Investment Insights of Nobel Prize Winners
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Transcript of Investment Insights of Nobel Prize Winners
Investment Insight of
Nobel Prize Winners
Michael ZhuangThe Investment ScientistMZ Capital Management
2013 Nobel Prize in Econ
• Eugene Fama– RISK based explanation of the market
• Robert Shiller – BEHAVIOR based explanation of the market
• Lars Peter Hansen– General Method of Moment or GMM– High power mathematical tool to measure the
market
Eugene Fama
• Efficient Market Hypothesis (EMH)– In a competitive capital market participated by
millions of people out to make an extra dime, there will not be any advantageous information left unused.
• Risk factors of the market– There are three factors of risk
Efficient Market Hypothesis (EMH)
• Weak form EMH– Past stock prices have no predictive power of future
stock prices.– Implication: technical analysis useless
• Semi-strong form EMH– All public information has no predictive power of
future stock prices– Implication: watching Jim Cramer waste of time
• Strong from EMH– Private information has no predictive power
More on Strong Form EMH
• There are evidences that Strong Form EMH is rejected
• Insider information: CEO, COO, CFO, 5% Owners, Directors
• Law markers• My experience trading insider information
after Sarbane Oxley Act.
Stock Prices are Predictable …• By company size
Smallest 2 3 4 5 6 7 8 9 Largest0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
17.64%
14.65% 14.64% 14.26%14.88%
13.80%12.84% 12.96%
11.40%10.68%
Annual Returns Relative to Size
Stock Prices are Predictable …• By P/B ratio
Lowest
(Valu
est) 2 3 4 5 6 7 8 9
Highest
(Gro
wthest)
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
20%18%
17% 17%15% 15% 14%
13%12%
8%
Annual Returns Relative to P/B
Contradiction to EMH?
• Isn’t this contradictory to Fama’s own Efficient Market Hypothesis?
• Alas Fama has a risk based explanation– Smaller stocks are riskier than larger stocks,
therefore investors in those stocks are compensated more by the market
– Value (non-growing) stocks are risker than growth stocks, therefore investors in those stocks are compensated more by the market
Fama French Three Factor Model
• Stock expected returns are determined by three risk factors– Beta, or correlation with the broad market.– Size, and– Valuation
Fama French Five Factor Model
• Unified pricing model for stocks and bonds• Stock/Bond expected returns are determined
by five factors– Beta– Size– Valuation– Duration– Credit
Risks That Pay
• Beta risk• Size risk or small cap risk• Value risk• Duration risk• Credit risk
Risks That Don’t Pay
• Idiosyncratic risk, or individual stock risk– Individual stocks risk can be diversified away
costlessly, therefore it’s not compensated by capital market
• Agency risk– Risk that your agent don’t work for your best interest.
Example: Lloyd Blankfein Goldman CEO Congressional Testimony
• Information asymmetric risk– No hedge funds for my clients.
Can Money Managers Pick Stocks
• S&P Active vs Passive Study: No!• Academic research– 25% of money managers outright lost money
picking stocks– 75% of money managers make some money but
not enough to overcome their costs– Only 0.24% of money managers make money
picking stocks, they may not repeat.
Can Analyst Predict Stocks?
• Overwhelming evidences say NO!• Analysts’ “buy” “sell” “upgrade” “downgrade”
calls have very little advantageous information.
• Analysts earning forecasts five years out are negatively correlated to actuals. (La Porta) Thus those companies forecasted to have the strongest growth to have the worst returns.
How I Apply Fama’s Insight
• Construct well-diversified portfolio to seek broad exposure to all five risk factors with a tilt towards small cap and value.
• Shun actively managed funds, use DFA or Vanguard instead.
• Rebalance to maintain risk exposure
Robert Shiller
• “Eugene Fama is like a good friend who believe in a different religion.”
• “The market is not so much driven by risk factors but by animal spirits.”
• Author of two “Irrational Exuberance” books, called the tech bubble and housing bubble.
• Co-creator of Case-Shiller Real Estate Index
Stock Prices Too Volatile
Robert Shiller’s Explanation
• Price volatility shouldn’t be 13x dividend volatitility
• People are basically irrationally• Stock prices are driven by fear and greed;
stock prices are alternating between underpriced and overpriced.
PE10 Can Predict LT Market Ret
How I Apply Shiller’s Insight
• Another Great Depression when stocks drop 85% is nothing to fear
• Not that I can predict it …• But I know how to deal with it after the fact …
Dividend to Rescue
Rebalance Periodically
• Not just as a mean of maintaining risk exposure
• But also can earn additional 50 bps in return a year.
Trading Is Hazardous
Lowest 2 3 4 Highest Index0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
17.64%16.93%
16.33%15.22%
12.11%
17.90%
Portfolio Returns vs Turnover (1991-1996)
Investment Do and Don’t
• Do diversify• Do tilt toward small cap and value• Do rebalance• Don’t pick stocks• Don’t pick active fund managers• Don’t time market• Don’t trade frequently