Confusion: Can an anomaly be an open secret, and not defensible, and still somehow persist?
For example, I’m especially interested in the momentum anomaly. The momentum folks make a very compelling case that the behavioural econ reasons that brought it into existence are so dang powerful that it somehow persists, even though there are many papers/articles/books about it that anyone can read.
I personally found this just compelling enough to run a momentum experiment, based on a strategy that has done extremely well in reducing volatility and drawdowns in the past. Momentum strategies naturally lag bull markets, but more than earn their keep during the downturns, so this was the long-awaited test.
...and it performed almost comically badly. Either the anomaly evaporated, or the specific version I was testing evaporated, or it did badly this one time but still outperforms over multiple cycles, or it was only ever an artifact of overenthusiastic back-testing.
If open secrets can persist in public… for how long? What are the factors that lead to them ultimately not working? Is it possible that an anomaly could exist in public indefinitely?
Could you expand on which momentum anomaly you tested? One type is cross-sectional momentum (buy the top 1/10th of stocks that went up and short the bottom 1/10th), which is subject to major periods of drastic underperformance. This is all well documented in the literature. The other type is using momentum on the market as a whole, perhaps switching between asset classes based on momentum. I would not think that you could assess a strategy based on 6 months of performance.
My view as an investor since the 1980s is that the EMH is true to a 0th approximation. However massive agency issues in the fund management industry leave room to outperform on a risk adjusted basis if your incentives are different from the average fund manager. Some anomalies are just not exploitable by fund managers/agents because they would lose all their funds under management after periods > 12 months of underperformance.
Sure—I was testing a dual momentum strategy over the market as a whole, with a 12-month lookback period. The ‘dual’ refers to both absolute momentum, and relative momentum between asset classes (bonds, US stocks, non-US stocks).
I haven’t evaluated it properly yet, but the signals it generated told me to stay in stocks until the end of March, at which point I ought move into bonds, just in time to miss the recovery. Over the period I’ve tested it so far (16 months) it has returned −4%, while my benchmark is at +18%. I am still mildly interested to see how it pans out, but I ignored the signals and am now only tracking it on paper.
Sports bookies deal with “investors” that have net biases—lots of people will, for example, bet on the home team because they’re fans. I also have it on pretty good authority that people drastically underestimate the variance in soccer matches between closely matched teams; when the World Cup comes around, a simple strategy of “bet on the underdog in every match” makes money.
I’m not exactly sure what you mean by “defensible”. It’s true that some anomalies evaporate almost immediately once they are noticed, but others persist long after that—even for decades.
One notable example of a long-lived inefficiency was the capping of the Euro/Franc rate at 1.20 from 2011 to 2015. This was announced publicly by the Swiss National Bank so it was available information. A price cap is a glaring market inefficiency, exploitable with a simple grid strategy. If the EMH were true, the rate should have settled at 1.20 almost instantly, but in fact, it took about three years for this to happen. And Forex is about as liquid as markets get.
Confusion: Can an anomaly be an open secret, and not defensible, and still somehow persist?
For example, I’m especially interested in the momentum anomaly. The momentum folks make a very compelling case that the behavioural econ reasons that brought it into existence are so dang powerful that it somehow persists, even though there are many papers/articles/books about it that anyone can read.
I personally found this just compelling enough to run a momentum experiment, based on a strategy that has done extremely well in reducing volatility and drawdowns in the past. Momentum strategies naturally lag bull markets, but more than earn their keep during the downturns, so this was the long-awaited test.
...and it performed almost comically badly. Either the anomaly evaporated, or the specific version I was testing evaporated, or it did badly this one time but still outperforms over multiple cycles, or it was only ever an artifact of overenthusiastic back-testing.
If open secrets can persist in public… for how long? What are the factors that lead to them ultimately not working? Is it possible that an anomaly could exist in public indefinitely?
Could you expand on which momentum anomaly you tested? One type is cross-sectional momentum (buy the top 1/10th of stocks that went up and short the bottom 1/10th), which is subject to major periods of drastic underperformance. This is all well documented in the literature. The other type is using momentum on the market as a whole, perhaps switching between asset classes based on momentum. I would not think that you could assess a strategy based on 6 months of performance.
My view as an investor since the 1980s is that the EMH is true to a 0th approximation. However massive agency issues in the fund management industry leave room to outperform on a risk adjusted basis if your incentives are different from the average fund manager. Some anomalies are just not exploitable by fund managers/agents because they would lose all their funds under management after periods > 12 months of underperformance.
LW readers interested in the topic may like reading the Alphaarchitect blog. https://alphaarchitect.com/blog/
Sure—I was testing a dual momentum strategy over the market as a whole, with a 12-month lookback period. The ‘dual’ refers to both absolute momentum, and relative momentum between asset classes (bonds, US stocks, non-US stocks).
I haven’t evaluated it properly yet, but the signals it generated told me to stay in stocks until the end of March, at which point I ought move into bonds, just in time to miss the recovery. Over the period I’ve tested it so far (16 months) it has returned −4%, while my benchmark is at +18%. I am still mildly interested to see how it pans out, but I ignored the signals and am now only tracking it on paper.
Sports bookies deal with “investors” that have net biases—lots of people will, for example, bet on the home team because they’re fans. I also have it on pretty good authority that people drastically underestimate the variance in soccer matches between closely matched teams; when the World Cup comes around, a simple strategy of “bet on the underdog in every match” makes money.
I’m not exactly sure what you mean by “defensible”. It’s true that some anomalies evaporate almost immediately once they are noticed, but others persist long after that—even for decades.
One notable example of a long-lived inefficiency was the capping of the Euro/Franc rate at 1.20 from 2011 to 2015. This was announced publicly by the Swiss National Bank so it was available information. A price cap is a glaring market inefficiency, exploitable with a simple grid strategy. If the EMH were true, the rate should have settled at 1.20 almost instantly, but in fact, it took about three years for this to happen. And Forex is about as liquid as markets get.