The question I get asked the most during the past twelve months is “Why are factors not working?” Here are my top 12 personal thoughts on the topic—informed by 15+ years of successfully “factor investing”.
1. There is no such thing as factor investing.
There are two kinds of randomness, one that is harmless and one that can hurt.
Knowing which one your investments contain is important.
Alternative Title: A Common Misconception in Finance
What is the expected future return of a fairly-valued dividend paying stock?
Alternative Title: How to Avoid Bad Manager Timing
Strategy Risk: If you own a black-box ‘go-anywhere’ hedge fund that invests long and short, uses futures and derivatives at any frequencies, you are mostly exposed to the strategy risk.
Asset Risk: On the other hand, if you buy and hold S&P500 for the long-run, you are mostly exposed to the underlying asset risk.
Volatility is how much something moves up and down. The stock market is more volatile than the bond market, on average. Yet, a black-box hedge fund might be less volatile than S&P500, but is it less risky?
Here are my 8-thoughts and 1 solution idea about Campbell Harvey and Yan Liu recently released paper on their influential concept of the factor zoo. To sum it up, it says that there are too many data-mined factors out there and that we should be using much higher t-statistics to accept factors.
One thing has not made sense to me.
Why does the first and likely the most important step of investing, which determines 95% of investment outcomes, is typically in the hands of Financial Advisors (including Wealth Managers and Consultants), while the second step, which barely moves the needle, belongs to Asset Managers?
Only showing the latest backtest versions without disclosing their out-of-sample degradation
Backtesting today’s static holdings (managers, asset allocations, sub-asset-classes) into the past - filled with look-ahead bias
A Story About Unexpected Risk.
It was at the beginning of 2008, at our downtown office on Pine Street in Manhattan. I was a young quant portfolio manager at AIG and I was standing in the office of one of my mentors, a talented senior portfolio manager who was looking nervously at his screen.
What is the most significant risk in quant (and all active) investing today?
In addition to market valuation ratios like CAPE, the slope of the yield curve is one of the most talked about signals used to estimate future recessions and market returns.
Having just attended a great AI conference in New York, here are some observations:
Can quantitative and fundamental approaches be successfully combined?
In my estimate, this has been a top 5 industry question for a long time, including this conference at which I’ll be speaking at tomorrow
The short answer is: Yes
Alternative Title: The Gap Everywhere
There exist many flavors of market timing.
Some are obvious:
Commodity Futures contracts were established in 1865, but commercially available data starts in 1959, leaving an 80+ year period of unstudied history. In our latest academic paper “Two Centuries of Commodity Futures Premia” Chris Geczy and I use hand-collected futures data to extend the well-known cross-sectional Value, Momentum and Basis factors in commodity futures back to 1877.