Alpha

A look back, and forward, at how, when, and why factors work

By Jesse Livermore, Chris Meredith, CFA, and Patrick O’Shaughnessy, CFA

May 2018Christopher Bacilio

RESUMEN TWEET STORM

EPS Erning per share is the profit of a company allocated to each outstanding share of common stock Earnings per share serves as an indicator of a company's profitability. 

Glamour stock

Definition:

A popular stock characterized by high earnings growth rate and a price that rise is faster than the market average in a bull market.

What is 'Momentum Investing'

Momentum investing is an investment strategy that aims to capitalize on the continuance of existing trends in the market. To participate in momentum investing, a trader takes a long position in an asset that has shown an upward trending price, or the trader short-sells a security that has been in a downtrend. The basic idea is that once a trend is established, it is more likely to continue in that direction than to move against the trend.

Read more: Momentum Investing https://www.investopedia.com/terms/m/momentum_investing.asp#ixzz5HBcWpmsh 

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This means timing is critical. You have to rebalance momentum often to earn alpha. And if you keep holding, say past a year, the excess return in years 2-10 is terrible

Value, therefore, is a convergent or corrective process: it succeeds because the companies themselves eventually recover. But quant value rebalances much more often than every ten years.

To earn the alpha you see here, first you need discipline, then you need to keep improving factor measurement, portfolio construction, and trading. Every aspect should get better over time as markets adapt.

We would probably point to the fact that in the current economic cycle, certain types of hyper-profitable "new economy" companies--think Facebook, Amazon, Netflix, Google--have dominated the return (ganancias) landscape (paisaje).

The Value factor is buying into the stocks at the very cheap prices and holding them for a one-year period. During that period, the fundamentals end up coming in weak, as expected. But the market, which is looking farther out into the future, becomes less pessimistic about the stocks and re-rates them higher, lifting their prices and valuations. At the end of the holding period, the Value strategy sells out of the stocks at the higher prices and valuations and rebalances into a new collection of stocks that have since become cheap by a similar process. This rebalancing lowers the strategy's valuation, "converting" the gains from the prior multiple expansion into a jump in EPS on the rebalancing date. The strategy repeats this process over and over again, generating a highly attractive net return. 

When set to a 12-month holding period, the Value Factor trades around the sweet spot of that process, leveraging it over and over again into a significant excess return. 

Conclusions

When a sophisticated asset allocator sits down with a money manager, the most common question is “what is your edge?” Any edge must come down to the ability to identify stocks with attractive expected returns, long or short. Sometimes, a single trade can make a career, because the excess returns ended up being strong, and the bet placed was sufficiently large. But there is no way to know ahead of time which managers will succeed in that kind of bet.

Value and Momentum, defined in terms of the earnings yield and the 6-month trailing return, respectively.