Joseph Mezrich Nomura Securities International Inc, New York. Global Quantitative Research

Transcription

1 Nomura Securities International, Inc. U.S. Quantitative Research Nomura Global Quantitative Equity Conference in London Natural Selection Joseph Mezrich Nomura Securities International Inc, New York. Global Quantitative Research 17 May 211 Please read the analyst certifications and important disclosures on pp gl

2 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 exist in overwhelming number and unparalleled variety. Bacteria inhabit effectively every place suitable for the existence of life. Should quantitative investors emulate dinosaurs or bacteria? 2

3 Do quants have dinosaur risk? How do bacteria diversify? Local adaptation to changing environments Local adaptation = optimizing to a specific (local) objective function 3

4 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 and high factor momentum Risk parity for strategy combination Alpha repair yet another adaptive strategy 4

5 Regime change for factors: Example 1 4 lative factor re eturn (%) Cumu Up-to-down Revisions EBITDA/EV Notes: Shows cumulative monthly returns to up-to-down revisions i and EBITDA/EV in Russell 1 universe. Factor returns are based on equal-weighted decile spread returns. Analysis ranges from January 1979 through April 211. Transaction costs are not considered. Source: Nomura Securities International Inc., Russell. I/B/E/S, Compustat, IDC. 5

6 Example 2: Accruals still work for high-estimate-dispersion stocks Cu umulative return to Accrual (%) High estimate dispersion stocks Mid estimate dispersion stocks Low estimate dispersion stocks Recession Regulation FD Note: Universe is Russell 3. 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 Sloan s (1996) definition using three-month change in trailing four-quarter average in financial statements, not using 12-month change in annual financial statements as Sloan originally used. Period of analysis is from January 1989 through March 211. Transaction costs are not considered. Source: Nomura Securities International Inc., Compustat, IDC, Russell, I/B/E/S, NBER. 6

7 Example 3: B/P has moved from low beta to no beta elation Rank Corr B/P-Beta B/P- Estimate dispersion Note: Shows cross-sectional rank correlations between B/P and beta, and between B/P and estimate dispersion in the Russell 1 universe. Period of analysis is from July 1984 through February 211. Source: Nomura Securities International Inc., Russell, Compustat, IDC, I/B/E/S. 7

8 Factor momentum selection based on return persistence Notes: Shows monthly factors (factors are non-sector neutral) selected using the highest factor momentum strategy (6-month) in the Russell 1. At each point of time, there are three selected factors. The factor labels are sorted according to frequency of selection, with highest frequency at the bottom. Period of analysis are from January 1984 to March 211. Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell and IDC 8

9 Quant core funds beat fundamental core funds in Q1 211 Quant vs. Fundamental 8 Quant core funds +4 bp in YTD %) mulative alpha ( Cu Fundamental core funds Dec bp in YTD 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 (g blue line). Currently, 16 quant core funds and 48 fundamental core funds are in each fund universe. Transaction costs are not considered. Period of analysis is from January 23 through April 211. Source: Nomura Securities International Inc., Bloomberg, Russell, S&P. 9

10 Factor momentum fuels quant core funds 8 Quant fund alpha and factor momentum Quant core funds 4 35 Cu t core funds (%) ve alpha of quan Cumulati Aug 27 Quant meltdown Five-year factor momentum Aug mulative return of 5yr factor mom mentum (%) 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 longshort positions among our 52 factors based on five-year factor performances in the Russell 1 universe. Currently, 16 quant core funds are in the fund universe. Transaction costs are not considered. Period of analysis is from January 23 through March 211. Source: Nomura Securities International Inc., Bloomberg, Compustat, I/B/E/S, Russell, S&P and IDC. 1

11 Factor momentum historically fuels quant core funds Quant fund alpha and factor momentum Cumulative retu urn of factor mom mentum strategy (%) Five-year factor momentum (best 5 factors from 52 factors) Five-year factor momentum (best 1 factors from 52 factors) Quant core funds Aug 27 Quant meltdown Cumulative alph ha of Quant Core funds (%) 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 1 factors (dark blue line) are owned as long-short positions among our 52 factors based on five-year factor performances in Russell 1 universe. Currently, 16 quant core funds arein the fund universe. Transaction costs are not considered. Period of analysis is from January 1989 through March 211. Source: Nomura Securities International Inc., Bloomberg, Compustat, I/B/E/S, Russell, S&P and IDC. 11

12 Alpha similarities in quant and fundamental core investments.7 Alpha correlation in quant and fundamental core funds Three- -year alpha corre elation Quant core funds Fundamental core funds Aug 27 Quant meltdown 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 48 fundamental core funds are in each fund universe. Period of analysis is from January 2 through April 211. Source: Nomura Securities International Inc., Bloomberg, Russell, S&P. 12

13 Factor momentum fuels quant value and growth funds Cum mulative alpha of Quan nt value funds (%) Quant value fund alpha and value-style factor momentum Value-style factor momentum Quant value funds Aug 27 Quant meltdown Cumulative return of factor momentum m (%) growth funds (%) Cumu ulative alpha of Quant Quant growth fund alpha and growth-style factor momentum Growth-style factor momentum Quant growth funds Aug 27 Quant meltdown Cumulative return n of factor momentum m (%) 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 valuestyle 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 1. 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 factors (growth, earnings sustainability [flipped polarity for earnings variability], GARP, and others categories) based on five-year factor performances in Russell 1. Transaction costs are not considered. Period of analysis is from January 23 through 2 April 211. Source: Nomura Securities International Inc., Bloomberg, Compustat, I/B/E/S, Russell, S&P and IDC. 13

14 Alpha diversification among quant styles Cumulative alpha of quan nt funds (%) Alphas in Quant Core, Value and Growth funds Quant Core funds Quant Growth funds Quant Value funds Aug 27 Quant meltdown 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 1 quant growth funds are in each fund universe. Transaction costs are not considered. Period of analysis is from January 23 through 2 April 211. Source: Nomura Securities International Inc., Bloomberg, Russell, S&P. 14

15 Mood for quants is getting better? Not only useful for alpha opportunities, quant strategies can provide diversification with fundamental investments. Source: Pensions & Investments. 15

16 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 and high factor momentum Risk parity for strategy combination Alpha repair yet another adaptive strategy 16

17 Combinatorics a cheap approach to factor discovery 2, 16, Comb binations 12, 8, 4, Number of factors Notes: Shows number of combinations to select three factors from a different number of factors. Source: Nomura Securities International Inc. 17

18 Return to low-volatility factor selection strategy thly returns, % Cumulative mont 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 1. Period of analysis is from January 198 through end September 21. Transaction costs are not considered. Past performance should not and cannot be viewed as an indicator of future performance. Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC. 18

19 Three strategies: factor momentum (best returns), low volatility, and combination 3 low volatilities Best Returns combined 25 hly returns, % Cumulative mont low volatility best return combined Annualized Return Annualized Volatility Annualized IR Note: Shows monthly cumulative returns (top chart) and summary (bottom chart) of three strategies: (1) selecting three factors out of 45 with the lowest 12-month return volatilities, blue line; (2) selecting three factors out of 45 with the best 12-month returns, red line; and 3) investing equally in strategies (1) and (2). Universe is the Russell 1. Period of analysis is from January 198 through end September 21. 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, and IDC. 19

20 What gets selected using the low-volatility strategy Note: Shows monthly factors (sector-neutral) selected using the lowest volatility strategy in the Russell 1. At each point to time, there are three selected factors. The factor labels are sorted according to frequency of selection, with highest frequency at the bottom. Period of analysis is from January 198 through September 21. Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC. 2

21 What gets selected ected using the factor-momentum o tu strategy Note: Shows monthly factors (sector-neutral) selected using the highest factor momentum strategy in the Russell 1. At each point to time, there are three selected factors. The factor labels are sorted according to frequency of selection, with highest frequency at the bottom. Period of analysis is from January 198 through September 21. Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC. 21

22 Priced and priceless low-volatility and factor-momentum strategies select different types of factors factor momentum low vol Frequen ncy of selection 9% 8% 7% 6% 5% 4% 3% 2% 32% 77% 68% 23% 1% % Non-Price factors Price factors Note: Shows frequency of price-relatedrelated factor and non-price-related related factor selection in (1) low-volatility strategy and (2) highest factor-momentum strategy. Period of analysis is from January 198 through September 21. Universe is the Russell 1. Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC. 22

23 Cumulative Monthl y Returns, % Factor Momentum Minimum Variance Equal Weighted Risk Parity (unlevered) Risk Parity (levered 1.5X) Combining strategies 4 2 Nov-88 Nov-89 Nov-9 Nov-91 Nov-92 Nov-93 Nov-94 Nov-95 Nov-96 Nov-97 Nov-98 Nov-99 Nov- Nov-1 Nov-2 Nov-3 Nov-4 Nov-5 Nov-6 Nov-7 Nov-8 Nov-9 Nov-1 Note: Shows monthly cumulative returns of five strategies: (1) selecting three factors out of 45 with 6-month minimum variance, purple line; (2) selecting three factors out of 45 with the best 6-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 1. Factors are built non-sector neutral. Period of analysis is from December 1988 through November 21. 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, and IDC. 23

24 Combining strategies via dynamic risk parity weights Weighted according to Risk Parity (FM: factor momentum; MV: minimum variance) 1 = 1+ = + =1 Or write the weights in another way = + = + Strategy Allocations min variance (6 m) best return (6 m) Equal Weighted Risk Parity Weighting Risk Parity Weighting (1.5X Levered) Annualized Return Annualized Volatility Annualized IR Note: Shows summaries of five strategies: (1) selecting three factors out of 45 with 6-month minimum variance, purple line; (2) selecting three factors out of 45 with the best 6-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 1. Factors are built non-sector neutral. Period of analysis is from Dec 1988 through November 21. 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, and IDC. 24

25 Alpha Repair adaptive selection 6 US 11.7% absolute return YTD 211 Outperformed Russell 1 81bps in April, 211 and 2.6% YTD 211 annualized outperformance: 3.5% since 27, model public 3.3% past 5 yrs 4.1% past 1 yrs rns, % Cu umulative Excess Retu regression line 22 Jan 27, US Alpha Repair model published Model public -1 Jan-97 (%)_ return over NOMURA 4 ( Jan-98 Jan-99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Japan Outperformed NOMURA 4 56 bp in April % in YTD 211 annualized outperformance: 1.4 % since 28, model public 9.8 % past 5 yrs 9.7% past 1 yrs Cumulative excess Regression line 12 Sep 28, Japan Alpha Repair model published Model public De ec-99 Ju un- De ec- Ju un-1 De ec-1 Ju un-2 De ec-2 Ju un-3 De ec-3 Ju un-4 De ec-4 Ju un-5 De ec-5 Ju un-6 De ec-6 Ju un-7 De ec-7 Ju un-8 De ec-8 Ju un-9 De ec-9 Ju un-1 De ec-1 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. 25

26 Alpha Repair uncorrelated with other quant funds lation Three-y year alpha corre Alpha correlation in quant core funds and US alpha repair Within Quant core funds Between US alpha repair and Quant core funds Aug 27 Quant meltdown Notes: Shows three-year alpha correlation in quant core funds (dark blue line) and alpha correlation between quant core funds and US alpha repair (red line), where the average of all pairwise alpha correlations are calculated in quant core funds. Currently, 16 quant core funds and 48 fundamental core funds are in each fund universe. Period of analysis is from January 2 through April 211. Source: Nomura Securities International Inc., Russell, S&P, Compustat, I/B/E/S, IDC, Bloomberg. 26

27 Any Authors named on this report are Research Analysts unless otherwise indicated Analyst Certification I, Joseph Mezrich, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company. Conflict-of-interest disclosures Important disclosures may be accessed through the following website: If you have difficulty with this site or you do not have a password, please contact your Nomura Securities International, Inc. salesperson ( ) or grpsupport@nomura.com for assistance. Online availability of research and additional conflict-of-interest disclosures Nomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG and THOMSON ONE ANALYTICS. For clients in Europe, Japan and elsewhere in Asia it is available on NOMURA.COM, REUTERS and BLOOMBERG. Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page or requested from Nomura Securities International, Inc., on If you have any difficulties with the website, please grpsupport-eu@nomura.com for technical assistance. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content of research reports in which their names appear. Marketing Analysts identified in some Nomura research reports are research analysts employed by Nomura International plc who are primarily responsible for marketing Nomura s Equity Research product in the sector for which they have coverage. Marketing Analysts may also contribute to research reports in which their names appear and publish research on their sector. Disclaimers This publication contains material that has been prepared by the Nomura entity identified at the top or bottom of page 1 herein, if any, and/or, with the sole or joint contributions of one or more Nomura entities whose employees and their respective affiliations are specified on page 1 herein or elsewhere identified in the publication. Affiliates and subsidiaries of Nomura Holdings, Inc. (collectively, the 'Nomura Group') ), include: Nomura Securities Co., Ltd. ('NSC') (NSC) Tokyo, Japan; Nomura International plc ('NIplc') ), United Kingdom; Nomura Securities International, Inc. ('NSI'), New York, NY; Nomura International (Hong Kong) Ltd. ( NIHK ), Hong Kong; Nomura Financial Investment (Korea) Co., Ltd. ( NFIK ), Korea (Information on Nomura analysts registered with the Korea Financial Investment Association ('KOFIA') can be found on the KOFIA Intranet at ); Nomura Singapore Ltd. ( NSL ), Singapore (Registration number E, regulated by the Monetary Authority of Singapore); Capital Nomura Securities Public Company Limited ( CNS ), Thailand; Nomura Australia Ltd. ( NAL ), Australia (ABN ), regulated by the Australian Securities and Investment Commission ('ASIC') and holder of an Australian financial services licence number ; P.T. Nomura Indonesia ( PTNI ), Indonesia; Nomura Securities Malaysia Sdn. Bhd. ( NSM ), Malaysia; Nomura International (Hong Kong) Ltd., Taipei Branch ( NITB ), Taiwan; Nomura Financial Advisory and Securities (India) Private Limited ( NFASL ), Mumbai, India (Registered Address: Ceejay House, Level 11, Plot F, Shivsagar Estate, Dr. Annie Besant Road, Worli, Mumbai- 4 18, India; SEBI Registration No: BSE INB112993, NSE INB , INF , INE ). 27

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