Elections, Managed Futures, and Four New Factors
Below is our tenth issue of The Idea Farm Weekly! If you are enjoying the emails please feel free to pass along to your friends and colleagues.
In this issue we include some research from Steve LeCompte at CXO Advisory, one of my all-time favorite resources. Steve sifts through reams of academic studies and distills the findings into a coherent summary. Considering how many studies come out on a daily basis (most of which are nearly unreadable), it is incredibly useful to have someone condense the material and even more importantly, offer a practicioner’s view on cautionary points. We have included four recent summaries, and here is an example from the Four Factor study below:
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- The investment (change in total assets) factor generates a gross average monthly return of 0.44%, playing a role similar to that of the Fama-French book-to-market factor.
- The ROE factor generates a gross average monthly return of 0.60%, playing a role similar to that of the Carhart momentum factor.
- Relative to the Carhart four-factor model, the new model:
- Outperforms in explaining earnings surprise, idiosyncratic volatility, financial distress, net stock issuance and composite issuance (as well as, naturally, asset growth and return on equity) anomalies.
- Performs similarly in explaining size/momentum, abnormal corporate investment and size/book-to-market anomalies.
- Underperforms in explaining the accruals anomaly.
- Progressive testing of many different factors and combinations of factors on the same sets of stock return data builds data snooping bias, such the the performance of the best models deteriorates when applied to new data.
- Factor return calculations ignore trading frictions associated with periodic portfolio reformation and costs of shorting, thereby substantially overstating returns implied for strategies seeking to exploit these factors.
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Here are five sample summaries sent to subscribers:
Stock Market and the Election Cycle
Managed Futures as a Portfolio Diversifier
Market Cap Concentration as a Stock Market Predictor
A More Logical Four Factor Model of Stock Returns
CXOadvisory.com presents financial markets models, research summaries, analyses and reviews designed for objective, unique and concise value to serious investors, financial advisors and money managers — a modicum of actionable conclusions filtered from a very noisy environment. The default approach is to challenge any and all conventional market wisdom with analytical skepticism. Part of CXOadvisory.com is subscriber-only, and part is free. The CXO Advisory Group LLC of Manassas, Virginia maintains the site.
CXO Advisory Group LLC founder Steve LeCompte is editor of CXOadvisory.com, responsible for all site content. His prior experience includes: project officer on the staff of Admiral H.G. Rickover at Naval Reactors; engineering and program management for complex systems with International Business Machines; senior consultant and executive manager for market research and new media development with units of International Data Group, including International Data Corporation; and, longstanding private investor in stocks, mutual funds, exchange-traded funds and options. He holds a B.S. in physics, summa cum laude, from Miami University and an M.S. in Physics from the University of Michigan. He is a graduate of the Program Management Course of the Defense Systems Management College.