by researchers when constructing asset pricing factors. By purposely data mining over two thousand different versions of each factor, we find that Sharpe ratios exhibit substantial variation within a factor due to different construction choices, which results in sizable non-standard errors and allows for p-hacking. We provide simple suggestions that reduce the average non-standard error by 70%. Our study has important implications for model selection exercises.

Financial Markets Responding to Climate Risks

This paper provides new evidence showing that carbon transition risk is becoming increasingly material and is priced both in equity and debt markets. We find that there is a widespread price-earnings discount linked to corporate carbon emissions. This discount varies, however, by sector and trends differently in Europe than in the US. We also find that a small discount emerges for corporate bonds, although it is statistically significant only for small caps. Finally, we find evidence that the pricing discount also emerges, albeit to a smaller extent, for other greenhouse gas emissions.

Alpha from Short-Term Signals

Short-term alpha signals are generally dismissed in traditional asset pricing models, primarily due to market friction concerns. However, this paper demonstrates that investors can obtain a significant net alpha by combining signals applied on a liquid global universe with simple buy/sell trading rules. The composite model consists of short-term reversal, short-term momentum, short-term analyst revisions, short-term risk, and monthly seasonality signals. The resulting alpha is present across regions, translates into long-only applications, is robust to incorporating implementation lags of several days, and is uncorrelated to traditional Fama-French factors.

Litigation Finance as Alternative Investment

Litigation finance is a rapidly growing niche asset class focused on debt and equity investments in litigation claims and law firms. We find that in-sample returns in the space have been in excess of 20% annually with limited correlation to other investment areas. This apparent excess return may be due to information asymmetry and barriers to entry in the space. Our findings highlight the opportunities and risks for investors in this nascent asset classes and suggest such excess returns are due in part to limits to the speed with which efficient markets take hold.

Avoiding Momentum Crashes

Across markets, momentum is one of the most prominent anomalies and leads to high risk-adjusted returns. On the downside, momentum exhibits huge tail risk as there are short but persistent periods of highly negative returns. Crashes occur in rebounding bear markets, when momentum displays negative betas and momentum volatility is high. Based on ex-ante calculations of these risk measures we construct a crash indicator that effectively isolates momentum crashes from momentum bull markets. An implementable trading strategy that combines both systematic and momentum-specific risk more than doubles the Sharpe ratio of original momentum and outperforms existing risk management strategies over the 1928–2020 period, in 5 and 10-year sub-samples, and an international momentum portfolio.

About Larry Swedroe

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larryswedroe

About Larry Swedroe

Are You Ready to Become a Better Investor?

Important Disclosures