New strategy:
#418 – Momentum and the Firm Fundamental Cycle
Period of rebalancing: Quarterly
Markets traded: equities
Instruments used for trading: stocks
Complexity: Very complex strategy
Bactest period: 1970-2015
Indicative performance: 8.80%
Estimated volatility: 6.82%
Source paper:
Han, Yufeng and Huang, Zhaodan and Tian, Weidong and Zhou, Guofu: Momentum, Reversal, and the Firm Fundamental Cycle
https://ssrn.com/abstract=3282420
Abstract:
We link momentum and long-run return reversal to the cyclic behavior of firm fundamentals, which are represented by a fundamental index that summarizes succinctly and efficiently a broad range of business activities at firm level. In responding to repeated unanticipated positive (negative) shocks in fundamentals, investors continue to raise (lower) prices for winner (loser) firms, yielding momentum. However, due to the cyclicality of firm fundamentals, the unanticipated positive (negative) shocks decrease in magnitude overtime and eventually reverse, generating the reversal pattern. In addition, we find that firm fundamentals can explain stronger momentum in microcap stocks, and a long/short decile portfolio based on the firm fundament index outperforms the popular momentum portfolio substantially by doubling the Sharpe ratio and does not suffer crashes.
New research papers related to existing strategies:
#21 – Momentum Effect in Commodities
Urquhart, Zhang: Do Momentum and Reversal Strategies Work in Commodity Futures? A Comprehensive Study
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3271841
Abstract:
This paper investigates the performance of three different trading strategies – Jegadeesh and Titman (1993), George and Hwang (2004) and Gatev, Goetzmann and Rouwenhorst (2006) – in 29 commodity futures from January 1979 to October 2017. We find there is no significant reversal profit across 189 formation-holding windows for all the three strategies. However, there are statistical and economically significant momentum profits, and the profitability increases with the rising of formation-holding periods. The strategy of inversing the conventional Gatev, Goetzmann and Rouwenhorst (2006) is more profitable than the other two momentum strategies on a risk-adjusted basis; but the superiority declines sharply since 1998. Momentum returns are quite sensitive to market conditions but the crash of momentum returns are partly predictable. Return seasonality, risk and herding also provide partial explanation of the momentum profits.
#94 – Trading on Earnings Announcements
Heitz, Narayanamoorthy, Zekhnini: Filings of Material Information and the Disappearing Earnings Announcement Premium
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3296537
Abstract:
It has been known for over fifty years that, on average, abnormal returns can be earned by buying a stock just prior to its earnings announcement and selling it immediately after. This trading strategy, which is unconditional on the actual earnings outcome, has been widely reported in the popular press as well as subject to extensive academic research. We provide the first evidence that it has disappeared in recent years. Additionally, our evidence suggests that increased filings of material information (Form 8-K), as a consequence of the 2004 Disclosure Regulation, plays a role in the disappearance. These filings appear to preempt the information in earnings announcements and reduce the information uncertainty. Our results are consistent with information uncertainty-based explanations for the erstwhile earnings announcement premium rather than behavioral theories focusing on limited attention from investors.
#237 – Dispersion Trading
Faria, Kosowski, Wang: The Correlation Risk Premium: International Evidence
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3276601
Abstract:
In this paper we carry out the first cross-country analysis of the correlation risk premium. We examine the statistical properties of the implied and realized correlation in European equity markets and relate the resulting premium to the US equity market correlation risk and a global correlation risk premium. We find evidence of strong co-movement of correlation risk premiums in European and US equity markets. Our results support the existence of a global correlation risk premium that is priced in international equity option markets. We document the dependence of the correlation risk premium on macroeconomic policy uncertainty and related variables.
And three additional related research papers have been included into existing free strategy reviews during last 2 weeks:
#5 – FX Carry Trade
#129 – Dollar Carry Trade
Opie, Riddiough: Global Currency Hedging with Common Risk Factors
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3264531
Abstract:
We propose a novel method for dynamically hedging foreign exchange exposure in international equity and bond portfolios. The method exploits time-series predictability in currency returns that we find emerges from a forecastable component in currency factor returns. The hedging strategy outperforms leading alternative approaches out-of-sample across a large set of performance metrics. Moreover, we find that exploiting the predictability of currency returns via an independent currency portfolio delivers a high risk-adjusted return and provides superior diversification gains to global equity and bond investors relative to currency carry, value, and momentum investment strategies.
#26 – Value (Book-to-Market) Anomaly
Zhou: Can Cash-Flow Beta Explain the Value Premium?
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3244791
Abstract:
It is well documented that the cash flow beta can partly explain the source of the value premium. This paper presents an empirical test that cast doubt on this widely accepted belief. We double sort the stocks with their value and quality dimension and obtain four corner portfolios: (A) expensive quality, (B) cheap junk, (C) cheap quality and (D) expensive junk stocks. Prior research has shown that the value premium concentrates on cheap quality minus expensive junk (i.e. undervalued minus overvalued) but is not significant in cheap junk minus expensive quality stocks. If cash-flow beta is the source of the value premium, we would expect a larger cash-flow beta difference between the cheap quality and expensive junk portfolio. However, our empirical test shows that β_CF ((B) cheap junk) – β_CF ((A) expensive quality) >>β_CF ((C) cheap quality)-β_CF ((D) expensive junk). In other words, B minus A does not contribute to the profit of the value premium but contribute most to the difference of the cash flow beta between value and growth portfolios. Therefore, our result may serve as evidence that the cash flow beta may only spuriously explain the value premium. Or, at least, the cash-flow risk premium estimated in the portfolio regression approach is biased.
Benjamin Franklin once said "… in this world nothing can be said to be certain, except death and taxes." and we completely agree with that quote. Traders and portfolio managers often strongly concentrate on a process of building the strategy which delivers the highest outperformance. But a lot of them forget to include taxes into that building process. And this can be a significant mistake as the following research paper shows:
Goldberg, Hand, Cai: Tax-Managed Factor Strategies
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3309974
Abstract:
We examine the tax efficiency of an indexing strategy and six factor tilts. Between June 1995 and March 2018, average value added by tax management exceeded 1.4% per year at a 10- year horizon for all the strategies we considered. Tax-managed factor tilts that are beta 1 to the market generated average tax alpha between 1.6% and 1.9% per year, while average tax alpha for the tax-managed indexing strategy was 2.3% per year. These remarkable results depend on the availability of short-term capital gains to offset. To a great extent, they can be attributed to loss harvesting and the tax rate differential.
