Volume 18, No. 1, First Quarter 2020

The Fully-Anticipated P/E Promise and Its Realization

by: Martin L. Leibowitz, Stanley Kogelman, and Anthony Bova

In this paper, time paths of P/Es are projected, by applying a theoretical model in which the totality of “fully anticipated” future “franchise” investments serve as the source of higher P/Es. At the outset, the P/E path slowly ascends until the first franchise opportunity is reached and funded. The actual act of funding transforms the “anticipated” franchise value potential into “realized” value-equivalent earnings. This equivalence does not change the price in the P/E numerator but, the P/E ratio declines because the new earnings flow into the ratio’s denominator. The P/E decline bottoms out at a level based on new going-forward franchise investment potential and then rises until the next franchise event.

In summary, this saw tooth pattern should not be surprising. If we view a firm’s Franchise Value as a promise of future productive growth, then realization should lead to on-going Franchise Value declines – unless previously unexpected sources of future growth are uncovered. And, in actual markets, it is just such “unexpected” events and prospects – of both a positive as well as a negative nature – that intermittently bubble to the surface. While admittedly based on a highly theoretical model with the limiting assumption of perfect foresight, this specter of a downward gravitational P/E pull should act as a cautionary note for analyses that project an existing high P/E forward onto a higher earnings level assumed to be reached at some future point in time.

Do High-Frequency Traders Improve Your Implementation Shortfall?

by: Robert A. Korajczyk and Dermot Murphy

We take advantage of a regulatory change that effectively imposed a “tax” on HFT order activity on Canadian equity venues to study the resulting effect on the execution costs of large institutional trades.We find that bid–ask spreads increase and price impact decreases for these trades following the regulatory change. The price impact effect is strongest for informed institutional traders. Our evidence indicates that this tax on high-frequency trading is associated with higher transaction costs for small, uninformed trades and lower transaction costs for large, informed trades. Hence, the tax increased the subsidy for informed traders from uninformed traders.

Timing is not Everything—Assessing Manager Skill in Factor Timing

by: Andrew Chin and Piyush Gupta

We introduce an innovative framework to assess the contribution and persistence of factor timing within US large-cap equity funds. After decomposing active returns into three components—strategic factor contribution, tactical factor contribution and security selection—we find that they are all significant but security selection is the dominant contributor. We also find that the portfolio managers who rely on factor timing to drive performance do not seem to exhibit persistence in their abilities. Finally, across all funds, strategic and tactical factor tilts do not drive future active returns. Security selection is the key differentiator for future outperformance.

Trends Everywhere

by: Abhilash Babu, Ari Levine, Yao Hua Ooi, Lasse Heje Pedersen and Erik Stamelos

We provide new out-of-sample evidence on trend-following investing by studying its performance for 82 securities not previously examined and 16 long–short equity factors. Specifically, we study the performance of time series momentum for emerging market equity index futures, fixed income swaps, emerging market currencies, exotic commodity futures, credit default swap indices, volatility futures, and long–short equity factors. We find that time series momentum has worked across these asset classes and across several trend horizons. We examine the co-movement of trends across asset classes and factors, he performance during different market environments, and discuss the implications for investors.

Time-Series Variation in Factor Premia: The Influence of the Business Cycle

by: Christopher Polk, Mo Haghbin and Alessio de Longis

Factor cyclicality can be understood in the context of factor sensitivity to aggregate cash-flow news. Factors exhibit different sensitivities to macroeconomic risk, and this heterogeneity can be exploited to motivate dynamic rotation strategies among established factors: size, value, quality, low volatility and momentum. A timely and realistic identification of business cycle regimes, using leading economic indicators and global risk appetite, can be used to construct long-only factor rotation strategies with information ratios nearly 70% higher than static multifactor strategies. Results are statistically and economically significant across regions and market segments, also after accounting for transaction costs, capacity and turnover.

Fair and Responsible Drug Pricing: A Case Study of Radius Health and Abaloparatide

by: Qingyang Xu and Andrew W. Lo

“Case Studies” presents a case pertinent to contemporary issues and events in investment management. Insightful and provocative questions are posed at the end of each case to challenge the reader. Each case is an invitation to the critical thinking and pragmatic problem solving that are so fundamental to the practice of investment management.

Nonlinear Time Series Analysis

by: Ruey S. Tsay and Rong Chen • reviewed by: Alireza Yazdani

“Book Reviews” identifies important, and often popular, new books from a wide range of investment topics. Beyond providing a summary and review of the content and style of the books, “Book Reviews” seeks to contribute to a conscious, critical, and informed approach to investment literature.

Practitioner’s Digest • Vol. 18, No. 1

The “Practitioners Digest” emphasizes the practical significance of manuscripts featured in the “Insights” and “Articles” sections of the journal. Readers who are interested in extracting the practical value of an article, or who are simply looking for a summary, may look to this section.