Objective research and reviews to aid investing decisions
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For complete reverse chronological listings of blog entries, see: External (Secondary) Research for summaries of research done by others; Original (Primary) Research for summaries of our own work; and, Reviews for a few discussions of books, web sites and products.
Exceptional performance can stem from: (1) doing something others are doing, but doing it better; and (2) doing something different. Do hedge funds that have innovative strategies (do something different) systematically outperform? In their August 2008 paper entitled "Strategy Distinctiveness and Hedge Fund Performance", Ashley Wang and Lu Zheng construct a "Hedge Fund Strategy Distinctiveness Index" (SDI) and test the predictive power of this index for future hedge fund returns. Specifically, they define SDI as [1 - R-squared] from a two-year regression of the returns for an individual hedge fund against the average returns of funds with the same investing style. This index represents the percentage of variation in a fund's returns not explained by the variation of its peer's returns. Using monthly return data for 2767 live and dead hedge funds over the period January 1994 through June 2007, they conclude that:
The following chart, taken from the paper, tracks the five-year persistence
of the average SDI for portfolios of hedge funds formed quarterly based on past
fund SDI across the entire 1996-2007 sample period. The chart shows that differences
in average SDI, arguably related to hedge fund innovativeness, diminish considerably
over the two years after portfolio formation but persist for at least five years.
In summary, hedge fund investors are probably better off with maverick funds, perhaps new ones every couple of years, than with those cut from the herd.
For related research, see Blog Synthesis: Mutual Funds and Hedge Funds.
The inflation rate forecast flyoff now incorporates 40 months of live testing for three granular (month-by-month or quarter-by-quarter) 12-month trailing consumer inflation rate forecasts, all freely available on the web: (1) the BMO Nesbitt Burns United States Economic Outlook; (2) our own simple extrapolation (CXO); and, (3) the Financial Trend Forecaster (FTF) Moore Inflation Predictor. The flyoff is for one-month-ahead accuracy only. Which model is winning? Using accumulated forecast and actual inflation data for 4/05-7/08, we find that: More...
Do presidential election polling data have any effect on stock returns? In other words, do investors act on the survey-indicated election prospects for the two major party candidates? Presumably, investors would tend to enter (exit) stocks if they thought the candidate with policies more (less) favorable for equity valuation were gaining ground. Using Gallup Daily polling data and contemporaneous daily closing levels of the S&P 500 index from June 6 (when the major party nominations solidified) through August 17 (49 trading days), we find that: More...
As compiled by Standard and Poor's, estimated S&P 500 aggregate operating earnings takes another nosedive as reporting for the second quarter winds down. Forecasts for most future quarters continue to decline. See Earnings Trends for a summary and Stock Market Status for the impacts on the Real Earnings Yield Model and the Reversion-to-Value Model.
Do short-term relative mispricings of equity sectors offer a means to capture abnormal returns? To investigate, we measure the returns from trading potential "errors" in the relative price movements of a pair of sector exchange-traded funds (ETF) selected from the following:
Materials Select Sector SPDR (XLB)
Energy Select Sector SPDR (XLE)
Financial Select Sector SPDR (XLF)
Industrial Select Sector SPDR (XLI)
Technology Select Sector SPDR (XLK)
Consumer Staples Select Sector SPDR (XLP)
Utilities Select Sector SPDR (XLU)
Health Care Select Sector SPDR (XLV)
Consumer Discretionary Select SPDR (XLY)
Using daily adjusted closing prices (incorporating dividends) for these ETFs during 12/22/9-8/15/08, we find that: More...
Just what does it mean to be a quant? In his December 2002 article entitled "The Boy's Guide to Pricing & Hedging " Emanuel Derman offers an "abbreviated poor man’s guide" to quantitative finance. He observes that: More...
At the suggestion of a reader, we began tracking on 5/4/06 the intermediate-term stock market outlooks of Steve Todd. Steve Todd is founder of the Todd Market Forecast, which states: "For the years 2003, 2004 and 2005, The Todd Market Forecast was rated # 1 for the preceding ten years [by Timer Digest]. For the year 2006, we slipped to # 3 and in 2007, we were ranked # 5." His short-term and intermediate-term stock market outlooks are available on a weekly basis at Decision Point. His outlooks are clear and binary, bullish (buy) or bearish (sell). Because Decision Point offers no historical archives, accumulation of recorded switches between these two outlooks is very slow. Since 5/4/06, he has changed his intermediate-term outlook 12 times. Before that, according to the May 2006 commentaries, he had not changed this outlook since April 2005. In reviewing these calls, we find that: More...
We occasionally select for retrospective review an all-time "best selling" research paper of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the February 2006 version of the paper entitled "Pairs Trading: Performance of a Relative Value Arbitrage Rule" (download count over 14,500) by Evan Gatev, William Goetzmann and Geert Rouwenhorst. The study tests the trading of mismatches in the dividend-adjusted prices of pairs of stocks that historically move together. Specifically, when the price spread between such a pair widens, short the winner and buy the loser and hold until prices converge. Using daily stock prices for a broad sample of reasonably liquid stocks over the period 1962-2002, the authors conclude that: More...
Do stocks in Australia confirm pervasiveness of the value premium and the size effect? In their August 2008 paper entitled "Size and Book-to-market Factors in Australia" Michael O’Brien, Tim Brailsford and Clive Gaunt measure the value premium and the size effect in the Australian market. Using company-specific accounting information from annual reports and contemporaneous stock prices for 98% of all Australian listed firms during 1982-2006 (25 years), they conclude that: More...
Do stop-loss orders (automated position exits based on a cumulative loss threshold) enhance returns and reduce risk? In their 2008 paper entitled "The Value of Stop Loss Strategies" Adam Lei and Huihua Li investigate whether traders using stop-loss strategies to exit losing positions in individual stocks outperform a comparable buy-and-hold strategy. They test the following strategy alternatives: holding periods of three months, six months or one year; stop-loss thresholds of 5, 10 or 20 daily return standard deviations; reinvestment of stopped out positions in either the S&P 500 index or the one-month Treasury bill; and, a fixed stop price or a trailing stop price that follows stock price upward (but not downward). Using historical and simulated daily return data for a broad sample of NYSE/AMEX-listed stocks and random buy dates over the period 1970-2005, they conclude that: More...
Taking the same approach as used for the calendar year at Trading Calendar, what is the typical cumulative return profile for the U.S. stock market over the four-year presidential term? Using monthly closing levels of the S&P 500 index from December 1951 through July 2008 (13+ presidential terms), we find that: More...
