New strategies:
#361 – Idiosyncratic Commodity Momentum
Period of rebalancing: Monthly
Markets traded: commodities
Instruments used for trading: futures, CFDs
Complexity: Complex strategy
Bactest period: 1993 – 2014
Indicative performance: 17.50%
Estimated volatility: 29.42%
Source paper:
Shpak, Iuliia and Human, Ben and Nardon, Andrea: Idiosyncratic Momentum in Commodity Futures
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3035397
Abstract:
This paper provides novel findings on idiosyncratic momentum in commodity futures. Momentum strategy that forms portfolios on the basis of commodity-specific returns delivers compelling investment returns which are substantially more robust and superior to total return momentum on an absolute and risk-adjusted basis. Furthermore, idiosyncratic return momentum is materially more persistent than total return momentum in that it delivers statistically significant positive returns over longer term horizons including ranking periods of up to 24 months. A set of commodity specific and equity markets inspired factors are examined. Notably, the results corroborate that hedging pressure and term structure are sources of risk premium in commodity futures. The analysis in this chapter expose that momentum in commodity futures is fundamentally different to the momentum effect in equity markets. Specifically, momentum in commodity futures is entirely attributed to the momentum effect in long-only portfolios whilst none of the short-only strategies’ returns are either profitable or statistically significant. Lastly, the two types of long-only momentum significantly outperform a passive investing into a broad market index such as S&P GSCI.
#362 – Small Industry Premia
Period of rebalancing: daily
Markets traded: equities
Instruments used for trading: stocks
Complexity: Very complex strategy
Bactest period: 1973 – 2017
Indicative performance: 14.03%
Estimated volatility: 12.09%
Source paper:
Zaremba, Adam and Umutlu, Mehmet: Size Matters Everywhere: Decomposing the Small Country and Small Industry Premia
https://ssrn.com/abstract=3035891
Abstract:
We explore the country and industry size effects by decomposing market value into four components: short-term return, representing momentum; long-run return, representing reversal; composite issuance; and lagged market value. We examine the implications of this decomposition for the country and industry size premia within a sample of 51 equity markets for the years 1973–2017. We confirm a significant size effect across countries and uncover an industry size effect: small industries markedly outperform large industries. While the cross-sectional dispersion in market value is determined almost exclusively by the lagged market value component, the country and industry size premia have two primary drivers: lagged market value and long-run reversal. Our analysis also discovers an industry issuance effect and a remarkable January effect in both country and industry returns. Finally, we also shed some light on the vanishing small country effect in the last decade.
New research papers related to existing strategies:
#130 – Investment Factor
Ward, Muller, Semnarayan: Negative Investment Returns in a Developing Market Context
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2965628
Abstract:
Financial theory posits a positive relationship between the value of investment that firms undertake and subsequent shareholder returns. Surprisingly, recent studies on United States data have found a negative relationship between investment and subsequent shareholder return. This anomaly contravenes the basic theory of investment, as well as traditional capital asset-pricing models, and several conflicting risk-related and behavioural explanations have been suggested by other researchers. South Africa’s developing market is characterised by relatively high arbitrage costs, and high risk conditions, and offers a suitable context to re-examine this anomaly. This study confirms a negative relationship between the value of investment that firms undertake and subsequent shareholder returns in a developing market context. Over the period from December 2004 to December 2016, shares on the Johannesburg Stock Exchange with lower investment rates consistently outperform shares with higher investment rates. The explanation for this anomaly requires further study.
#130 – Investment Factor
#224 – Profitability Factor Combined with Value Factor
Barroso, Maio: The Risk-Return Tradeoff Among Equity Factors
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2909085
Abstract:
We examine the risk-return trade-off among equity factors. We obtain a positive in-sample risk-return trade-off for the profitability (RMW) and investment (CMA) factors of Fama and French (2015, 2016), while for the market and momentum factors there is a negative relation. The out-of-sample forecasting power (of factor volatility for factor returns) is economically significant for both RMW and CMA: By constructing a trading strategy that relies on such predictability, we obtain annual Sharpe ratios above one and utility gains above 5% per year. We also find weak evidence that the factor variances are negatively correlated with the aggregate equity premium.
Three additional related research papers have been included into existing free strategy reviews during last 2 weeks:
A new financial research paper related to:
#5 – FX Carry Trade
Anatolyev, Gospodinov, Jamali, Liu: Foreign Exchange Predictability During the Financial Crisis: Implications for Carry Trade Profitability
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3029725
Abstract:
In this paper, we study the effectiveness of carry trade strategies during and after the financial crisis using a flexible approach to modeling currency returns. We decompose the currency returns into multiplicative sign and absolute return components, which exhibit much greater predictability than raw returns. We allow the two components to respond to currency-specific risk factors and use the joint conditional distribution of these components to obtain forecasts of future carry trade returns. Our results suggest that the decomposition model produces higher forecast and directional accuracy than any of the competing models. We show that the forecasting gains translate into economically and statistically significant (risk-adjusted) profitability when trading individual currencies or forming currency portfolios based on the predicted returns from the decomposition model.
A new research paper related to multiple currency strategies:
Aloosh, Bekaert: Currency Factors
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3022623
Abstract:
We examine the ability of existing and new factor models to explain the comovements of G10-currency changes. Extant currency factors include the carry, volatility, value, and momentum factors. Using a new clustering technique, we find a clear two-block structure in currency comovements with the first block containing mostly the dollar currencies, and the other the European currencies. A factor model incorporating this “clustering” factor and two additional factors, a commodity currency factor and a “world” factor based on trading volumes, fits all bilateral exchange rates well, whatever the currency perspective. In particular, it explains on average about 60% of currency variation and generates a root mean squared error relative to sample correlations of only 0.11. The model also explains a considerable fraction of the variation in emerging market currencies.
And an interesting paper about the artistry in a building of multi-factor portfolios:
Israel, Jiang, Ross: Craftsmanship Alpha: An Application to Style Investing
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3034472
Abstract:
Successful investing requires translating sound investment concepts into actual trading strategies. We study many of the implementation details that portfolio managers need to pay attention to; such choices range from portfolio construction to execution. While these kinds of decisions apply to any type of investment strategy, they are particularly important in the context of style investing. Consider two managers who both intend to capture the value factor in a long/short context: each manager might make a number of decisions, many of which can lead to meaningfully different outcomes. These choices can often explain why one value manager outperforms another. Ultimately, what may seem like inconsequential design decisions can actually matter a lot for style portfolios. In fact, the skillful targeting and capturing of style premia may constitute a form of alpha on its own — one we refer to as “craftsmanship alpha.”
