Investing Expertise

How do broker-employed stock analysts operate? In their March 2013 paper entitled “Inside the ‘Black Box’ of Sell-Side Financial Analysts”, Lawrence Brown, Andrew Call, Michael Clement and Nathan Sharp summarize the results of a survey and follow-up interviews designed to discover key inputs and incentives affecting sell-side equity analyst outputs, including earnings forecasts and stock recommendations. They conducted the 23-question survey via email during January 9 through February 6 of 2013, with a promise of strict confidentiality. Using information from 365 responses from sell-side analysts (10.9% of 3,341 targeted) and 18 detailed follow-up interviews (17 by telephone and one in person), they find that: Keep Reading

What proportion of long-short equity hedge fund managers effectively time the stock market? In their January 2013 paper entitled “Hedge Fund Managers’ Market Timing Skills”, Xin Li and Hany Shawky investigate whether long-short equity hedge funds (the oldest and largest hedge fund category) exhibit market timing skill by adjusting positions with market trends. Specifically, they examine hedge fund return correlations with the Fama-French model factors (market, size and book-to-market ratio) during three major crises: the Long-Term Capital Management (LTCM) collapse in the fall of 1998; the quant crisis in August 2007; and, the financial crisis in 2008. They also examine market timing behaviors of individual hedge funds over their respective lifetimes by relating fund beta to market return via a nonlinear function accounting for risk aversion and/or market liquidity. Using monthly returns for 1,571 long-short equity hedge funds having at least 48 months of returns, and contemporaneous Fama-French factor returns, during January 1994 through January 2011, they find that: Keep Reading

Andrew Abraham, founder of Abraham Investment Management, prefaces his 2013 book, The Bible of Compounding Money: The Complete Guide to Investing with World Class Money Managers, by stating: “I wrote this book because I wanted to separate the snake oil from reality when investing. …By investing with world class money managers I have compounded money and thus been able to live my dreams and enjoy this with my family. I have a complete set of rules for investing in and identifying world class money managers. It is both a quantitative approach as well as qualitative approach full of due diligence. I want to ‘try’ to buy the best managers, diversify among them and make sure they are liquid and transparent. Nothing is held back. Everything is disclosed.” Using examples of successful investors and drawing upon his own experience as a trader and investor, he concludes that: Keep Reading

What research is available on investment approaches, allocations and results for U.S. university endowments? In their January 2013 paper entitled “A Survey of University Endowment Management Research”, Georg Cejnek, Richard Franz, Otto Randl and Neal Stoughton summarize available research on university endowment money management and performance. They identify four streams of research: (1) governance structure and investment policy statement; (2) asset allocation; (3) performance; and, (4) spending. Based on this research, they conclude that: Keep Reading

Do analyst stock ratings usefully predict associated returns? In his November 2012 paper entitled “Are Stock Recommendations Useful”, Ireneus Stanislawek examines the relationship between stock ratings offered by sell-side analysts around the globe over the past decade and future stock returns. He defines an overall analyst rating ratio for a stock as the number of positive ratings minus the number of negative ratings, divided by the total number of ratings. He also considers the monthly change in this ratio for a stock, employing a lag to exclude the immediate impact of a rating change on stock price. Using monthly stock ratings and returns for MSCI World Index stocks (an average of 23,000 ratings per month) from the end of 2001 through mid-2012, he finds that: Keep Reading

Are there certain kinds of insider trades that are more exploitable than others? In their August 2012 paper entitled “Insider Trading Patterns”, David Cicero and Babajide Wintoki define and examine two kinds of insider trading: (1) isolated trades (no trades in prior or subsequent months; and, (2) sequenced trades (occurring in successive months). They hypothesize that when insiders have short-maturity (long-maturity) information, they tend toward isolated (sequenced) trading. They measure insider trading informativeness via post-trade abnormal returns to associated stocks, calculated relative to returns for matched stocks with no insider trading or via adjustment based on a four-factor (market, size, book-to-market, momentum) model of stock returns. Using a broad sample of insider trades in U.S. stocks aggregated monthly by insider, along with associated stock prices and firm characteristics, during January 1986 through December 2011, they find that: Keep Reading

Are investment advisors worth the price? In the August 2012 version of their paper entitled “The Impact of Financial Advisors on the Stock Portfolios of Retail Investors”, Marc Kramer and Robert Lensink investigate the impact of financial advisors on individual investor portfolio returns, risk, trading frequency and diversification. For sampled investors, the sponsoring bank standardizes strategic asset allocation advice, but the advisors made available to investors by the bank have great latitude in recommending specific stocks. While all investors are eligible for advice, each elects either an advisory relationship (randomly selected advisors) or self-directed trading. The study emphasizes controlling for any self-selection bias associated with the type of investors who seek advice, and focuses on common stock holdings to avoid any conflicts associated with mutual fund incentives. Using demographics and complete histories of common stock positions and trades for 5,661 individual advised and self-directed Dutch investors during April 2003 through August 2007 (193,418 monthly returns), they find that: Keep Reading

“CFOs vs. CEOs as Inside Traders” describes research finding that, based on data from before the Sarbanes-Oxley Act (SOX), investors should assume that Chief Financial Officers (CFO) are better inside traders than Chief Executive Officers (CEO). Does this finding hold after SOX? In the August 2012 update of their paper entitled “CEOs, CFOs, and COOs: Why Are Certain Insiders’ Trades More Informative?”, Heather Knewtson and John Nofsinger examine insider trading performance of CEOs, CFOs and Chief Operating Officers (COO) spanning SOX implementation. They measure trading performance based on 50-day future returns for overlapping portfolios formed daily to capture executive stock purchases (more informative than sales) unique to category (the other two categories not trading that day) within the past 50 days. They consider both equal and dollar value weightings of qualifying trades. They estimate trading alpha based on a four-factor (market, size, book-to-market, momentum) model of stock returns. They consider subsamples based on pre-SOX versus post-SOX, and CEOs with and without experience as CFO. Using executive trading disclosures, contemporaneous returns for associated stocks and risk factor data during 1992 through 2009, they find that: Keep Reading

Do top-performing mutual funds reliably continue to be top performers. In their June 2012 semiannual report entitled “Does Past Performance Matter? S&P Persistence Scorecard”, Standard and Poor’s summarizes performance persistence statistics for U.S. mutual funds overall and for funds grouped by capitalization focus of holdings. They measure persistence of the top 25% (quartile) and top half of funds across multiple subsequent years and frequency of migration of all performance quartiles from one multi-year interval to the next. Using annual performance data for a broad sample of U.S. mutual funds during March 2002 through March 2012, they find that: Keep Reading

Which consensus forecast of U.S. economic indicators is best? How does the U.S. equity market react to consensus forecast errors? In their April 2012 paper entitled “Market Reaction to Information Shocks: Does the Bloomberg and Briefing.com Survey Matter?”, Linda Chen, George Jiang and Qin Wang investigate the accuracy of, and equity futures market reactions to, competing Bloomberg and Briefing.com survey-based forecasts for the values of scheduled weekly, biweekly, monthly and quarterly economic announcements. They focus on 14 announcements commonly treated as important: Building Permits, Capacity Utilization, Case-Shiller 20-city Index, Consumer Confidence, Consumer Price Index, Durable Goods Orders, Existing Home Sales, GDP Advance, Leading Indicators, Non-farm Payrolls, Personal Spending, Producer Price Index, Retail Sales and Unemployment Rate. They introduce standardization to compare errors across different indicator scales. Using consensus forecasts and announced values of 59 economic indicators, along with contemporaneous high-frequency price and volume data for the nearest S&P 500 futures contract (as available), over the period January 1998 through August 2010, they find that: Keep Reading