How to Build a Systematic Innovation Factor in Stocks

2.February 2024

The aim of this article is multifold. It aims to answer the research question: does a portfolio consisting of top innovators outperform the S&P 500 index? To address this question, a strategy of investing long in top innovators according to their ranking is developed, and its performance is compared to that of the broad-based index. Based on the common belief that higher innovativeness carries higher risk, it aims to evaluate the volatility associated with innovative stocks. Additionally, it aims to analyze the impact of sector factors on the portfolio’s performance. Finally, it conducts a comparative analysis between the portfolio’s performance and that of the ARK Innovation ETF (ARKK), which specifically focuses on investing in companies relevant to the theme of disruptive innovation.

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Are Commodities a Good Investment? It Depends on the Country

22.September 2023

In recent years, the diversification potential of commodities has come under scrutiny. While the majority of studies examining the role of commodities in a portfolio typically focus on U.S. investors or those dealing primarily with U.S. dollar-denominated assets, Dequiedt et al. (2023) offer a unique perspective by considering the viewpoint of domestic investors in a sample of 38 developed and emerging countries. The study explores the relationship between diversification benefits of commodities for local investors and country’s level of commodity risk exposure. Findings reveal that incorporating commodities tends to enhance the Sharpe ratio of the optimal domestic asset portfolios in most countries with low commodity dependence but doesn’t benefit highly commodity-dependent ones.

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Which Investors Drive Factor Returns?

20.June 2023

If different investors share a common goal, why are there differences in strategy choices and portfolio characteristics across investor classes? Elsaify (2022) attempts to provide an answer. In his study, he documents heterogeneity in investors’ processing abilities, which is the key factor influencing investor’s strategy choice and finds that such heterogeneity stems from factor timing ability.

According to the results, hedge funds seem to have the highest attention capacity, the most precise information and excel at factor timing. On the other hand, long-term investors (insurance companies and pension funds), brokers, and short-sellers exhibit low attention capacity because of their timing inability. They spend relatively more attention on the fundamental, their portfolios have the least dispersion and variance and their impact on factor returns is limited.

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Should We Rebalance Index Changes Immediately?

30.August 2022

Passive index funds are believed to offer low fees, nearly limitless liquidity, very low trading costs and (most of the time) they beat most active managers. Although not all of the above are accurate, there are still many arguments in favour of passive indexing. However, what is often left forgotten are avoidable travails linked to index funds. In general, after an index rebalances, traditional cap-weighted index funds buy high and sell low. Their tendency to add recent highfliers and drop unloved value stocks is what causes investors to lose. Arnott et al. (2022) target the stock selection problem around index rebalancing and propose several ideas on how to adjust index strategies in order to earn above-market returns. They present simple ways to construct an index, thanks to which it is possible to reduce both negative effects of buy-high/sell-low dynamic and the turnover costs of cap-weighted indices.

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Takeover Factor Explains the Size Effect

18.July 2022

The size effect assumes a negative relationship between average stock returns and firm size. In other words, it states that low capitalization stocks outperform stocks with large capitalization. Although generally accepted, the size effect keeps being challenged. Researchers have been asking how important the firm size characteristic actually is, and whether it is possible to replace the traditional size factor of Fama and French asset pricing model (1993) with more accurate factor. Recently, one potential challenger has emerged – so-called takeover factor, employed by Easterwood et al. (2022). In their study, they work on the assumption that small firms are often targets of takeovers, which gives us a different perspective on merger and acquisition news in regards to size effect. Their results show that M&A component of average returns explains the size premium entirely.

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