Insider buying, Cliff Asness, value and behaviour, banks and sectors to watch
Director dealings are one of those data points that can sometimes spark more questions than answers. On paper, big director buys can be an under-the-radar message about exciting future news or earnings. Big director sales can be a signal that there’s trouble ahead.
But while details of insider trades are irresistible to many on the outside, there’s a risk that there’s no story there at all. Big buys might just be the CEO trying to send signals of optimism. Big sales can be down to anything from messy divorces, school fees and tax bills. We’re all human, right?
So this is an interesting chart from the small-cap fund managers at Liontrust:
Under the index performance is a chart that tracks the quarterly ‘buys per sell’ ratio in the market since 1999. Rather than counting all the trades, this ratio counts the number of ‘insiders’ who either buy or sell in that period. So it’s the number of buyers against the number of sellers.
It makes a strong case that insiders are good at buying in uncertainty - the buying ratio spikes higher when the market falls. Nadirs in 2002, 2008 and 2022 all saw heavy buying activity. And that buying appears well timed - these trades often capture the bottom of the market.
Here’s another view:
This time the lower part of the chart shows the net value of insider trading. Almost universally, the net value of shares sold by directors exceeds the value of shares bought.
There have just been a few quarters when the net value was positive. And only a couple of occasions when there were two consecutive quarters of positive values. One was in 2002 and one was at the end of 2022.
So while 2022 was a hard year for many, it seems company insiders are finding reasons to be cheerful. Here’s the report.
In case you’re interested, here are some other articles from me this week:
A look at ways of finding cheap growth shares (Peter Lynch style) for Interactive Investor (here)
How and when to use a quality-bargain strategy for SharePad (here)
Cliff Asness and Barry Ritholtz on value, momentum and behaviour
Cliff Asness is interesting for a few reasons.
One is that he made the step from academic finance to professional money management and then made a fortune out of it.
He has stuck very closely to the academic spine behind the strategies at his firm, AQR. In particular he is an advocate for using value and momentum. And on this (and many other things) he’s usually one of the good guys but has a habit of… how can I put this?… being “robust” in his views. Which is a good thing.
Asness trained under the Nobel Prize winning economist, Eugene Fama. But the two men don’t see everything the same way. Fama has never properly accepted momentum as a return driver worthy of making it into his multi-factor models. Asness thinks that’s wrong… and that is where this podcast conversation really starts.
Here are a few observations:
Rational versus behavioural
An early question is why is the momentum disagreement even a thing? It’s because momentum doesn’t really have a rational driver (like value does). Most agree that human behaviour plays an important part - so that doesn’t square with the way Fama thinks.
Later, Asness says he’s become much more convinced of the fact that human behaviour is a major driver of his strategies:
[Paraphrasing] “There has always been a tension in quantitative finance about why these things work.
“If someone shows you a great backtest there are two possible explanations for it (assuming it’s not gibberish). It’s either that you’re taking an actual rational risk and being compensated for it, or it’s behavioural finance: some people are making errors.
“Take two Nobel laureates. Eugene Fama (the rational guy) and Richard Thaler (the behavioural guy).
“If you’d asked me when I left Chicago who I think is more right, I would have been 75/25 in the Gene camp. Now I think it would be 75/25 with Thaler. And all that means is more of why our stuff works I think is taking the other side of behavioural biases than a rational risk premium, than I used to.”
Value / growth switch since 2020
It takes a much longer time for excesses to get squeezed out of the market than people think, especially if you’re on the wrong side of it. If you’re a growth stock investor, the last couple of years you’re thinking you’re in such pain it has to be extreme.
AQR start with measures that don’t look at the absolute returns, but at the actual valuation ratios of stocks. At the peak of the bubble in 2020 it got to by far the widest ever - north of the tech bubble. After two-plus phenomenal years it is now at the 89th percentile.
There has been a junk rally in 2023. But believe it or not, value has had a very strong start to this year.
But you don’t fix 13 years of things getting more expensive in just one year.
“Nothing is a certainty. There can be huge reversals in any trend. We are still very excited to be seeing a mispricing that, prior to Covid, I would have considered almost close to tied with the most extreme ever. And we’re seeing the wind at its back.
“Over a time horizon of a few years we’re super excited about value.”
Is the size effect a thing?
Another important factor to consider is the size effect (small beats big) - but is this even a factor any more?
AQR’s view is that there never really was one. It’s not like it has been arbitraged away. Small-caps tend to have higher betas, which was one potential driver of outperformance. More recent research suggests that those betas were underestimated and that their alphas were overestimated. Where you meet in the middle, you find there is no small-cap effect going on.
“I think many anomalies, factors and effects that quants and academics believe in, do work better among small-caps. Long-cheap, short-expensive in small-caps has a higher gross risk-adjusted return. Net, they are more expensive to trade. I have no problem with someone saying “I love small-value”, because I think value really does work better.
“But the small-cap effect often gets conflated. It is not small-value. It is that small is better than large.
“That said, small-caps do worse against more modern factors.”
Value and quality since the global financial crisis
Value lost during the post global financial crisis period for “rational reasons”. That was because expensive companies by-and-large outperformed not just on price but they also out-executed. They grew more in terms of earnings, sales and cash flows.
Pure value investors (in a quant sense) win on average because prices fall too far. The expensive stuff is better (the companies are better), but not that much better. But sometimes (not often) the expensive stuff ends up being worth it. When that happens, quant value will suffer.
Another consideration is bubbles. In bubbles (like the post-GFC period) everyone wants the darlings with the greatest stories, regardless of whether they are executing - and value suffers painfully as a result.
Caring about price versus anything (even if it were immune to the potential skew of intangibles) was not a very good thing until late 2020 since the GFC.
What is the impact of share buybacks?
They are largely a ‘nothing’. They are a more tax efficient dividend. For different levels of innumeracy and paranoia, both the political left and the political right (in the US) hate stock buybacks.
Recent evidence shows that companies that perform buybacks do better than those that don’t (implying that management think the stock is undervalued). It’s also the case that the shareholders own that cash anyway. Some companies seem to do them to mask management stock option payments - but even in these cases, it’s not the buyback that is bad.
Making sense of banks, technology and healthcare
At the start of the week, I was seriously thinking of writing something with a view to finding ideas in the UK and European banking sector. I’ve changed my mind about that! That’s not to say that there aren’t opportunities, but that there are so many moving parts with banks that having a bank analyst to lean on would be essential.
This article from Terry Smith sums things up on the bear side: Why I never invest in bank shares. Smith was once a bank analyst so he has at least some idea. Not only do they generate poor returns compared to other sectors, there’s also the unfortunate fact that if one falls over, even the good ones can become vulnerable. Add in the fact that innovation in and around the finance sector is producing more exciting and potentially more profitable companies, why would you buy shares in a bank?
But while banking seems to be teetering on a precipice, is there anything good going on?
This is an interesting article from AllianceBernstein that rethinks the conventional view of the technology and healthcare sectors: Redefining Offense and Defense in Equities: The Evolution of Technology and Healthcare
In the offence/defence stakes, technology is traditionally seen as quite aggressive. In rising markets it flies and in down markets it slumps. And that really tallies with what we saw from high profile tech giants last year. But the truth is that much of the tech sector is sturdier and more predictable than you might think. Which means that low-beta tech could be worth a look as a defence against rising rates.
On the flip-side of that, healthcare has traditionally been a defensive play. And that certainly proved to be the case last year, too. But look harder, and you find that healthcare is packed with innovation companies (without resorting to super-speculative biotech). So here we have a sector that could offer much more offence (in a good way) than text book portfolio theory might have you believe.
Have a great weekend!
Ben
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