Investing Expertise

How do professional analysts value stocks? In their March 2014 paper entitled “Peering Inside the Analyst ‘Black Box’: How Do Equity Analysts Model Companies?”, Andreas Markou and Simon Taylor examine the private stock valuation models of a group of analysts working in research departments of large investment banks. They examine both modeling methods and inputs. Using 53 Excel-based valuation models from professional analysts covering the European healthcare and chemicals sectors acquired during the third quarter of 2009, they conclude that: Keep Reading

As of the end of 2012, we stopped adding forecasts to the Guru Grades database and published a preliminary report on findings. As of the end of 2013, we have completed the grading of all forecasts added during 2012 and now publish a final Guru Grades report.

The final report encompasses 6,582 graded forecasts from 68 gurus, adding 123 forecasts to the preliminary study (an increment of about 2%). The final report also incorporates a few minor corrections. The relatively small number of additional grades and corrections do not materially affect preliminary findings. Specifically:

• Terminal forecast accuracy is still 46.9%.
• Averaged by guru rather than across all forecasts, terminal accuracy is still 47.4%.

Accuracy rates change for individual gurus involved in the 123 incremental forecasts. We have updated the detailed forecast grading for these individuals. The histogram of guru accuracies in the final report is somewhat more symmetric than that in the preliminary report.

The final Guru Grades report will remain available indefinitely as a caution to investors on: (1) the (un)predictability of complex systems such as financial markets; and, (2) the risk or relying on grades self-assigned by students of financial markets.

Do funds that have Ph.D. holders in key positions outperform those that do not? In their October 2013 paper entitled “What a Difference a Ph.D. Makes: More than Three Little Letters”, Ranadeb Chaudhuri, Zoran Ivkovich, Joshua Pollet and Charles Trzcinka investigate whether institutional money management firms that rely on key personnel holding Ph.D. degrees outperform those that do not. They also test publication of articles in leading economics and finance journals as a discriminator among Ph.D. holders. They focus on U.S. equity funds, which comprise over half of assets under institutional money management. They first match funds with and without Ph.D. holders in key positions by investment objective (12 styles), assets under management and past performance. They then examine the Ph.D./non-Ph.D. performance differential based on several performance measures. Using information self-reported by institutional money management firms for U.S. equity funds (performance, fee and key personnel biographies), and separate article searches in leading publications, during June 1993 through December 2007, they find that: Keep Reading

Do equity analyst stock recommendations have the same post-publication predictive value worldwide? In the September 2013 version of their paper entitled “Where are the World’s Best Analysts?”, Campbell Harvey, Sam Radnor, Khalil Mohammed and William Ferreira assess the ability of equity analysts by global region (Asia ex-Japan, Japan, Europe ex-UK, the UK and the U.S.) to forecast returns of the stocks they cover by measuring average cumulative returns after buy and sell recommendations. They adjust all returns based on regional stock indexes. Using analyst forecasts during 2005 (after regulations regarding analyst research change) through 2012, they find that: Keep Reading

Do expert investment consultants advising institutions recommend outperforming funds? In their September 2013 paper entitled “Picking Winners? Investment Consultants’ Recommendations of Fund Managers”, Tim Jenkinson, Howard Jones, and Jose Vicente Martinez analyze survey data to determine what factors drive consultant fund recommendations, what impact their recommendations have on fund flows and how well their recommendations perform. While individual investment consultants do not publicly disclose their recommendations, survey responses allow assessment of aggregate recommendations (a list of top-rated funds) from consultants accounting for over 90% of the U.S. consulting market. To assess recommended fund performance, the authors compare recommended funds to style-matched alternatives based on returns and three-factor (market, size, book-to-market) and four-factor (plus momentum) alphas. They measure performance net of trading frictions but gross of fees of both fund managers and the investment consultants themselves. Using responses from an average 29 investment consultants to annual survey questions on their recommendations of long-only active U.S. equity funds, along with size/performance data for the funds they rate and similar funds, during 1999 through 2011 (13 years), they find that: Keep Reading

A reader suggested a review of the stock market commentary of Mark Hulbert, editor of the Hulbert Financial Digest, which tracks the recommendations of a wide range of investing newsletters. He is also a regular columnist at MarketWatch. Because Mark Hulbert uses his Hulbert Stock Newsletter Sentiment Index (HSNSI) as a principal quantitative tool in formulating his market outlook, we evaluate the usefulness of that index in predicting stock market returns rather than his qualitative commentary. HSNSI “reflects the average recommended stock market exposure among a subset of short-term market timers tracked by the Hulbert Financial Digest.” Mark Hulbert presents HSNSI as a contrarian signal for future stock returns; when HSNSI is high (low), he views the outlook for stocks as materially bearish (bullish). Using a sample of 287 values of HSNSI over the period July 2002 through September 2013 (generated by searching MarketWatch.com for “HSNSI” and its predecessor “HSSI”) and contemporaneous daily closes of the S&P 500 Index, we find that: Keep Reading

What are the trading behaviors of the best-performing hedge funds? In his June 2013 paper entitled “How do Hedge Fund ‘Stars’ Create Value? Evidence from Their Daily Trades”, Russell Jame uses transaction-level data to investigate the magnitude and source of hedge fund equity trading profits. His sample includes name, equity trade dates (but not non-equity trades, if any), execution prices and transaction costs for 74 hedge funds and 579 other institutions over a 12-year period. He estimates performance by constructing buy and sell portfolios from trades and computing portfolio-level returns over intervals of the next 21, 63, 126 and 252 trading days (emphasizing 252 days as closest to the average holding period of a typical hedge fund). He excludes portfolios with fewer than ten stocks as too noisy. He considers gross return, gross DGTW-adjusted return (return on a stock less the value-weighted return on a benchmark portfolio with the same size, book-to-market and momentum characteristics as the stock) and net DGTW-adjusted return. Using detailed trading data as described during January 1999 through December 2010 and associated stock prices through December 2011, he finds that: Keep Reading

What works better for currency trading, technical or fundamental analysis? In their April 2013 working paper entitled “Exchange Rate Expectations of Chartists and Fundamentalists”, Christian Dick and Lukas Menkhoff compare the behavior and performance of technical analysts (chartists) and fundamental analysts (fundamentalists) based on monthly surveys of several hundred German professional dollar-euro exchange rate forecasters, in combination with respondent self-assessments regarding emphasis on technical and fundamental analysis. Forecasts are directional only (whether the dollar will depreciate, stay the same or appreciate versus the euro) at a six-month horizon. The authors examine three self-assessments (from 2004, 2007 and 2011) to classify forecasters as chartists (at least 40% weight to technical analysis), fundamentalists (at least 80% weight to fundamental analysis) or intermediates. Using responses from 396 survey respondents encompassing 33,861 monthly time-stamped forecasts and contemporaneous dollar-euro exchange rate data during January 1999 through September 2011 (153 months), they find that: Keep Reading

How do broker-employed stock analysts operate? In their March 2013 paper entitled “Inside the ‘Black Box’ of Sell-Side Financial Analysts”, Lawrence Brown, Andrew Call, Michael Clement and Nathan Sharp summarize the results of a survey and follow-up interviews designed to discover key inputs and incentives affecting sell-side equity analyst outputs, including earnings forecasts and stock recommendations. They conducted the 23-question survey via email during January 9 through February 6 of 2013, with a promise of strict confidentiality. Using information from 365 responses from sell-side analysts (10.9% of 3,341 targeted) and 18 detailed follow-up interviews (17 by telephone and one in person), they find that: Keep Reading

What proportion of long-short equity hedge fund managers effectively time the stock market? In their January 2013 paper entitled “Hedge Fund Managers’ Market Timing Skills”, Xin Li and Hany Shawky investigate whether long-short equity hedge funds (the oldest and largest hedge fund category) exhibit market timing skill by adjusting positions with market trends. Specifically, they examine hedge fund return correlations with the Fama-French model factors (market, size and book-to-market ratio) during three major crises: the Long-Term Capital Management (LTCM) collapse in the fall of 1998; the quant crisis in August 2007; and, the financial crisis in 2008. They also examine market timing behaviors of individual hedge funds over their respective lifetimes by relating fund beta to market return via a nonlinear function accounting for risk aversion and/or market liquidity. Using monthly returns for 1,571 long-short equity hedge funds having at least 48 months of returns, and contemporaneous Fama-French factor returns, during January 1994 through January 2011, they find that: Keep Reading