This action might not be possible to undo. Are you sure you want to continue?
Applied Quantitative Strategy
Technical Factors and Value Don’t Mix
Wesley R. Gray, PhD email@example.com +1.773.230.4727 Jack Vogel firstname.lastname@example.org +1.484.995.5001 Summary Moving average (MA) trading rules have worked historically: the investor can capture a large portion of positive return months and eliminate large drawdowns. The MA (2,10) trading rule has been the most effective MA rule when applied to the S&P 500 index.
Applying MA rules to a simple quantitative value strategy actually destroys performance. For example, a portfolio of highly liquid Magic Formula stocks (average daily value traded must be greater than $1.5mm) moves from a CAGR of 12.11% to 7.66% over the 1970 to Yang Xu 2010 period, while volatility goes from 19.47% to 15.01%--not a great risk/reward tradeoff. email@example.com +1.267.324.2551 Value strategies can be attractive, but they are very difficult to risk manage. If one believes there are no free lunches in the real-world (or very few), this result will not be surprising: value investing can be very rewarding…if you have an iron stomach! We all remember the college wisdom: beer before liquor, never been sicker; liquor before beer, in the clear. Unfortunately, technicals with the S&P, invest with glee, technicals with cheap, makes you weep.
MF, MA (2, 10)
Source: Empiritrage, LLC Research PLEASE SEE THE DISLAIMER AND DISCLOSURES AT THE END OF THIS REPORT. The information set forth herein has been obtained or derived from sources believed by Empiritrage, LLC (“Empiritrage”) to be reliable. Empiritrage does not make any representation or warranty, express or implied, as to the information’s accuracy or completeness, nor does Empiritrage recommend that the attached information serve as the basis of any investment decision. This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments, and may not be construed as such. This document is subject to further review and revision.
T: +1.773.230.4727 | F: +1.888.517.5529 | 3830 Kelley Ave. Cleveland, OH 44114 | firstname.lastname@example.org
Magic Formula (MF) Calculations 1. All Rights Reserved. invest in the risk free rate. Average rankings and rank universe We analyze 2 strategies: top decile MF and top decile MF with an MA (2.10) trading rule (MF_MA). otherwise. LLC 2 22 January 2012 2011 © Empiritrage. If the rule is triggered.5mm in average daily traded volume (adjusted by the CPI in the backtest) Annual rebalance (June 30) Adjusted for survivor bias. LLC. Analysis Details Jan 1. The rule is triggered if the 2 month goes below the 10 month SMA. 2010 Firms must have at least $1. LLC Applied Quantitative Strategy BACKGROUND INFORMATION Strategy Outline MA (2. Calculate earnings before interest and taxes (EBIT) to total enterprise value (TEV) and rank universe 2. Calculate EBIT to net property plant and equipment (NPPE) plus net working capital and rank universe 3. and corporate actions No financials or utilities Equal-weight decile portfolios Data provided by sources accessed by Empiritrage.10) looks at the 2 month (~50 day) and the 10 month simple moving averages (~200 day). the index. delistings. 1970 through December 31.Empiritrage. .
*Asset Pricing Model Descriptions CAPM=Capital Asset Pricing Model 3-Factor=Fama and French Model 4-Factor=Fama and French Model plus Carhart Momentum Factor 5-Factor=Fama and French Model plus Carhart Momentum Factor plus Pastor Stambaugh Liquidity Factor 3 22 January 2012 2011 © Empiritrage. but a large decrease in CAGR. There is only a . .Empiritrage.6 Source: Empiritrage. the stand-alone magic formula has a decent chance of outperforming the broader market. LLC Research There is a slight decrease in risk associated with the MA (2.67 correlation with the MF_MA strategy and the S&P 500 Index The market exposure beta is around .10) magic formula strategy. LLC Research There is not a single 10-year period where the MA rule applied to the magic formula can add value on a CAGR basis. All Rights Reserved. LLC Applied Quantitative Strategy Annual Performance Source: Empiritrage. LLC. MF_MA Underperforms the simple buy-and-hold S&P 500 index. Over any 10-year cycle.
LLC Research The MF_MA rule does nothing with respect to risk management: be prepared for absolute chaos. LLC. with no real value-added trade-off between risk and reward. All Rights Reserved. LLC Applied Quantitative Strategy Annual Performance Source: Empiritrage. . 4 22 January 2012 2011 © Empiritrage. LLC Research The MF_MA rule causes the strategy to outperform in bear markets and underperform in bull markets.Empiritrage. Long Return Overview—Monthly Performance Source: Empiritrage.
5 22 January 2012 2011 © Empiritrage. LLC. LLC Research Similar to the annual return analysis. Unfortunately. LLC Research MF_MA is ugly. LLC Applied Quantitative Strategy Value of $100 Invested (Log Scale) Source: Empiritrage. All Rights Reserved. Market Cycle Performance Source: Empiritrage. there is a definitive tradeoff between between risk and reward. the MF_MA rule has limited ability to add value.Empiritrage. .
LLC Research MF_MA certainly drops the worst drawdown (52%38%). but over any 5-year period the MF_MA system’s valueadd is negligible (actually worse than the buy-and-hold version of the magic formula system!). LLC Research The MF_MA rule sometimes makes matter worse. however. All Rights Reserved. 6 22 January 2012 2011 © Empiritrage. the rule does keep one from getting crushed in the 2008 Credit Crunch. LLC. Stress Events Source: Empiritrage.Empiritrage. . LLC Applied Quantitative Strategy Draw Down Analysis Source: Empiritrage.
. LLC Research The MF_MA strategy does a good job keeping the investor out of trouble during a handful of down markets. LLC Research MF_MA (top figure) shows a surprisingly stable negative alpha over any 10-year rolling alpha period.Empiritrage. LLC Research Source: Empiritrage. LLC. but fails to reliably provide value after controlling for the Fama-French 3-factor benchmark. All Rights Reserved. but doesn’t do enough to eliminate the “really big problems. Performance during S&P 500 Down Months Source: Empiritrage. The standard magic formula shows a small positive alpha.” 7 22 January 2012 2011 © Empiritrage. LLC Applied Quantitative Strategy Risk/Reward Robustness Source: Empiritrage.
options and other financial instruments.g. quantitative backtests) have many inherent limitations. commodities and/or granting/writing options one could lose the full balance of their account. all of which can adversely affect actual trading results. Empiritrage. futures. which may vary. and should not be interpreted as. nor can it accept responsibility for errors appearing in the document. Hypothetical performance results (e. There is a risk of substantial loss associated with trading commodities. and no hypothetical trading record can completely account for the impact of financial risk in actual trading. the ability to withstand losses or adhere to a particular trading program in spite of trading losses are material points which can adversely affect actual trading results. No representation is being made that any fund or account will or is likely to achieve profits or losses similar to those shown herein. there are frequently sharp differences between hypothetical performance results and the actual results subsequently realized by any particular trading program.Empiritrage. References to specific securities and issuers are for illustrative purposes only and not intended to be. For example. All funds committed to such a trading strategy should be purely risk capital.. They are intended for illustrative purposes only. recommendations to purchase or sell such securities. express or implied. LLC. In addition. that long-term return and/or volatility targets will be achieved. Realized returns and/or volatility may come in higher or lower than expected. DISCLOSURES Performance figures contained herein are unaudited and prepared by Empiritrage. . some of which. are described herein. Hypothetical performance results are presented for illustrative purposes only. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results. LLC makes no express warranty as to the completeness or accuracy. While all the information prepared for this document is believed to be accurate. investors should carefully consider their financial position and risk tolerance to determine if the proposed trading style is appropriate. The hypothetical performance results contained herein represent the application of the quantitative models as currently in effect on the date first written above and there can be no assurance that the models will remain the same in the future or that an application of the current models in the future will produce similar results because the relevant market and economic conditions that prevailed during the hypothetical performance period will not necessarily recur. 8 22 January 2012 2011 © Empiritrage. hypothetical trading does not involve financial risk. LLC. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. Past performance is not indicative of future results. Before trading. It is also possible to lose more than the initial deposit when trading futures and/or granting/writing options. LLC Applied Quantitative Strategy DISCLAIMER The views expressed are the views of the authors and are subject to change at any time based on market and other conditions. All Rights Reserved. Investors should realize that when trading futures. In fact. but not all. This document shall not constitute an offer to sell or the solicitation of any offer to buy any security and should not be construed as such. There is no guarantee.
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue reading from where you left off, or restart the preview.