Are Value Investing and Momentum Investing Robust Anomalies?

Are Value Investing and Momentum Investing Robust Anomalies?

April 21, 2015 $mtum, $vlue, Momentum Investing, Stock Selection Research, Value Investing
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Beating a Dead Horse: Value investing and momentum investing work

At this stage in our lives we’ve essentially memorized the CRSP/Compustat database. Name an anomaly and we can probably tell you the stats on it fairly quickly.

Legitimate anomalies can usually be described via a behavioral finance lens:

  1. Can we identify poor psychology in the market? (Why do prices get dislocated along the way)
  2. Can we identify the limits to arbitrage? (Why don’t large pools of capital arbitrage the anomaly away)

There are 2 anomalies that stand out among all other anomalies: Value investing and momentum investing.

But don’t take our word for it, check out one of my favorite papers on the subject of “anomaly chasing:”

…and the Cross-Section of Expected Returns

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

You can find the entire laundry list of the papers examined here.

The authors argue that published papers suffer from serious data-mining efforts, and therefore, we need to adjust our statistical inference metrics to account for this fact.

We 100% agree with this insight.

And after considering this “high-bar,” there are only 3 anomalies that withstand the test of time: Value, Momentum, and Durable Consumption Goods (DCG). Value and momentum we know and love, whereas, DCG, while interesting, is a questionable strategy based on our internal research. (one can get the data here)

Perhaps more interesting is the fact that 300+ “anomalies” identified in the academic literature, once adjusted for data-mining, don’t pass the gauntlet. You’ll also notice that many of these strategies are wrapped in “smart beta” wrappers in the current marketplace.

Some examples:

  • Dividend Yield
  • Size
  • Sentiment
  • Liquidity
  • Profitability
  • Volatility
  • Carry
  • Beta

Are you buying a backtest? Or are you buying a sustainable alpha process?

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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.