Transaction Costs Optimization for Currency Factor Strategies

18.June 2020

A lot of backtests of systematic trading strategies omit transaction costs (in the form of spreads and fees). Simulation is then simpler, but resultant model portfolio and its performance can be misleading. In the case of currency factor investing, backtest without the tcosts simulation can pick currencies with wider spreads and higher volatilities. And in real trading, with real-world transaction costs, a strategy can, therefore, perform significantly worse than expected. A research paper written by Melvin, Pan, and Wikstrom offers an elegant optimization methodology to incorporate transaction costs into the backtesting process which allows strategies to retain their alpha …

Authors: Michael Melvin, Wenqiang Pan, Petra Wikstrom

Title: Retaining Alpha: The Effect of Trade Size and Rebalancing Frequency on FX Strategy Returns

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Trend Breaks in Trend-Following Strategies

9.June 2020

Trend-following strategies are very effective when markets are cleanly trending, but they suffer when trends end too soon. How markets behaved during the last few years, were they prone to last-longing trends? Are we able to immunize trend-following to endure the negative impact of trend breaks better? A research paper written by Garg, Goulding, Harvey, and Mazzoleni finds a negative relationship between the number of turning points (a month in which slow 12-month and faster 2-month momentum signals differ in their indications to buy or sell) and risk-adjusted performance of a 12-month trend-following strategy. The average number of turning points experienced across assets has increased in recent years. But we can implement a “dynamic” trend-following strategy that adjusts the weight it assigns to slow and fast time-series momentum signals after observing market breaks to recover much of the losses experienced by static-window trend following…

Authors: Garg, Goulding, Harvey, Mazzoleni

Title: Breaking Bad Trends

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Embedded Leverage in High Beta Funds and Management Fees

4.June 2020

Risk-averse investors want higher returns at any cost. If they are constrained and are not able to use leverage on their own, they will look for other ways to increase their performance. Recent academic paper written by Hitzemann, Sokolinski, Tai suggests, that such risk-seeking investor will search for a high-beta fund that will give them requested embedded leverage, even when that fund charge higher than average fees. Resultant net alpha of those high-beta funds is then negative, and this effect can explain the significant part of the underperformance of the overall mutual fund industry. And now, the logical question follows: As hedge funds have even higher fees than mutual funds, what is embedded in them, that constrained clients normally can’t access? Higher leverage and access to option-like return distribution? Maybe…

Authors: Hitzemann, Sokolinski, Tai

Title: Paying for Beta: Embedded Leverage and Asset Management Fees

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Quantpedia in May 2020

1.June 2020

May is behind us, and we are bringing you our summary Quantpedia’s research again. Nine new Quantpedia Premium strategies have been added into our database, and nine new related research papers have been included in existing Premium strategies during last month.

Additionally, we have produced 16 new backtests written in QuantConnect code. Our database currently contains over 290 strategies with out-of-sample backtests/codes.

Also, four new blog posts you may find interesting have been published on our Quantpedia blog.

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Long-Short vs Long-Only Implementation of Equity Factors

26.May 2020

How should be equity factor strategies implemented? In a long-only smart beta) way? As a long-short strategy, as most of the hedge funds usually do? Or in a partially-hedged fashion by going long equity factor and shorting market to offset some of the market risks? There is no one universal answer as it depends on the investment mandate and constraints of each fund manager contemplating to implement factor investing strategies. But recent academic paper written by Benaych-Georges, Bouchaud and Ciliberti suggests that it’s a good idea to go in the direction of long-short implementation (if it’s possible). Managing short book can be challenging; however, the added benefit of lower correlation among strategies gives resultant factor portfolio a significant boost in the return-to-risk ratio (even after accounting for realistic implementation and shorting costs).

Authors: Benaych-Georges, Bouchaud, Ciliberti

Title: Equity Factors: To Short Or Not To Short, That is the Question

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Stocks Not For the Long Run?

21.May 2020

There are very few observations of the attributes of financial markets that are considered by most of the investors as nearly permanent facts. One of the most often cited examples is that over the long interval stocks outperform bonds. But is it really such truth? Over how long interval? 10 years, 20 years, 30 years? As the new and better historical data are becoming available for analysis, they show interesting findings. Let’s show one example. There exist one very long interval during which the return of stocks was nearly equal to bonds. What do you think is the length of such an interval in the case of the US? It’s 150 years! Yes, that’s correct, there was a one-and-half-century long period in the history of the United States when the performance of stocks and bonds was nearly identical. We do not imply that it will be the case in the 21st century. But an important research paper written by Edward McQuarrie shows that investors must prepare for even the most unexpected possibilities when they are making their asset allocation decisions.

Author: McQuarrie

Title: The US Bond Market before 1926: Investor Total Return from 1793, Comparing Federal, Municipal and Corporate Bonds Part II: 1857 to 1926

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