Early Friday morning, a friend texted me. Here’s what he said:
“Will you come talk to my co-workers?! They are talking about stopping their 401(k) contributions because of what’s going on! Driving me nuts!”
Still not quite awake, I replied, “What?”
Within seconds, he replied, “Stock market fell 500 points this morning, Carl! It’s all the way down to 17,537!”
My first thought: “Wow! The Dow is over 17,000.” And this is where things got a bit exciting for me as a financial professional.
You see, about five years ago, I decided to totally ignore the stock market, especially breaking news about the stock market. I hadn’t stopped investing, but since investing is meant to be done over decades, I had this crazy idea that maybe I would really, truly act out that whole long-term thing. That meant thinking about five years, 10 years, even 20 years from now. But I most definitely wouldn’t be thinking about what happened in one week, let alone one day.
So I made sure I had a diversified portfolio of investments. And then, I proceeded to do nothing. I also ignored the stock market news entirely, which has been surprisingly easy.
But Friday morning, for really the first time in five years, it registered: The Dow had gone from just under 12,000 to over 17,000. That’s a gain of almost 50 percent over the last five years. Now that’s what I call amazing!
Less amazing, however, is what the markets will do, or not do, over the next few days. So you choose: five days or five years.
This commentary originally appeared June 27 on NYTimes.com
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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2016, The BAM ALLIANCE
The world of finance and asset pricing used to be fairly simple. At first, there was just the single-factor capital asset pricing model, with market risk (beta) as the sole factor to explain the differences in returns of diversified portfolios. Over time, the working model evolved into a still relatively simple four-factor model, adding value, size and momentum. Each of these four factors carried large premiums.
However, as John Cochrane put it, today we have a literal factor zoo, with more than 600 factors having been identified in the literature (roughly 300 of which have been identified in top journal articles and highly regarded working papers).
Subsequent research has found that in out-of-sample tests, about half the factors produced zero to negative premia, even prior to considering transaction costs. Thus, the findings involving these factors were likely the result of data mining, or they were just lucky outcomes. Either that or they were behavioral anomalies that, post-publication, would be easily arbitraged away.
The Effect Of Publication
In the study “Does Academic Research Destroy Stock Return Predictability?”, published in the January 2016 issue of the Journal of Finance, authors R. David McLean and Jeffrey Pontiff re-examined 82 factors published in tier-one academic journals and were only able to replicate the reported results for 72 of them. At least 10 out of 82 factors were artifacts of reporting mistakes in the databases, which have since been corrected.
They also found that, post-publication, the “average characteristic’s return decays by about 35%.” In addition, they found that “characteristic portfolios that consist more of stocks that are costly to arbitrage decline less post-publication. This is consistent with the idea that arbitrage costs limit arbitrage and protect mispricing.”
Paul Calluzzo, Fabio Moneta and Selim Topaloglu contribute to the literature and to our understanding of how markets work and become more efficient over time (the adaptive markets hypothesis) with their December 2015 study, “Anomalies are Publicized Broadly, Institutions Trade Accordingly, and Returns Decay Correspondingly.”
They hypothesized: “Institutions can act as arbitrageurs and correct anomaly mispricing, but they need to know about the anomaly and have the incentives to act on the information to fulfill this role.” To test their assumption, the authors considered whether “knowledge of the anomaly is in the public domain based on the year of academic publication” and if “the accounting data necessary to compute the anomaly rankings is publicly available.”
They then studied the trading behavior of institutional investors in 14 well-documented anomalies, building long-short portfolios to determine whether they exploited the anomalies and helped bring equity prices closer to efficient levels. The 14 anomalies they evaluated were: total accruals, net stock issues, composite equity issues, net operating assets, gross profitability, asset growth, capital investments, investment-to-assets, book-to-market, momentum, distress (failure probability), Ohlson O-score, return on assets and post-earnings announcement drift.
Anomaly Study Results
Their study covered the period January 1982 through June 2014. Following is a summary of their findings:
The authors concluded: “Institutional trading and anomaly publication are integral to the arbitrage process which helps bring prices to a more efficient level.” Their findings demonstrate the important role that both academic research and hedge funds (in their role of arbitrageurs) play in making markets more efficient.
Increasing Challenges For Active Managers
In our book, “The Incredible Shrinking Alpha,” Andrew Berkin and I provide evidence showing there are four major themes behind the trend toward a persistently declining ability for active managers to generate true risk-adjusted alpha. One of these four explanations is that academic research continues to uncover anomalies that have generated alphas in the past.
The study by Calluzzo, Moneta and Topaloglu provides evidence demonstrating that by publishing the findings on factors that provide premiums, academic research converts what once was alpha into beta (or loading on a common factor that investors can easily access through low-cost and passively managed funds). This has a negative impact on the ability of active managers to generate future alpha. In addition, through the process of arbitrage, the premiums also tend to shrink, creating further hurdles for generating alpha.
This commentary originally appeared June 20 on ETF.com
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2016, The BAM ALLIANCE
“Hope deferred makes the heart sick, but a longing fulfilled is a tree of life.” So reads a Solomonic proverb penned in the 10th century B.C. Consider with me, however, a contemporary application of this ancient wisdom, especially in the realm of personal finance.
Hope Deferred
“We’ve got to apologize, Tim,” said a financial planning client with whom I had a great relationship.
“Whatever for?” I asked.
“You know that new Lexus? The one that backs itself into a parallel parking spot?”
“Yes, I’ve seen the commercials.”
“We bought one,” the client said, with his head bowed in apparent shame.
I’d never communicated that these folks—or anyone, for that matter, who has sufficient means—shouldn’t use said means to purchase a vehicle of their choosing. But the general impression the public has toward financial advisors and educators seems to be that we all think the best use of money is in storing it up and avoiding its deployment. Defer, defer, defer.
It’s hard to argue that we in the money business don’t have a tendency to overstate the benefits of deferred gratification. Some (loudly) preach the outright virtue of financial asceticism early in life, pledging that present deprivation will surely result in future comfort, if not abundance.
The cowed mentee may be afraid to ask the question begged: “But how long should I defer? And what if that future never comes?”
As someone who spent several days inches from death after a serious car accident early in life, I know too well that tomorrow is not a promise. As someone who has walked beside a dear friend and client, during his career and all the way through the completion of his retirement dream home, only to watch him leave it—and this earth—shortly thereafter, I firmly believe that it’s entirely responsible to allocate a portion of one’s means at every stage of life to unabashed enjoyment. (And I’m very pleased to say that was true of my friend.)
Perhaps it is a worthy aim to practice the habits of frugality so you can accommodate the occasional extravagance.
Perhaps a 30-year mortgage is preferable to the 15-year variety if it allows a young family to take more memorable vacations while everyone is still under one roof.
Perhaps it’s advisable to turn down the promotion that would allow you to secure your financial future sooner if it would compromise your values in the present.
Perhaps there isn’t necessarily more virtue in spending tomorrow what could be spent today.
Perhaps it’s permissible to buy the Lexus that backs itself into a parking spot—guilt free.
A Longing Fulfilled
But the voice of wisdom is often multidimensional. Simple, but not simplistic. Surely this beautiful poetry isn’t meant to be used as a blunt tool to rationalize financial thoughtlessness. Yes, a “longing fulfilled is a tree of life,” but we’re still talking about a longing, I remind myself.
Perhaps the impulsive purchase is too shortsighted to qualify as a longing.
Perhaps the joy gained in fulfilling a want or desire is proportionate to the extent of the longing.
Perhaps the best use of financial planning is to help identify which longings are worthy, and to create a plan to enjoy the realization of their fulfillment. But it certainly is not to exclusively encourage deferment and hope for the best.
This commentary originally appeared July 2 on Forbes.com
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2016, The BAM ALLIANCE