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Value by Design?

Stephan Kessler, Bernd Scherer and Jan Philipp Harries
The Journal of Portfolio Management Quantitative Special Issue 2020, jpm.2019.1.122; DOI: https://doi.org/10.3905/jpm.2019.1.122
Stephan Kessler
is co-head of quantitative investment strategy research at Morgan Stanley in London and a lecturer at University of St. Gallen in St. Gallen, Switzerland
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Bernd Scherer
is senior MD and head of asset management at a privately held German bank and a research associate at EDHEC in Lille, France
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Jan Philipp Harries
is research assistant at the Chair of Finance and Corporate Governance at the University of Wuppertal in Wuppertal, Germany
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Abstract

Although academics and practitioners frequently refer in their work to equity value investing, no consensus exists as to what this style exactly encompasses. For a wide range of 3,168 alternative implementations (design choices) of what could all constitute value portfolios, the authors document the impact of parameter pertubations on risk-adjusted returns. The observed dispersion in Sharpe ratios allows the authors to identify the hierarchy of design choices and to better assess the degrees of freedom consumed within the strategy development process. The authors can therefore derive critical t-values that adjust for overfitting. This will prove to be useful in research governance and strategy selection.

TOPICS: Style investing, statistical methods

Key Findings

  • • Design choices create large variations in risk-adjusted returns. Characterizing factor investing as (scientific or smart) betas with no alpha underestimates the importance of skillfull choices.

  • • Among design choices, signal definition is most important in explaining risk–return differences. However, even inferior signals can lead to significant performance gains when combined with selected portfolio construction choices, indicating the potential for data mining.

  • • Investment firms with credible research governance need more awareness of the many degrees of freedom their research teams consume daily. The statistical literature on multiple hypothesis testing can provide those tools.

  • © 2019 Pageant Media Ltd
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The Journal of Portfolio Management: 49 (4)
The Journal of Portfolio Management
Vol. 49, Issue 4
Multi-Asset Special Issue 2023
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Value by Design?
Stephan Kessler, Bernd Scherer, Jan Philipp Harries
The Journal of Portfolio Management Nov 2019, jpm.2019.1.122; DOI: 10.3905/jpm.2019.1.122

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Value by Design?
Stephan Kessler, Bernd Scherer, Jan Philipp Harries
The Journal of Portfolio Management Nov 2019, jpm.2019.1.122; DOI: 10.3905/jpm.2019.1.122
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  • Article
    • Abstract
    • DATA
    • SUMMARY OF INVESTMENT STRATEGY DIMENSIONS AND RELATED CHOICES
    • IMPACT OF INVESTMENT STRATEGY DESIGN CHOICE ON PERFORMANCE
    • IMPACT OF DESIGN CHOICES ON INVESTMENT STRATEGY RETURN CHARACTERISTICS
    • DESIGN CHOICE AND SIGNIFICANCE TESTING
    • DESIGN FISHING
    • CONCLUSION
    • ACKNOWLEDGMENTS
    • ADDITIONAL READING
    • ENDNOTES
    • REFERENCES
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