Alpha Architect

Trend to Passive Investing Negatively Affecting Active Funds

While the evidence makes clear that active management is a loser’s game (one that it is possible to win but so unlikely you should not try), we don’t want active managers to disappear. Hope should continue to triumph over evidence, wisdom, and experience because active managers help eliminate market anomalies and inefficiencies created by the misbehavior of investors (such as noise traders). That helps to ensure that capital is allocated efficiently.

Moving Average Distance and Time-Series Momentum

For investors that use trend-following strategies, Avramov, Kaplanski, and Subrhmanyam provided new evidence supporting momentum strategies and showed that the distance between short- and longer-term momentum signals provides additional explanatory power in the cross-section of equity returns.

Outperforming Cap- (Value-) Weighted and Equal-Weighted Portfolios

Antonello Cirulli and Patrick Walker, authors of the December 2023 study “Outperforming Equal Weighting,” examined whether equally weighted portfolios could be enhanced by avoiding negative exposure to some of the most prominent factor anomalies documented in asset pricing literature.

Peer-Reviewed Theory and Expected Stock Returns

The risk-based explanation provided by a peer-based review is a necessary ingredient for considering investment, but it is not a sufficient ingredient.

Crowded Trades Increase Crash Risks

Crowded equity positions in anomalies remain and have significant impacts in terms of risk and return dynamics.

The Financial Distress Puzzle

The empirical research findings demonstrate that the return premium generated by being long low-distress risk stocks and short high-distress risk stocks is persistent and that the capital asset pricing model (CAPM) and the Fama-French three-factor models cannot explain it. Hence, we have the distress puzzle, or anomaly.

The Temptation of Factor Timing

The timing of equity factor premiums has a strong allure for investors because academic research has found that factor premiums are both time-varying and dependent on the economic cycle.

After-Tax Performance of Actively Managed Funds

Ignoring the impact of taxes on the returns of taxable accounts is one of the biggest mistakes that can be made.

Focus on Income Can Undermine Returns: The Case of Covered Calls

Covered calls implemented to deliver higher derivative income should be expected to have (1) lower total returns, (2) higher tax realizations along the path, and (3) a more negatively skewed return profile. Investors who allocate to these strategies for their income alone, without accounting for these other considerations, might have made a devil’s bargain

The Magnificent Seven

When a small subset of companies makes up a large portion of a portfolio, for better or worse their returns will have a greater impact on overall portfolio results.

The Performance of Major Private Equity/LBO Firms

The claims of superior risk-adjusted performance by the PE industry are exaggerated. Given their lack of liquidity, opaqueness, and greater use of leverage, it seems logical that investors should demand something like a 3-4% IRR premium. Yet, there is no evidence that the industry overall has been able to deliver that.

Technology Spillover Impacts Stock Returns

The timelier adoption of new technology and the higher likelihood of large-scale technology adoption make the risk associated with technological innovation more systematic, which in turn increases returns required by investors for technology spillover recipients.

Dissecting the Idiosyncratic Volatility Puzzle

Idiosyncratic volatility (IVOL) is the volatility of a security that cannot be explained by overall market volatility—it is the risk unique to a particular security. IVOL contrasts with systematic risk, which is the risk that affects all securities in a market (such as changes in interest rates or inflation) and, therefore cannot be diversified away. On the other hand, the risks of high IVOL stocks can at least be reduced through diversification.

International Value Stocks Offering “More Bang for the Buck”

Over the very long term, while value stocks have been less profitable and have had slower growth in earnings than growth stocks, they have provided higher returns.

ESG Preferences Negatively Affecting Market Efficiency

While ESG investors can express their values through their investments, they should expect lower returns from their portfolios—though they also will be taking less investment risk.

The Research and Development Factor

The higher returns to high R&D stocks represent compensation for heightened systematic risk not captured in standard asset pricing models.

The Role of ESG in Equity Returns Across Private, Primary, and Secondary Markets

The continued popularity of sustainable strategies could create sufficient cash flows to offset the risk premium in the lower-scoring stocks, at least until an equilibrium is reached.

Implications of Regime-Shifting Stock-Bond Correlation

The correlation between stocks and bonds should be a critical component of any asset allocation decision, as it impacts not only the overall risk of a diversified multi-asset class portfolio but also the risk premia one should expect to receive for taking risk in different asset classes. The problem for investors is that the correlation between stocks and bonds fluctuates extensively across time and economic regimes.

Dissecting the Investment Factor

Investment predicts returns because, given expected profitability, high costs of capital imply low net present value of new capital and low investment, and low costs of capital imply high net present value of new capital and high investment.

Structured Notes Are Financial Fairy Tales

Wall Street’s product machine is continuously pumping out fairy tales; structured products should be avoided.

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Larry Swedroe

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