Thursday, May 12, 2016

Researchers Say Research Negatively Affects Fund Performance

From Price Action Lab:

Stay Ahead Of Fundbusters
Evidence is growing that academic research in investment strategy design negatively impacts fund profitability due to a crowding effect when anomalies are revealed and investors learn about any mispricing. And while academic research does its best job in turning the efficient market hypothesis into a self-fulfilling prophecy, fund managers and traders have one choice: stay ahead of academic research.

From Quantifying Backtest Overfitting in Alternative Beta Strategies by Antti Suhonen, Matthias Lennkh, and Fabrice Perez, 2016:
McLean and Pontiff (2016) review the post-publication performance of 97 variables that academic research has shown to predict cross-sectional stock returns. The authors find that the returns are 26% lower out-of-sample, and 58% lower post-publication, indicating both a data mining effect (evidenced by the lower out-of-sample performance) and a crowding effect (investors learning about a mispricing from academic publications).
This is the abstract from McLean and Pontiff (2016)
We study the out-of-sample and post-publication return predictability of 97 variables shown to predict cross-sectional stock returns. Portfolio returns are 26% lower out-of-sample and 58% lower post-publication. The out-of-sample decline is an upper bound estimate of data mining effects. We estimate a 32% (58%–26%) lower return from publication-informed trading. Post-publication declines are greater for predictors with higher in-sample returns, and returns are higher for portfolios concentrated in stocks with high idiosyncratic risk and low liquidity. Predictor portfolios exhibit post-publication increases in correlations with other published-predictor portfolios. Our findings suggest that investors learn about mispricing from academic publications.
The above should be obvious. I wrote in this blog about the challenges that academic research poses as far back as in 2012:...MORE