“Employees are our greatest asset” is a phrase often heard from companies. However, due to accounting rules requiring that most expenditures related to employees be treated as costs and expensed as incurred, the value of employees is an intangible asset that does not appear on any balance sheet. That leaves the interesting question of whether employee satisfaction provides information on future returns.
After 40 years or so, quantitative investing has evolved into a thriving practice. A major feature of the quantitative approach involves developing underlying numerical models and testing them on a historical (data) record and then forecasting where alpha may be embedded into the prices of a set of stocks. Whether you agree or disagree with this approach, it is difficult to deny that with the advanced state of data access and computational skill, “quants will win the day in ESG investing”. Such is the premise of this article and happily, it is accompanied by a compelling argument.
The superior performance of low-volatility stocks was first documented in the literature in the 1970s—by Fischer Black in 1972, among others —even before the size and value premiums were “discovered.” The low-volatility anomaly has been shown to exist in equity markets around the world. Interestingly, this finding is true not only for stocks but for bonds as well. In other words, it has been pervasive...but
Who among us wouldn't want to be the savior that predicts a market crisis and saves our clients from losses in capital -- or even better -- profits from them? A central topic of interest for academics is whether there are more precise tools to predict financial crises. Those who believe so dedicate their efforts to finding early warning indicators.
We will be hosting our 5th annual Democratize Quant conference later this month via Zoom. The event is 100% free but we do screen participants to enforce our "no spammers" policy. https://alphaarchitect.com/democratizequant/
Factor Updates for: Standardized Performance Factor Performance Factor Exposures Factor Premiums Factor Attribution Factor Data Downloads
How well do quantitative investors navigate around the changes to the accounting standards that are endemic to the financial data used in quantitative strategies? The numbers reported on financial statements are wholly governed by regulation and by each firm’s interpretation of those accounting standards. So how do quants stick to their empirical evidence on old data methods or do they react in terms of the strategy when the change in standards is material?
As mind-bending as it sounds, although a company’s internally generated intangible investments generate future value, they are currently not accepted as assets under US GAAP. Omission of this increasingly important class of assets reduces the usefulness and relevance of financial statement analysis that uses book value. In fact, Amitabh Dugar and Jacob Pozharny, authors of the December 2020 study “Equity Investing in the Age of Intangibles,” concluded that the relationship between financial variables and contemporaneous stock prices has weakened so much for high intangible intensity companies in both the U.S. and abroad that investors can no longer afford to ignore the changes in the economic environment created by intangibles.
Taken together, our results suggest that firms’ personnel expenditures reflect not just the cost of labor in the current period but also the investment in human capital contained within that cost, and that market participants fail to fully understand the opportunity and efficacy of human capital development embedded in the disclosure of the expense.
The factor performance modules have been updated on our Index website
From 2017 through March 2020, the relative performance of value stocks in the U.S. was so poor, experiencing its largest drawdown in history, that many investors jumped to the conclusion that the value premium was dead. It is certainly possible that what economists call a “regime change” could have caused assumptions to change about why the premium should exist/persist.
Having conducted an inordinate amount of research on the momentum factor, we find it comforting (likely due to confirmation bias!) that independent researchers have identified the same thing we have found -- frog in the pan is a robust way to measure momentum if one is seeking to take advantage of the momentum factor.
Negative outcomes from unconditional long exposure to the VIX led Campasano to examine the performance of an Enhanced Portfolio that dynamically invests in the S&P 500 Index and VIX futures.
The weight of the evidence suggests we recently exited a secular bull market driven by high real earnings growth and have entered a secular bear market driven by high inflation. The takeaway is that while investors have become highly conditioned to buy the dip, the current dip is occurring with relative sentiment significantly bearish (i.e., retail likes equities more than institutions). Historically, that has not been a great time to buy equities.
Inflation -- what's that? ... It has been quite a while since inflation has been considered a problem. Today, however, the angst surrounding the possibility of a resurgence in inflation is real and “top of mind” for investors. If the current fear becomes a reality, how should investors react? What strategies and asset classes perform well in a rising inflationary environment? If inflation does resurge beyond a temporary phase, how should investors restructure or reposition their portfolios? The purpose of this article is to provide context for those decisions.
The reported results we covered have important implications for investors in terms of portfolio construction, risk monitoring, and manager selection. Because these common factors explain almost all the returns of bond portfolios, investors should construct their bond portfolios using low-cost, passively (systematically) managed funds with these factors in mind and then carefully monitor their exposure to these systematic risks.
Allocations to illiquid assets have become increasingly popular requiring asset managers to consider portfolio-wide liquidity characteristics. Although determining the price of illiquidity is a challenge for investors, the construction of a portfolio that includes liquidity constraints can be even more daunting. How do we optimize asset allocation with liquidity as a significant constraint on the portfolio?
The main takeaway for investors is that Kelly, Moskowitz, and Pruitt demonstrated that past return characteristics are strongly predictive of a stock’s realized exposures to common risk factors, providing direct evidence that price trend strategies are in part explainable as compensation for common factor exposures—past returns predict betas on factors and those factors have high average returns.
Private investment opportunities seem to have been filling investors' portfolios. These investment vehicles come with a discount to the assets value to pay investors for taking on illiquidity risk. Readers of this article are treated to the development of a theory and a practical model that quantifies the illiquidity discount.
We are calling it quits for the holidays. Most of us have kids and Santa is coming to town!
We'll talk research and educate investors next week.
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