Alpha Architect

Who Bears the Cost of Machine Learning in Credit Markets?

The primary idea behind this research is that a more sophisticated statistical technology (in the sense of reducing predictive mean squared error) produces predictions with greater variance than a more primitive technology. These technologies range from a simple logistic regression of default outcomes based on borrowers and default variables to random forest machine learning models. Said differently, improvements in predictive technology act as mean-preserving spreads for predicted outcomes—in this case, predicted default propensities on loans, which also means that there will always be some borrowers considered less risky by the new technology, or “winners”, while other borrowers will be deemed riskier “losers”, relative to their position under the pre-existing technology.

Machine Learning: The Recovery of Missing Firm Characteristics

Firm characteristics are often missing, which forces both researchers and practitioners to come up with workarounds when handling missing data. Previous approaches resorted to either dropping observations with missing entries or simply imputing the cross-sectional mean of a given characteristic. As both procedures accompany serious drawbacks (see below), there is a need for more advanced methods. The authors set up an attention-based machine learning model, motivated by recent advances in natural language to find some answers

Global Factor Performance: February 2022

The factor performance modules have been updated on our Index website

The Fed Put is Alive and Well

The question of whether or not the FED considers or responds to the stock market in its policy decisions has been studied fairly extensively, the subject of the existence of the "FED put" continues to pop up in the literature. In this particular revival of the issue, the authors are among the first to study FOMC minutes, transcripts, and other sources of information using textual analysis in order to provide an answer to the question: Does the FED respond to stock market events and if it does, what is the nature of the response?

Is The Value Premium Smaller Than We Thought?

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.

DIY Asset Allocation Weights: February 2022

Full exposure to domestic equities. Half exposure to international equities. Full exposure to REITs. Full exposure to commodities. No exposure to intermediate-term bonds.

What Explains the Momentum Factor? Frog-in-the Pan is Still the King.

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.

Female Representation in the Academic Finance Profession

To date, there is no large-sample empirical evidence on gender balance and career outcomes in academic finance. Though we have looked into and observed where are the women in finance and women in the C-Suite. This paper specifically looks to proved insight into the statistics of female representation in the academic arena of finance.

Portfolio Strategies for Volatility Investing

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.

What Relative Sentiment Says About Market Regime Change

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.

The Best Strategies for Dealing with Inflation? Factors and Trend-Following

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.

Important Insights Into Index Versus Active ETF Management

can be boiled down to the following: Index ETFs come with increased transparency and marketability; Active ETFs come with lower operational costs and increased portfolio management flexibility.

Empowering Investors Through Education Actually Works!

Empowering investors through education is a foundational tenet of our firm and a big reason why we write these posts. The article we cover here is a meta-analysis 76 randomized studies on the impacts and design of financial education, a topic we've hit on before. It' almost cliche now to hear parents and educators demand schools take the initiative to make financial education a high priority. However, it's reasonable to ask, does financial education even work?

Factor Investing in Sovereign Bond Markets

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.

Trend-Following Filters – Part 4

This article considers a different type of filter called the Kalman filter. The Kalman filter is a statistics-based algorithm used to perform the estimation of random processes. Our research will explain what Kalman Filters are and utilize them with financial time series data for trend following purposes.

Asset Allocation and Private Market (i.e. illiquid) Investing

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?

Should I launch an Active ETF or Index ETF?

summary, there are no right answers when it comes to launching an active or an index ETF. However, by understanding the basics of the regulatory landscape and the costs/benefits of each approach, both consumers and ETF operators can make more informed decisions. Thanks for reading!

What Do Mutual Fund Investors Really Care About?

Are individuals just naïve performance chasers, unaware of the financial literature, or are they sophisticated investors? Pretty much.

DIY Asset Allocation Weights: January 2022

Current Exposures:

Full exposure to domestic equities.
Full exposure to international equities.
Full exposure to REITs.
Full exposure to commodities.
No exposure to intermediate-term bonds.

Interesting Insights into How Endowments Invest

Despite their popularity and the ease of access to university-based endowments, there is little in the academic literature about the history of endowment investing. In this article, the authors aim at filling this gap.

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Important Disclosures

Research Insights

Are You Ready to Become a Better Investor?

Important Disclosures