Investing Expertise

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: Keep Reading

Can investors count on continued outperformance from hedge funds with exceptionally strong recent returns? In their July 2008 paper entitled “The Performance Persistence of Equity Long/Short Hedge Funds”, Markus Schmid and Samuel Manser apply a flexible portfolio-based approach to investigate the persistence of raw and risk-adjusted returns for long/short equity hedge funds. Using return and holdings data for 1,150 long/short equity hedge funds over the period 1994-2005, they conclude that: Keep Reading

How do the typical portfolio and performance of self-directed investors differ from those of investors who employ financial advisors? Do financial advisors systematically add value by providing information to, and tempering the irrationalities of, individual investors? In his March 2008 paper entitled “The Influence of Financial Advice on Individual Investor Portfolio Performance”, Marc Kramer compares the investment portfolio content and performance of advised and self directed investors in the Netherlands. Using portfolio data for a diverse mix of 15,675 individual Dutch investors over the 52-month period from April 2003 to August 2007, he concludes that: Keep Reading

How can investors and speculators tell foolish, theoretical and practical investing/trading schemes apart? In his August 2002 paper entitled “Cranks, Academics and Practitioners”, former head of quantitative strategies at Goldman Sachs Emanuel Derman briefly circumscribes this question. He notes that:

“…[A]s I skimmed through the crank file I found it hard to feel superior. Instead, …I always saw a pale reflection.”

“Holy [the crank], holey [the academic], wholly [the practitioner]. Which approach is best? Sometimes you can’t even tell which approach is which. Finance, after nutrition and psychology, may be the field in which it’s hardest to distinguish between a really enthusiastic academic or practitioner and a genuine crank…”

“Crankademic? Pranktitioner? The real thing? Can one devise a Turing test to tell the difference? The mind reels, boundaries blur, not a bad thing really.”

In summary, it seems that nature to a significant degree favors diversity over survival of the fittest.

Consider reading the entire one-page essay.

Have Regulation FD (Fair Disclosure) of 2000 and the Global Analyst Research Settlements of 2002 effectively removed incentives for sell-side analysts to curry favor with their own and covered company management teams by issuing inflated earnings forecasts? In their May 2008 paper entitled “Conflicts of Interest and Analyst Behavior: Evidence from Recent Changes in Regulation”, Armen Hovakimian and Ekkachai Saenyasiri investigate whether these two regulatory actions reduced the average analyst earnings forecast bias found in prior studies. Based on the annual earnings forecasts of sell-side analysts and associated actual annual earnings over the period 1984-2006, they conclude that: Keep Reading

Do the favorite equity investments of stock market newsletter gurus reliably outperform the market? One way to answer this question is a test of the performance of the favorite investments identified in the historical reports at NewsletterAdvisors.com published from 11/1/05 to 11/1/07. In each of these seven reports, a group of “top investment gurus reveal their favorite investment ideas.” NewsletterAdvisors.com is published by Business Financial Publishing, “a diversified publisher of investment news, research, and analysis for individual investors through paid subscription newsletters, free e-letters, and regular special reports.” Using historical price data from Yahoo!Finance for the sample of 70 favorite investments in in the seven reports and contemporaneous S&P Depository Receipts (SPY) performance data for benchmarking, we find that: Keep Reading

Do Commodity Trading Advisors (CTAs), generally associated with the “managed futures” hedge fund style, successfully time their chosen markets? These traders take long or short positions in investment vehicles with low transaction cost (such as futures contracts) to exploit trends in commodity prices, exchanges rates, interest rates and equity prices. In the February 2008 version of their paper entitled “Market Timing of CTAs: An Examination of Systematic CTAs vs. Discretionary CTAs”, Hossein Kazemi and Ying Li investigate the return and volatility timing ability of CTAs and examine whether there is a difference in market timing abilities between systematic and discretionary traders. To this end, they develop a set of risk factors based on returns from the most heavily traded futures contracts. Using monthly, net-of-fees return data for 1994-2004 (encompassing 278 live and 622 defunct CTA funds), they conclude that: Keep Reading

What is the nature and value of stock recommendations made by bloggers? Do investors/traders act on them? In his recent paper entitled “The Impact of Blog Recommendations on Security Prices and Trading Volumes”, Veljko Fotak measures the performance and influence of blogger stock recommendations based on a sample of 340 buy and 160 sell recommendations from 122 distinct bloggers (with posted biographies) via Seeking Alpha during 2006. Using this sample, along with daily price and volume data for the recommended stocks, he concludes that: Keep Reading

What proportion of mutual funds truly, after accounting for luck, generate positive alpha? Is there a reliable way to find such funds? In the March 2008 version of their paper entitled “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas”, Laurent Barras, Olivier Scaillet and Russ Wermers apply a new technique to measure the role of luck across a large sample of mutual funds. Using monthly returns for 2,076 U.S. actively managed domestic equity mutual funds (1,304 growth, 388 aggressive growth and 384 growth and income) existing for at least 60 months during 1975-2006, they conclude that: Keep Reading

Does the Wall Street Journal’s SmartMoney Fund Screen help its readers beat the market? In the February 2008 version of their paper entitled “Do Mutual Fund Media Recommendations Hold Value? An Empirical Analysis of the Wall Street Journal’s SmartMoney Fund Screen”, George Comer, Norris Larrymore and Javier Rodriguez employ two methods to test the performance of mutual funds listed at the ends of the Wall Street Journal’s SmartMoney Fund Screen columns during the year before and the year after publication. These weekly columns flag top performing mutual funds based on criteria such as fund objective, historical returns and expense ratios. The authors collect and assign the funds in these lists to one of five fund categories: domestic equity, international equity, sector, hybrid (asset allocation and balanced funds) and fixed income. Using daily returns for 399 mutual funds (263 unique) listed during 2005, they conclude that: Keep Reading