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Why we do need to actively manage an equity portfolio during
earning releases period?
Julien Messias, Uncia Asset Management
[email protected]
http://eqderivatives.com/
Earning releases periods can be defined by :
- The fact that it is impossible to forecast any market reaction
on any earnings release. - Focusing on market reaction to
fundamental data release rather than to fundamental
data itself, it is possible to take profit from this period of
inefficiency.
Earnings releases : a lottery
Even if it is very difficult to admit for our Equity Analysts
friends, all the empirical data available show that
it is impossible to predict the market reaction following an
earnings release. Thus, we need to distinguish
the fundamental aspect (Turnover, EBITDA) which is less
impredictible, from the price signal aspect, the
latter, even looking at fundamental data already released,
remaining impossible to predict.
Empirically, the specific move, linked to earnings release, is
on average null, on a statistical perspective,
its distribution exhibiting a very high leptokurticity.
Therefore, for an Asset Manager whose aim is to
optimize his Sharpe ratio, it is not worthwhile to keep the
positions over the earnings (assuming transaction
fees and liquidity fees to be marginal).
Lets remind at this stage Daniel Zajdenweber in his book
Lconomie des Extrmes : "Admitting that
we had, between 1983 and 1992, as many days up as days down at
the New York Stock Exchange (NYSE),
hypothesis often verified on the other stock exchanges,
including Paris (D. Zajdenweber [1994]), then the
main part of the index increase occured during roughly 3% of the
business days, or 8 days per year. []
Empirical Distribution of the returns
over the earnings release.
In red, PER >25. In black, PER
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For the practitioner, this phenomenon is an anxiety factor,
because it means that the few extreme daily
variations count by far more in the yearly performance than the
very numerous small variations. ". Thus,
the yearly performance of an asset manager or a financial asset
relies on 8 to 10 daily performances
The Asset Manager should remain very low-profile when facing
such period of high uncertainty. But we
may wonder: How to turn earnings releases from a risk into a
source of alpha?
PEAD, what is it ?
PEAD means Post-Earnings-Announcement-Drift. It is a behavioral
bias studied since 1968 and the original
article by Ball & Brown An Empirical Evaluation of
Accounting income Numbers . Since then, many
researchers have been going through this effect over the last 50
years, especially in the US. Although
many interpretations exist, the broad philosophy remains quite
simple, but so counterintuitive...The aim
is to follow the trend over weeks or months, buying a stock
after a spike over the earnings, or selling a
stock after a dip over the earnings : this is the opposite of
managing a portfolio through the upsides, that
remains a very mean-reverting approach. Many papers by Bouchaud,
Potters and al. (Two Centuries
of Trend-Following ), plead for this trend-following approach.
But it needs a very harsh discipline, the
latter being very difficult to stick to, given the human
characteristics of investors. The explanations of the
success of PEAD rely on the time needed to interprete and digest
the information by some main financial
actors.
First, the main financial institutions often deal with very
strict investment processes. This makes their
reaction time lasting when new information arrives : Investment
Comitee needs to be gathered
Then, lets speak about the equity analysts:
Financial analysts are known to be market movers and have a
significant impact on many stocks,
especially analysts from bulge-brackets banks. The Equity
Analysts lag, when arriving new information,
is empirically proven, the point is to get benefit from it :
when new significant information arrives (with a
very sharp move of the underlying), the analyst first has to
reexamine the inputs of his model, then write
down his investment case, and eventually release it. This
process does not happen instantaneously, it
takes some time: this is the reason why the impact of the
analyst on the stock price only occurs some
weeks later. Moreover, do you think it is likely after a very
sharp move up (resp. a very sharp leg down),
that the equity analyst downgrades (resp. upgrades) his Target
Price? No, because the analyst forecasts
the pursuit of the trend and then feeds the trend-following
aspect of the market.
This strategy seems simple as an investment philosophy, but is
quite complex to deal with. It needs a very
rigorous follow-up, and perfectly fits universes known as
Momentum, such as Nasdaq 100 and Nasdaq
Composite in the US. In Europe, this strategy is very difficult
to put in place because the information
release occurs in two stages: the Earnings Release (ER) before
the market opens, releasing the past
accounting data, and the Earnings Call (EC) occurring during the
market, during which the management
of the company discloses the guidances, i.e future information.
Thus it is very common to notice very
large market moves from the Earnings Release , to after the
Earnings Call . In the US, the information
is simultaneous, with Earnings Release , and Earnings Call
occuring After-Market with a 30 minutes
lag, the following days open price taking into account the full
information (ER+EC).
The Equity Analysts lag
Source : CFA
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This investment universe, known as Momentum is one of the main
field of expertise of Uncia AM, the
French High Growth specialist. This way of managing asset is
very different from the traditional value
way of investing; applying the value investor recipes in this
Momentum universe may lead to catastrophe.
Therefore, in addition to the fundamental criteria through our
stock-picking that remains our DNA we
optimize our way of investing by taking PEAD effect into account
in our market timing. This is the result of
a long research on the 4 main US indices (Standard & Poors
500, Russell 2000, Nasdaq100 and Nasdaq
Composite), the last two being the best proxies of our style. We
run the study from 2003 to 2015, thus
with different markets environment. Conclusions are:
This strategy is robust, regarding all the checks done, the
scientific methodology applied and the sample
used (more than 200 000 publications).
For instance, the historical composition of these indices has
been used to avoid any survivorship or birth
bias in the sample used and issues linked to liquidity as
discussed before (every stock with market
capitalization less than 1 Bln USD was excluded).
The PEAD produces abnormal return statistically positive, even
if positive signals seem more robust than
negative signals (Nasdaq Composite graph and Nasdaq 100).
In orange the strategy applied to the
Nasdaq Composite universe
Maxdrawdown : -11.18%
In blue, the benchmark HFRIEHI.
Maxdrawdown : -30.59%
Source : Uncia AM
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Using systematically this strategy can be used as a predictor of
the corresponding index. The investors
over reaction after a result publication is an indicator of
their mood and risk aversion. If investors over
react more on good news rather than after bad news we could
conclude that their mood is more optimistic
than pessimistic. So, the strategy will create an implied net
positive exposure.
The graph shows that, on the Nasdaq Composite, the strategy
non-market neutral (with a net exposure
related to signals from the PEAD) outperforms significantly the
market neutral strategy, particularly in
2008 (sharp drop of the market) and 2013 (strong rise of the
market).
In orange the strategy applied to the
Nasdaq 100 universe
Maxdrawdown : -7.79%
In blue, the bechmark HFRIEHI.
Maxdrawdown : -30.59%
Source : Uncia AM
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To summarize, many investors are skittish and reticent to invest
in the Growth style, given the
outperformance of the Value style as illustrated by Fama and
French in 1997 in Value vs Growth: The
International Evidence. According to Lancetti, this
underperformance of the Growth style, over a long
period of time, is the direct consequence of the investors
overreaction on negative for Growth shares
which is very significant, whereas for Value stocks, the latter
do not suffer as much.
Therefore, controlling this effect, growth style and value style
have equal performance over a long period
of time.
Welcome in the PEAD and its Smart Earnings universe!
Uncia AM is the French specialist of High Growth management
style. For more information, go to our
website www.uncia-am.com or [email protected]
In orange, the strategy applied to
the Nasdaq Composite universe,
non-market neutral,
Maxdrawdown : -11.18%
In blue, the strategy applied to the
Nasdaq Composite universe, market
neutral.
Maxdrawdown : -11.81%
Source : Uncia AM
http://www.uncia-am.com/mailto:[email protected]
