What are the levers that managers can pull to drive return for any investment strategy? This piece boils it down to consistency, magnitude, and conviction, and finds that even the best managers have done a poor job at portfolio construction. Most would be better off equal-weighting their own portfolios.
The first of many hopefully...my good friend Steven Wood and I have been tossing around the idea of collaborating on some work in hopes it ups both of our research games. I often get asked whether or not factors go out of favor. This is a pretty good case study that yes, sometimes what worked in the past doesn't continue in the future.
There are a hundred ways to evaluate whether an investment is cheap--discounted cash flows, competitor multiples, mean reversion, multiple of projected earnings--the list goes on...and on. What's cheap now form a factor perspective?
Anyone overweight to non-U.S. allocations has suffered over the previous ten years. The current equity bull market has not been kind to non-U.S. allocations. At a recent conference I attended, the term ‘TINA: there is no alternative’ came up more than once in the context of allocating investor portfolios. It captures the collective sentiment that equities, despite a massive bull run and rising valuations, are one of few viable asset classes to park capital.
We are often asked how much should be allocated to microcap equities. As long-term investors that view the opportunity set through the lens of factors, our answer is usually some version of "probably more than you currently do." There is little empirical research specific to the intricacies of microcaps, and common benchmarks cast a shadow on the alpha that is readily apparent in active manager returns and factor spreads. This post attempts to provide an alternative framework for approaching and sizing strategic allocations to microcaps.
The final installment in this micro cap series touches on the massive factor spreads available in the micro cap space, structural biases that keep large investors out, and an argument for the persistence of factor returns.
Investing in micro caps poses a challenge for stock pickers. There's lots of noise in the data and, as we saw in the previous post, investing in micro caps requires expertise in many different types of investment situations—venture, growth, distressed, etc. This post attempts to cut through some of the noise inherent in micro caps to level the playing field.
For this post, I define the opportunity set of micro caps a bit differently than common benchmarks. I discuss some of the fundamental drivers of micro cap businesses and how their stage in the business life-cycle can distort fundamental metrics. Historically, 41% of the universe is in some sort of transition—evolving to new heights or devolving towards liquidation—which creates lots of noise in the data, and scares lots of investors away.
I've recently been exploring the world of micro cap stock investing. You don't hear much about this space except from the occasional banner ad promising a 10,000% return in a week by buying penny stocks. So I think micro cap gets a bad wrap. This is the first installment in a series on micro cap stocks. This area of the market is a playground for disciplined investors that believe in the power of factors.
Anyone in the investment industry not living under a rock has had an intense conversation with a client about the merits of passive exposures in investment portfolios. The cacophony of articles on this topic is both silent and deafening. Most include little proof for assertions of market efficiency and parrot a conglomeration of statements parsed from other articles. As a result, passive investors improperly forego dramatically higher potential returns for seemingly low cost market exposure.
Massive amounts of wealth are seeking equity income from a limited opportunity set. Valuations are rising. ETFs are faddish. Rates are poised to go up. I present five words of caution and make four suggestions for equity income investors.
A search for all equity ETF's available to U.S. investors in Bloomberg leads to a list of 969 candidates, a surprisingly large number of options for a relatively new investment vehicle. With investors seeking alternative income solutions in a low rate environment, most may be surprised to find that the perception of choice among ETF's is a mirage.
There is one trend in particular that I have been watching—the relationship between bond yields and equity valuations. Traditionally, there is a somewhat positive relationship between the two, but massive monetary policy intervention has thrown everything out of whack.
Quite often, investors get mired in the particulars of individual stocks. Sometime its best to take a step back to observe broad trends. Looking at corporate uses of cash over the last two decades, with a focus on the last few years, findings suggest that it is more important than ever for equity investors to evaluate quality metrics like balance sheet strength, quality of earnings, and corporate allocation policies.
Does the economic cycle have any bearing on investment success? Macro investment houses have constructed intricate frameworks to understand the “economic machine,” but economic data are notoriously prone to revisions, lags, and adjustments in measurement through time—none of which are suitable for timely and reliable investment signals. Certain fundamental characteristics—not economic variables—drive stock returns. This piece identifies investment themes that deliver persistent outperformance in multiple different economic environments.
We know from an untold number of academic papers that small stocks are supposed to outperform large stocks. Yet, the last five years have proven to be very different as the largest stocks have dramatically outperformed. Reversion to the mean and improved relative valuations argue for a look at the small cap space.
In my last two posts, I explored a fad which has washed over the investment community--low volatility investing. In my first post, I looked at the historical performance oflow volatility stocks and found outperformance to be inconsistent. I then established in my last post that Low Volatility investing is likely just value investing in re-packaged, and expertly marketed, form. In this final post, I relate the finding to the popular USMV ETF.
In a previous post, I looked at the historical performance of investing in low volatility stocks and identified that outperformance from the factor tends not to be very consistent over time, but is instead clustered. That raised some questions on whether volatility is a true investment factor, or if it's positive benefits are the product of other, more robust, investment factors.
What do snake oil and low volatility investing have in common? In a series of posts, I'll take a look at the low volatility phenomenon. In this fist post, I look at low volatility investing from a historical perspective.
One of the most common factors I get asked about in my travels is Sales Growth. One would think that investing in companies with massively growing sales is a great idea. Maybe they just signed a huge contract, or that new product toy was a holiday favorite. Unfortunately, companies whose sales are growing the fastest tend to be about as likely to succeed as this inexperienced skier circa 2004.
Be weary the current rally. Short covering is playing a prominent role. Market pundits have been talking about the outperformance of heavily shorted stocks for weeks. Make no mistake, short covering is a key factor in the market rally, but the decline of pessimism is ultimately a good thing for long-term investors.
Confounding, uncertain and volatile markets have left many investors wondering what glimmer of hope to hold on to. It isn't yet evident to investors, but in some respects the market is returning to normalcy.
Self-control, along with intelligence believe it or not, is one of the characteristics most commonly associated with success according to research. In this volatile market, self-control is an utmost requirement. It is typically after a drawdown such as the one we've experienced since July that investment strategy begins to come into question.
About this time each year we make resolutions regarding our future goals. We sign up for gym memberships, and swear off those unbreakable habits. We promise to eat salads for lunch, spend more time with family, and read a book a month. All of these things take time, and a lot of it, but require a paradigm shift.
Large growth stocks are winning the battle this year...by a lot. The Russell 1000 Value Index is down -7.3%, while its Russell 1000 Growth Index counterpart is up +2.6%. Tech heavyweights are crushing the competition, but at what price?
The Fed is in quite a predicament. Economic cycles typically last seven to ten years. The current cycle will be seven years old in early 2016. Humans have known of this cyclical pattern quite literally since the Book of Genesis--seven years of fat, seven years of famine. At some point, the current bull will yield to a bear market as all bull markets have.
The mettle of investors has been severely tested over the last few weeks. Since the market's recent June highs, a litany of issues in Greece, Iran, and China have plagued the stock markets. Emerging markets have reached bear market territory while U.S. large cap indices have broached the "correction" juncture. U.S. small cap is in a bear market as well. Long term U.S. Treasuries have rallied. The dollar has weakened. Commodities, including oil, have tanked. It's enough to make an investor's head spin.