What will happen if we mix ESG scoring with price momentum? Can we improve simple ESG investing strategy?

The pure price momentum can be combined with ESG scores using a Knapsack algorithm. Knapsack algorithm is a well-known mathematical problem of optimization, and in the case of momentum and ESG, can be used to make the momentum portfolios significantly more responsible, with lower volatility and better risk-adjusted return. The second option is to make the ESG portfolio substantially more profitable by using Knapsack algorithm to construct high ESG portfolio with large momentum. The approach resulted in a strategy with high ESG score and compared to pure momentum or momentum-ESG strategy, with significantly reduced volatility. Therefore, the ESG-momentum strategy has the best risk-adjusted return, the lowest drawdown, the lowest volatility and the most consistent returns.

The bear markets were and surely would be present in the equities in the future. While many fear them, experienced investors accept that the growth of the equity market cannot be constant and that inherent equity risk often manifests as a painful market drawdown. When someone designs a strategy, it is a general practice to check its performance during such downturns. Therefore, we can recommend an interesting novel research paper by Paul Geertsema and Helen Lu. The selected paper analyzes the risk of the most common equity factors and plots their over- or under-performance during multiple crisis periods since the Vietnam war until the COVID-19.

Authors: Paul Geertsema, Helen Lu

Title: The Risk in Risk Factors

The pandemic of COVID-19 brought many changes for the whole humanity. The financial markets where no exception, but the trading has continued. Nowadays, the order can be placed from anywhere around the world and almost all stock exchanges are electronic and algorithmic. However, there is still one exchange where the floor trading exists – NYSE. During these tough times, NYSE was also purely electronic, the floor trading was closed, and human interaction was not possible. A novel study by Brogaard, Ringgenberg and Roesch examines the role of floor traders in the recent era driven by computers. The conclusion is clear: in the current digital age, floor traders still matter.

Authors: Jonathan Brogaard, Matthew C. Ringgenberg, Dominik Roesch

Title: Does Floor Trading Matter?

After a month, we are back with a year-to-date performance analysis of a few selected trading strategies. In the previous article, we were writing about the performance of equity factors during the coronavirus crisis. Several readers asked us to take a look also on different types of trading strategies, so we are now expanding to other asset classes. We picked a subset of strategies that can be used as a hedge at the times of market stress (at least, that’s what the source academic research papers indicate) and checked how they fared.

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 costs 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