what investors can learn from bacteria

8/6/2019 What Investors Can Learn From Bacteria

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U.S. Quantitative Research

Nomura Securities International, Inc.

Nomura Securities International, Inc., New YorkGlobal Quantitative Research


what investors can learn from bacteria

Jose h MezrichPlease read the analystcertifications and important

14 June 2011

Nomura Securities International, Inc.sc osures on pp. . g


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Bacteria vs. Dinosaurs

Bacteria are, and always have been, the dominant forms of life on Earth.

The fossil record of life begins with bacteria.

Bacteria inhabit effectively every place suitable for the existence of life.

ac er a ex s n overw e m ng num er an unpara e e var e y.

Bacteria have been masters of diversification!

Do quantitative investors emulate dinosaurs or bacteria?

2Joseph Mezrich, 212.667.9316, [email protected]


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Do quants have dinosaur risk?

How do bacteria diversify?Local adaptation to changing environments

Local adaptation =

optimizing to a specific (local) objective function



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Outline

sources of dinosaur risk

Selection for different objectives examples of adaptive investing

Factor momentum and the success of quants dinosaurs?

Low factor volatility & high factor momentum

Alpha repair yet another adaptive strategy



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400

250

300

turn(%)

Up-to-down Revisions

150

200

lative

factorr

0

50Cumu

EBITDA/EV

-50

1979

1980

1982

1983

1985

1986

1988

1989

1991

1992

1994

1995

1997

1998

2000

2001

2003

2004

2006

2007

2009

2010


otes: ows cumu at ve mont y returns to up-to- own rev s ons an n usse un verse. actor returns are

based on equal-weighted decile spread returns. Analysis ranges from January 1979 through April 2011.Source: Nomura Securities International, Inc., Russell. I/B/E/S, Compustat, IDC.


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Exam le 2: Accruals still work for hi h estimate dis ersion stocks

Accruals strategy vs. Estimate dispersion

High estimate dispersion stocks

200

250

Accruals

(%)

Low estimate dispersion stocks

Recession

100

150

ulativ

ereturnt

0

50Cum Regulation FD

Note: Universe is Russell 3000. Shows cumulative monthly returns to accruals (equally weighted quintile spread) in each of three

groups categorized by level of dispersion of analyst estimates for current-year earnings (deflated by the absolute value of mean

estimate). Accruals are based on Sloans (1996) definition using three-month change in trailing four-quarter average in financial

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, - .

1989 through May 2011. Transaction costs are not considered.Source: Nomura Securities International, Inc., Compustat, IDC, Russell, I/B/E/S, NBER.


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Exam le 3: B/P has moved from low beta to no beta

0.6

-

0.2

0.3

0.4

0.5

tion

-0.1

0

0.1

Ra

nkCorrel

-0.4

-0.3

-0.2

4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0

B/P-Beta

Note: Shows cross-sectional rank correlations between B/P and beta, and between B/P and estimate dispersion in the Russell

1000 universe. Period of analysis is from July 1984 through May 2011.

Source: Nomura Securities International, Inc., Russell, Compustat, IDC, I/B/E/S.

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Selection Example 1

factor momentum and the success of uants

How abundant is factor momentum ?



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To exploit combinatoric explosion

20,000

8,000

12,000

,

ombinations

0

4,000

Number of factors


Notes: Shows number of combinations to select three factors from a different number of factors.

Source: Nomura Securities International, Inc.


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Factor momentum selection based on return ersistence


Notes: Shows monthly factor (factors are nonsector-neutral) selected using the highest factor momentum strategy (60-month). At each pointof time, there are three factors. The factor labels are sorted according to frequency of selection, with highest frequency at the bottom. Period

of analysis is from January 1984 to March 2011.

Source: Nomura Securities International, Inc., Compustat, I/B/E/S, Russell , IDC


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Quant core funds beat fundamental core funds in 2011 YTD

Quant vs. Fundamental

6

8

)

+1bp in YTDQuant core funds

4

ulativealpha(

+162 bp in YTD

0

2Cu

Dec 2010Fundamental core funds

Notes: Shows cumulative average alpha (relative return to the benchmark) in large-cap core funds based on quantitative

methodologies (dark-blue line) and large-cap core funds based on fundamental methodologies (light-blue line). Currently, 16 quant

-2

2003 2004 2005 2006 2007 2008 2009 2010 2011


core funds and 48 fundamental core funds are in each fund universe. Transaction costs are not considered. Period of analysis is from

January 2003 through May 2011.

Source: Nomura Securities International, Inc., Bloomberg, Russell, S&P.


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Factor momentum fuels uant core funds

35

408 C

Quant fund alpha and factor momentum

Quant core funds

20

25

30

6

mulat

ivereturn

corefun

ds(%)

5

10

15

2

4of5yrfact

ormoe

alp

haofquan

Quant meltdown

-15

-10

-5

0

-2

0

entum(%)

Cumulati

Aug 2010ve-year ac or momen um

Notes: Shows cumulative average alpha (relative return to the benchmark) of quant core funds (dark-blue line) together with

cumulative return of five-year factor momentum strategy, where the best five factors (long/short baskets) are owned as long-

short positions among our 52 factors based on five-year factor performances in the Russell 1000 universe. Currently, 16 quant

core funds are in the fund universe. Transaction costs are not considered. Period of anal sis is from Januar 2003 throu h

2003 2004 2005 2006 2007 2008 2009 2010 2011


. .

May 2011.Source: Nomura Securities International, Inc., Bloomberg, Compustat, I/B/E/S, Russell, S&P, IDC.


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Factor momentum historically fuels quant core funds

160

(%)

Quant fund alpha and factor momentum

Five-year factor momentum

5

10

100

120

140 Cumu

lativealpe

ntumstrateg

Five-year factor momentum

(best 10 factors from 52 factors)Quant core funds

-5

0

40

60

80

aofQuan

tCore

urnof

factormo Aug 2007

Quant meltdown

-

-10

-

0

20

funds(%)

Cumulativeret

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Notes: Shows cumulative average excess return of quant core funds relative to their benchmark (dark-blue line) together with

cumulative return of five-year factor momentum strategy, where the best five factors (light-blue line) or the best 10 factors (dark-blue

line) are owned as long-short positions among our 52 factors based on five-year factor performances in Russell 1000 universe.


Currently, 16 quant core funds are in the fund universe. Transaction costs are not considered. Period of analysis is from January

1989 through May 2011.Source: Nomura Securities International, Inc., Bloomberg, Compustat, I/B/E/S, Russell, S&P, IDC.


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0.7

Alpha correlation in quant and fundamental core funds

0.5

0.6

lation

Aug 2007

Quant meltdownQuant core funds

0.3

0.4

-yearalphacorr

Fundamental core funds

0.1

0.2Three

0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Notes: Shows three-year alpha correlation in quant core funds (dark-blue line) and fundamental core funds (light-blue line),

where the average of all pairwise alpha correlations are calculated within each fund group. Currently, 16 quant core funds and


. .

Source: Nomura Securities International, Inc., Bloomberg, Russell, S&P.


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Factor momentum fuels uant value and rowth funds

Quant value fund alpha and value-style factor momentum Quant growth fund alpha and growth-style factor momentum

30

35

40

14

16

18

20Cum

ulativereturv

aluefund

s(%) Value-style factor momentum

15

20

25

30

35

10

12

14

16Cum

ulativereturg

rowthfunds(%)

Growth-style factor momentum

10

15

20

25

4

6

8

10

noffactormo

mentu

lative

alphaofQuan

Quantvalue funds

Aug2007Quant meltdown

-10

-5

0

5

10

2

4

6

8

noffactormomentu

lativea

lphaofQuant

Aug 2007Quant meltdown

Quant rowth funds

Notes: Left chart shows cumulative average alpha (relative return to the benchmark) of quant value funds (dark-blue line) together with cumulative return of five-year value-

0

5

0

2

2004 2005 2006 2007 2008 2009 2010 2011

(%)C

um

-20

-15

-2

0

2004 2005 2006 2007 2008 2009 2010 2011

(%)

Cumu

style factor momentum strategy, where the best five factors are owned as long-short positions among our 34 value-style factors (value, earnings variability, GARP and

others categories) based on five-year factor performances in Russell 1000. Right chart shows cumulative average alpha (relative return to the benchmark) of quant growth

funds (dark-blue line) together with cumulative return of five-year growth-style factor momentum strategy, where the best five factors are owned as long-short positions

among our 37 growth-style factorsgrowth, earnings sustainability (flipped polarity for earnings variability), GARP and other categoriesbased on five-year factor

performances in Russell 1000. Transaction costs are not considered. Period of analysis is from January 2003 through May 2011.

Source: Nomura Securities International, Inc., Bloomberg, Compustat, I/B/E/S, Russell, S&P, IDC.



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Al ha diversification amon uant st les

18

Alphas in Quant Core, Value and Growth funds

12

14

tfunds

(%)

Quant Growth funds

Quant Value funds

6

8

alphaofquan

0

2

Cumulative

Aug 2007

Quant meltdown

-4

-

2004 2005 2006 2007 2008 2009 2010 2011

Notes: Shows cumulative median alpha (relative return to the benchmark) in large-cap core, value and growth funds based on


quantitative methodologies. Currently, 16 quant core funds, 6 quant value funds and 10 quant growth funds are in each fund

universe. Transaction costs are not considered. Period of analysis is from January 2003 through May 2011.Source: Nomura Securities International, Inc., Bloomberg, Russell, S&P.0


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Outline

Examples of structural change in popular factors

sources of dinosaur risk

Selection for different objectives examples of adaptive investing

Factor momentum and the success of quants dinosaurs?

Low factor volatility & high factor momentum

Risk parity for strategy combination

Alpha repair yet another adaptive strategy



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Selection Example 2low volatility

Selection based on low factor return volatility



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-

140

80

100

hlyreturns,

%

20

40

60

Cum

ulativemon

-20

0

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Note: Shows cumulative monthly returns to a strategy of selecting three factors

out of 45 factors with the lowest last one-year return volatilities. Universe is the

Russell 1000. Period of analysis is from January 1980 through end September

2010. Transaction costs are not considered. Past performance should not and

cannot be viewed as an indicator of future performance.

Source: Nomura Securities International Inc. Com ustat I/B/E/S Russell IDC.



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: ac or momen um es re urns , ow vo a y com na on

300

low volatilities Best Returns combined

150

200

250

hlyreturn

s,%

50

100

Cumu

lativemont

-50

0

1

980

1

981

1

982

1

984

1

985

1

987

1

988

1

989

1

991

1

992

1

994

1

995

1

996

1

998

1

999

2

001

2

002

2

003

2

005

2

006

2

008

2

009

Note: Shows monthly cumulative returns (top chart) and summary (bottom chart) of three strategies: (1) selecting three factors out of

low volatility best return combined

Annualized Return 4.16 8.61 6.39

Annualized Volatility 4.88 11.36 6.20

Annualized IR 0.85 0.76 1.03


w e owes -mon re urn vo a es, ue ne; se ec ng ree ac ors ou o w e es -mon re urns, re ne;

and (3) investing equally in strategies (1) and (2). Universe is the Russell 1000. Period of analysis is from January 1980 through endSeptember 2010. Factors are constructed sector-neutral. Transaction costs are not considered. Past performance cannot and should

not be viewed as indicative of future performance.

Source: Nomura Securities International, Inc., Compustat, I/B/E/S, Russell, IDC.


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What is selected usin the low-volatilit strate

Note: Shows monthly factors (sector-neutral) selected using the lowest volatility strategy. At each


po n o me, ere are ree ac ors. e ac or a e s are sor e accor ng o requency o se ec on,

with highest frequency at the bottom. Period of analysis is from January 1980 through September2010.



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What is selected usin the factor-momentum strate

Note: Shows monthl factors sector-neutral selected usin the hi hest factor momentum strate . At each


point to time, there are three factors. The factor labels are sorted according to frequency of selection, with

highest frequency at the bottom. Period of analysis is from January 1980 through September 2010.



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Priced and riceless

low-volatility and factor-momentum strategies select different typesof factors

68%

77%80%

90%

n

factor momentum low vol

32%40%

50%

60%

ncyofselectio

23%

10%

20%

30%

Freque

- - - -

Non-Price factors Price factors


factor-momentum strategy. Period of analysis is from January 1980 through September 2010.Source: Nomura Securities International, Inc., Compustat, I/B/E/S, Russell, IDC.


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5 year min-variance & 5 year max-returns

200

Factor Momentum

140

160

urns,%

Minimum Variance

80

100

120

ulativeMonthlyRe

20

40

60Cu

Note: Shows monthly cumulative returns of two strategies: (1) selecting three factors out of 45 with 60-

month minimum variance, purple line; (2) selecting three factors out of 45 with the best 60-month returns,

0

Nov-

88

Nov-

89

Nov-

90

Nov-

91

Nov-

92

Nov-

93

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94

Nov-

95

Nov-

96

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97

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98

Nov-

99

Nov-

00

Nov-

01

Nov-

02

Nov-

03

Nov-

04

Nov-

05

Nov-

06

Nov-

07

Nov-

08

Nov-

09

Nov-

10


. . - .

December 1988 through November 2010. Transaction costs are not considered. Past performance cannotand should not be viewed as indicative of future performance.



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Return to low-volatility factor selection strategy

0.7

Alpha correlation quant core funds and Min-variance strategy

0.4

0.5

0.6

rrelatio

n

Quant meltdown

0.1

0.2

0.3

rollin

galphac

-0.2

-0.1

0

3-year

Between Min-variance strategy

and Quant core funds

Notes: Shows three-year alpha correlation in quant core funds (dark-blue line) and alpha correlation between quant core

funds and minimum variance strategy (red line), where the average of all pairwise alpha correlations are calculated in quant

- .

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010


core funds. In minimum variance strategy, we select three factors out of 45 with 60-month minimum variance, every month.

Currently, 16 quant core funds are in each fund universe. Period of analysis is from April 1996 through November 2010.Source: Nomura Securities International, Inc., Russell, S&P, Compustat, I/B/E/S, IDC, Bloomberg.


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Weighted according to risk parity (FM: factor momentum; MV: minimum variance)

1 = 1 +

= + = 1

Or

=

+

=

+

Strategy Allocations

min variance

(60 m)

best return

(60 m) Equal Weighted

Risk Parity

Weighting

Risk Parity Weighting

(1.5X Levered)

Annualized Return 4.64 7.77 6.21 5.77 8.65

Annualized Volatility 6.18 17.78 9.05 6.27 9.41

Note: Shows summaries of five strategies: (1) selecting three factors out of 45 with 60-month minimum variance, purple line; (2) selecting three factors out of 45 with

the best 60-month returns, red line; (3) investing equally in strategies (1) and (2), blue line; (4) investing in (1) and (2) based on equal risk contribution, green line;

(5) 1.5 times leveraged strategy (4), black line. Universe is the Russell 1000. Factors are built nonsector-neutral. Period of analysis is from Dec 1988 through

November 2010. Transaction costs are not considered. Past performance cannot and should not be viewed as indicative of future performance.

nnua ze . . . . .


, ., , , , .


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180

200

220

Factor Momentum

Minimum Variance

Equal Weighted

120

140

160

hlyReturn

s,%

Risk Parity (levered 1.5X)

80

100

CumulativeMont

20

40

Note: Shows monthly cumulative returns of five strategies: (1) selecting three factors out of 45 with 60-month minimum

variance, purple line; (2) selecting three factors out of 45 with the best 60-month returns, red line; (3) investing equally in

Nov-

88

Nov-

89

Nov-

90

Nov-

91

Nov-

92

Nov-

93

Nov-

94

Nov-

95

Nov-

96

Nov-

97

Nov-

98

Nov-

99

Nov-

00

Nov-

01

Nov-

02

Nov-

03

Nov-

04

Nov-

05

Nov-

06

Nov-

07

Nov-

08

Nov-

09

Nov-

10


, , .

leveraged strategy (4), black line. Universe is the Russell 1000. Factors are built nonsector-neutral. Period of analysis isfrom December 1988 through November 2010. Transaction costs are not considered. Past performance cannot and

should not be viewed as indicative of future performance.



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Selection Example 3alpha repair

Selection based on Sharpe ratio



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40

50

60

s,

%

regression line

US

11.7% absolute return YTD 2011

10

20

30

mulativeExcessRetur

Model public

22 Jan 2007,US Alpha Repair

utper orme usse 1

81bps in April, 2011

and 2.6% YTD 2011

annualized outperformance:

3.5% since 2007, model public

3.3% past 5 yrs4.1% past 10 yrs

-10

0

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

J

an-11

Cu model published

120(%)_

60

80

100

returnoverNOMURA400

Model public

Regression line

Japan

Outperformed NOMURA 400

56 bp in April 2011

1.7 % in YTD 2011

annualized outperformance:

10.4 % since 2008, model public

0

20

40

c-99

un-00

c-00

un-01

c-01

un-02

c-02

un-03

c-03

un-04

c-04

un-05

c-05

un-06

c-06

un-07

c-07

un-08

c-08

un-09

c-09

un-10

c-10

Cumulativeexcess

12 Sep 2008,Japan Alpha Repair

model published

9.8% past 5 yrs

9.7% past 10 yrs

29

Notes: Shows cumulative monthly excess returns of Alpha Repair portfolios for U.S. and Japan. Past model performance should not and cannot

be viewed as indicative of future performance; complete details available upon request. Transaction costs are not considered.

Source: Nomura Securities International, Inc., Compustat, I/B/E/S, IDC, Russell.

D J D J D J D J D J D J D J D J D J D J D J D

Joseph Mezrich, 212.667.9316, [email protected]


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0.6

Alpha correlation in quant core funds and US alpha repair

Aug 2007

0.3

0.4

0.5

lation

Quant meltdownWithin Quant core funds

0.1

0.2

yearalphacorre

Between US alpha repair

and Quant core funds

-0.2

-0.1

0

Three-

Notes: Shows three-year alpha correlation in quant core funds (dark-blue line) and alpha correlation between quant core funds

-0.3

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

30

an a p a repa r re ne , w ere e average o a parwse a p a corre a ons are ca cu a e n quan core un s.

Currently, 16 quant core funds are in each fund universe. Period of analysis is from January 2000 through April 2011.Source: Nomura Securities International, Inc., Russell, S&P, Compustat, I/B/E/S, IDC, Bloomberg.

Joseph Mezrich, 212.667.9316, [email protected]


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