Alpha Architect

The Performance of Listed Private Equity

It is important to diversify the risks of private equity. This is best achieved by investing indirectly through a private equity fund rather than through direct investments in individual companies. Because most such funds typically limit their investments to a relatively small number, it is also prudent to diversify by investing in more than one fund. Unfortunately, the evidence we reviewed suggests that diversifying by investing in LPEs is not an effective strategy. And finally, top-notch funds are likely closed to most individual investors.

Value and Profitability/Quality: Complementary Factors

There are various measures of value and quality, with one being Marx’s gross profits-to-assets.

The Quality Factor and the Low-Beta Anomaly

The empirical evidence demonstrates that returns to the low-beta anomaly are well explained by exposure to other common factors, and it has only justified investment when low-beta stocks were in the value regime, after periods of strong market and small-cap stock performance, and when they excluded high-beta stocks that had low short interest.

Reducing the Risk of Momentum Crashes

The empirical research demonstrates that, on average, investing in previous winners and short selling previous losers offers highly significant returns that other common risk factors cannot explain. However, momentum also displays huge tail risk, as there are short but persistent periods of highly negative returns. Crashes occur particularly in reversals from bear markets when the momentum portfolio displays a negative market beta and momentum volatility is high.

Are Sustainable Investors Compensated Adequately?

Academic research has demonstrated that the higher risk associated with less sustainable firms should be compensated by higher returns. It also has shown that more sustainable firms have less investment risk.

And the Winner Is: Examining Alternative Value Metrics

Although the most efficient way to implement a value strategy may need to be clarified, it is clear that value has withstood the test of time and that some implementations are superior to others. The evidence suggests that P/B is not an efficient metric as a standalone criteria. Instead, value strategies that use P/B should include at least a measure of profitability while managing sector - and security-level diversification.

Diving Into the Performance of Factors

Researchers have raised questions and led to research into how many factors are needed, the replicability of originally reported results, and the decay of factor performance over time.

Improving Performance by Avoiding Negatives of Index Replication

There are several significant, well-documented benefits of index funds. In addition to outperforming a large majority of actively managed funds, they tend to have low fees, low turnover (resulting in low trading costs and high tax efficiency), broad diversification, high liquidity, and near-zero tracking error (generally assumed to mean that they incur negligible trading costs).

Negative Screening and the Sin Premium

While most sin stocks in the IC method were also identified as sin in the TA method, there were 57 firm-year cases where a company showed up as sin only in the IC method—these were false positive sin stocks as identified in the IC method.

Gold as a Safe-Haven Asset

I’ve received calls from clients inquiring about moving assets to gold. When I asked them why, three reasons dominated.

Pursuing Factor Premiums at the Industry and Country Level

This article examines the research conducted by Dimensional to determine the efficacy of an industry or country approach to factor investing.

The Reddit Road to Riches?

No surprise: reddit message boards don't lead to alpha generation.

Merger Arbitrage as Diversification Strategy

Merger arbitrage is an investment style in which investors seek to buy shares of firms that are acquisition targets with the objective of realizing the difference between the amount for which the target is being acquired and the stock price of the target shortly after the acquisition is announced. The stock price of the target company typically sells below the acquisition price, reflecting the uncertainty of the deal being completed (the arbitrage spread). Betting on mergers is a classic hedge fund arbitrage strategy.

Combining Reversals with Time-Series Momentum Strategies

Jiadong Liu and Fotis Papailias contribute to the momentum literature with their study “Time Series Reversal in Trend-Following Strategies,” published in the January 2023 issue of “European Financial Management,” in which they examined the reversal property of various financial assets.

Is a Naive 1/N Diversification Strategy Efficient?

A simple 1/N factor diversification strategy will likely be at least as efficient as more “sophisticated” versions.

Institutional Investors’ Impact on Factor Premiums

For anomalies that are risk-based, that is what we should expect to see because, while risk cannot be arbitraged away, cash flows can reduce the size of the premium. For the anomalies that are behavioral based, it appears that limits to arbitrage are still sufficient to allow them to persist post-publication.

Research and Development, Expected Profitability, and Expected Returns

Regardless of the model used, an anomaly for all models is that the empirical evidence demonstrates that stocks with high research and development (R&D) expenses have delivered a premium.

Are Short Covering Trades Informative?

The importance of the role played by short sellers has received increasing academic attention in recent years. Short sellers help keep market prices efficient by preventing overpricing and the formation of price bubbles in financial markets. Market efficiency is important because an efficient market allocates capital efficiently. If short sellers were inhibited from expressing their views on valuations, securities prices could become overvalued and excess capital would be allocated to those firms.

Intangibles and the Value Factor

This figure shows the long, short and long-short leg performance of the intangible value factor in comparison to the traditional value factor. The performance is shown for each of the four regions: U.S., Europe, Japan and Asia Pacific between June 1983 and December 2021. The monthly returns are ex-post volatility scaled to 5% p.m

Inside the Minds of Expected Stock Returns

Non-traditional investor preferences play an important role in explaining the cross-section of expected stock returns.

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Larry Swedroe

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