That gadfly of financial modelers and quants is back. This time, Taleb writes in such a way as to establish that he isn't a mere popularize/diluter of familiar academic arguments -- which is how the critics of many of his earlier books have painted him. And them.
CAPM / Alpha Theory
A recent paper on "Option Implied Volatility, Skewness, and Kurtosis and the Cross-Section of Expected Stock Returns" finds a positive relationship between each of the three listed characteristics of a distribution on the one hand and ex ante expected returns on the other. In the case of skewness in particular, this finding struck me as a bit odd.
A new paper addresses a group of industrial metals, the platinum group, and suggests that its components might be a wise addition to many portfolios on CAPM grounds.
The success of low-volatility strategies has been noted in the literature at least since the mid-1970s, with the publication of a seminal work by Haugen and Heins. And such strategies continue to prove successful today. Why do they still work? Why don't the excess profits draw in the bears, consuming all the picnic baskets, driving profit levels down to normal?
A strategy based largely on stop-loss and stop-gain rules, one that uses such rules as the sole means of shifting assets from one asset class to another, can earn statistically significant CAPM alpha, according to a provocative study from the University of Arizona.
Under standard portfolio theory assumptions, it takes three times longer to recover from the maximum draw-down for a particular strategy than it does to get there. Fortunately, those assumptions seem to be wrong in a way that allows for a more rapid return to a high water mark.
Asness, Frazzini and Pedersen produce data indicating that over a long period in the U.S., a regular bet-against-beta strategy, one not designed either to accentuate or to eliminate differences among the different industries represented in the portfolio, earned CAPM alpha of 0.73.
A portfolio becomes optimal by virtue not merely of what assets are in it, but by virtue of what is paid for each. Examining the implications of that point, Professor Johnstone finds a "logical circularity built into the CAPM equilibrium pricing mechanism."
D.J. Johnstone of the University of Sydney Business School tells us that if we understand Bayesian probability theory, we'll see that even a very informative signal can bring an increase in uncertainty, thereby raising the cost of capital. This is at least a little bit counter-intuitive, offending the verities about how wonderful is transparency.
Intuition (codified by many models) suggests that investors have to be bribed to accept risk, so that there ought to be a positive link for any given class of security between the amount of risk, and thus the measurement of volatility, on the one hand, and expected return on the other. A puzzle arises, then, from empirical research indicating that “idiosyncratic” volatility, that is, the volatility due to the characteristics of a specific security, is negatively correlated with return once one passes the mid-point of the range of volatility.
By Christopher Faille A presentation by Samuel Kunz, chief investment officer of the Policeman’s Annuity and Benefit Fund, Chicago, to the CFA Institute 2011 Asset and Risk Allocation conference addressed the pros and cons of “risk parity.” His presentation makes it seem that risk-parity portfolios (RPP) and the Capital Asset Pricing Model (CAPM) are sibling [...]
A perfectly "hedged" fund is one which has no downside risk. Its payoff relative to the market or some other benchmark is the same as that of the fund plus a put option that provides protection against the downside. In the real world...
Alpha not “dead” – just not always better than beta (as long as you’re sure about the future direction of markets of course)May 1st, 2011 | Filed under: CAPM / Alpha Theory, Today's Post
A recent research note concludes that alpha (as a performance measure) passed away recently after along battle with beta-tosis and several other ailments. But wait! Did Alpha's nose just twitch?
If only the marketplace for alpha fit neatly into a model from an Economics textbook.
New spin on the Fundamental Law of Active Management finds US mutual funds were “a victim of their own success”Mar 31st, 2011 | Filed under: CAPM / Alpha Theory, Real Estate, Today's Post
Finally, a version of the Fundamental Law that fundamental managers can actually use. But be forewarned, if you're a fundamental mutual fund manager, you won't like what it has to say...
Think your basket of thousands of stocks is the most diversified portfolio possible? Maybe not...
In the never-ending search for the source of hedge fund alpha, some have looked to factor timing. But a new study suggests that this, like many other possible explanations, falls short of explaining the hedge fund secret sauce.
Managers operating in mature and “efficient” markets rejoice! Study finds you too can generate alpha.Feb 22nd, 2011 | Filed under: Academic Research, CAPM / Alpha Theory, Today's Post
Thought managers in "inefficient markets" like emerging markets or small cap equities had the advantage when it comes to alpha-generation? Maybe not...
If a recent study of French institutional investors can be applied to a recent report on US equity markets, alpha opportunities abound for years to come.
Success breeds success – and expectations of continued success. Except in private equity, where success bodes reversion to the mean, a recent study on performance persistence argues.
A transnational study of mutual funds sheds light on one of the secrets of hedge funds' overall success.
Pop Quiz for Long/Short Equity Investors: When does a high “up-capture” not cost you a commensurately high “down-capture”?Dec 7th, 2010 | Filed under: CAPM / Alpha Theory, Today's Post
The dream long/short equity fund is one that has a high market "up-capture" with little or no market "down-capture". But how do you find your dream fund when up-capture and down-capture fluctuate all the time? Here's one innovative idea...
Retail and high net worth investors can now gain access to hedge funds through a number of more liquid vehicles. But is their liquidity one of the very reasons their performance may be lower?
The search for alpha is much like the search for oil, prompting us to muse a few years ago about whether there was going to be a Hubbert’s Peak in alpha. But regardless of whether the world is running out of “cheap alpha,” the process of refining crude returns into something that can power your [...]
With stock dispersion at all-time lows, is the art of stock-picking dead or just napping?
A recent academic study finds that hedge fund managers has "zero" ability to put their market timing skills to proper use and produce alpha.
Modern portfolio theory, the hallmark of institutional investing, isn't so modern anymore, according to a new report by State Street that encourages embracing new types of risk models and investment options.
New factor on the block: Research suggests you don’t need alternative investments to get an “illiquidity premium”Aug 2nd, 2010 | Filed under: Academic Research, CAPM / Alpha Theory, Today's Post
Move over "momentum factor", there's a new kid in town and it's one that is familiar to the alternative investment industry.
Study finds market “under-reaction” to Buffett’s 13F filings, proposes trading strategy to exploit itJul 28th, 2010 | Filed under: Academic Research, CAPM / Alpha Theory, Today's Post
In an age where hair-trigger investors exploit information in nanoseconds, here's a trade you can apparently take your sweet time to make.
Here's another reason to count domestic and geopolitics as betas.
A paper by a pair of institutional investment consultants challenges the notion of a "stock-picker's market" and finds that "beta-alpha" is the real source of returns - at least for US large cap managers.
At the very least, NASCAR and Formula One share two things in common with the alternative asset management industry...
Today we bring you part 2 of Erik Einertson’s special to AllAboutAlpha.com “The Five face of Alpha” (first installment here)… Alpha #2: Insurance Beta The second type of “Alpha” often found in the market can be referred to as insurance beta or Informationless Investing (Weisman 2002). This type of exposure has persistent tilts towards strategies [...]
As we have noted over the past several years, alpha is notoriously difficult to define and isolate since its existence depends not only on the target being observed, but on the perspective of its observer. The more we study alpha, it seems, the less we know about it. We are reminded of this irony by [...]
Usually the term "exotic beta" is associated with hedge funds. Finally, it's being applied to the largest pool of active management - mutual funds.
A study of the variables driving mutual fund alpha also reveals something about the changing nature of markets themselves.
With the un-alpha-like performance of the hedge fund portion of portable alpha strategies last year, it's easy to disregard alpha/beta separation as hype. But here's a must-read paper that shows why the concept is fundamentally sound.
Institutional equity allocations have dropped along with the markets over the past 2 years. But even as the market rebounds, there may be some fundamental reasons why institutional investors will throw in the towel on "60/40" for good this time around.