Managing Partner, Sauma Capital LLC & Professor, Columbia University
Welcome to the first issue of the tenth volume of The Journal of Investment Strategies. In this issue you will find three papers: “Corporate equity performance and changes in firm characteristics”, “Uncertain risk parity” and “What drives the January seasonality in the illiquidity premium? Evidence from international stock markets”.
In our first paper, titled “Corporate equity performance and changes in firm characteristics”, Brian Blank and Cole McLemore explore annual firm-level data and compare this with annual percentage changes in firm characteristics, emphasizing model predictive power and individual variation. Their analyses show a significant link between individual firm equity returns and percentage changes in total assets, book-to-market ratios, current ratios and shares outstanding, as well as historical returns and average market returns. The authors’ findings affirm prior work illustrating the importance of profitability, size, liquidity, momentum and market returns, although they observe minimal evidence of the importance of investment in capital expenditures. They also perform these analyses at the industry level and note the differences between various industries, including the cyclical nature of the business equipment and consumer durables industries in contrast to the utilities and energy sectors. The authors explain their methodology in great detail, and the paper is easy to follow.
Risk parity is a standard method of portfolio construction. Because it is an optimization, and optimized alignments can conceal latent risks, there is a strong conceptual argument for working from more than point estimates of covariance. Considering first and second moments, uncertain risk parity is solved using a loss function that weighs the variation in estimates. A secondary benefit of the machinery is a robust view of portfolio risk and uncertain risk decomposition, which applies to all portfolios regardless of construction. To accommodate the changes in composition that occur over time, a factor model in uncertain form can be enlisted to show the uncertain covariance between portfolios.
In the issue’s second paper, “Uncertain risk parity”, Anish R. Shah treats covariance as uncertain in order to find a risk parity weighting that does not count on perfectly optimized hedges and is robust to changes in regime. The uncertain risk contributions calculated en route are of general interest in themselves. Reporting a portfolio’s uncertain risk decomposition sets a limit around numbers and reveals fragility. For instance, a market could seem hedged in a long–short portfolio but it surfaces as the biggest risk when parameters are considered across their error range.
In “What drives the January seasonality in the illiquidity premium? Evidence from international stock markets”, the third and final paper in this issue, Adam Zaremba and Nusret Cakici comprehensively examine and attempt to explain the January effect in the illiquidity premium. Using 47 000 stocks from 23 major international stock markets for the years 1991–2019 and utilizing sorts and regressions, they show that the January effect in the illiquidity premium is a prevalent global phenomenon and demonstrate a strong and pervasive calendar seasonality in liquidity pricing across different geographical regions. The entire illiquidity premium is realized almost solely in January. Further, they show that this seasonal pattern is driven by a parallel phenomenon in small firms; the size factor thoroughly explains the January seasonality in the illiquidity premium. From a practical perspective, their findings cast doubt on the validity of seasonal timing strategies for the illiquidity factor premium. Future studies could extend their framework into emerging and frontier markets.
On behalf of the editorial board, we hope you are doing well during the Covid-19 pandemic. This issue marks the start of the tenth volume of The Journal of Investment Strategies. Without your continued support this journal would not have had such longevity; many special thanks for that and your keen interest in our journal. We are grateful to Dr Arthur Berd, a dear friend and colleague, who established the journal. Our goal is to share with you the growing list of practical papers on a wide variety of topics on modern investment strategies that we continue to receive from both academics and practitioners.
The authors' findings affirm prior work illustrating the importance of profitability, size, liquidity, momentum and market returns, although we observe minimal evidence of the importance of investment in capital expenditures.
This paper treats covariance as uncertain in order to find a risk parity weighting that does not count on perfectly optimized hedges and is robust to changes in regime.
What drives the January seasonality in the illiquidity premium? Evidence from international stock markets
This study is, to the best of the authors’ knowledge, the first attempt to comprehensively examine and explain the January effect in the illiquidity premium.