I love it when people place creative names on otherwise boring academic papers (Katz is one of the best).
Case Closed by Haugen
Great review by Empirical Finance here. The problem is that every quant with a FactSet subscription knows what factors outperform. If you pull up a symbol of a highly rated multi-factor stock (say, CORE, AEA, etc) you see all the same holders – AQR, Rentec, DFA, LSV, etc. So, what is the edge here? Before it was unique acess to data, but now? Hmmph.
Abstract:
This article provides conclusive evidence that the U.S. stock market is highly inefficient. Our results, spanning a 45 year period, indicate dramatic, consistent, and negative payoffs to measures of risk, positive payoffs to measures of current profitability, positive payoffs to measures of cheapness, positive payoffs to momentum in stock return, and negative payoffs to recent stock performance. Our comprehensive expected return factor model successfully predicts future return, out of sample, in each of the forty-five years covered by our study save one. Stunningly, the ten percent of stocks with highest expected return, in aggregate, are low risk and highly profitable, with positive trends in profitability. They are cheap relative to current earnings, cash flow, sales, and dividends. They have relatively large market capitalization and positive price momentum over the previous year. The ten percent with lowest expected return (decile 1) have exactly the opposite profile, and we find a smooth transition in the profiles as we go from 1 through 10. We split the whole 45-year time period into five sub-periods, and find that the relative profiles hold over all periods. Undeniably, the highest expected return stocks are, collectively, highly attractive; the lowest expected return stocks are very scary – results fatal to the efficient market hypothesis. While this evidence is consistent with risk loving in the cross-section, we also present strong evidence consistent with risk aversion in the market aggregate’s longitudinal behavior. These behaviors cannot simultaneously exist in an efficient market.
What is the edge? Good question. Haugen has been publishing his methods since 1996 at least. There shouldn't be an edge after this many years. But according to Investars, Haugen's firm is top rated in the Quantitative category for most time periods, including the 3 month period ending yesterday — up 38% vs 11% for S&P. I suspect the paper describes what he was doing last year, and leaves out a detail or two about what he is doing this year.
Table 1 (T-statistics on the most significant factors) shows that the predictive power of the factors has been dropping over time (even adjusting for the fact that the last period is 5 years and so has fewer samples than the previous 10-year periods). See Zhijian Huang's papers “Real-Time Profitability of Published Anomalies” (or 'momentum of anomalies' as I call it)
Are there any ETFs which track these highly rated multi factor stocks. I think there is the Hennessey mutual funds and Wisdom Tree dividend ETFs?
Hi Meb,
So, what do you believe is key to finding a sustainable edge? (“Don't publish once you find it” doesn't count as an answer). Maybe this would be a good survey question.
Thanks,
Carl
AlanPendleton's point about the good Investars showing does seem to suggest some edge. Though note the VERY high turnover of the Investars portfolio and the fact that they don't factor in trading costs or frictions.
Interesting paper “Value and Momentum Everywhere”; authors suggest that rather than operating efficiently the market swings between favoring value and momentum strategies. “We study the links between value and momentum strategies universally across asset classes and their
connections to global macroeconomic and liquidity risks.”
http://papers.ssrn.com/sol3/papers.cfm?abstract...
Interesting paper “Value and Momentum Everywhere”; authors suggest that rather than operating efficiently the market swings between favoring value and momentum strategies. “We study the links between value and momentum strategies universally across asset classes and their
connections to global macroeconomic and liquidity risks.”
http://papers.ssrn.com/sol3/papers.cfm?abstract...