
Risk & Reward - Q3 2024
We use our quarterly journal, Risk & Reward, to present innovative and timely analysis from our quantitative investment teams.
Firms within the same economic cluster frequently see correlated share price movements and are characterized by delayed momentum spillover. Using two distinct approaches for grouping companies – sell-side analyst coverage and industry classification – we explore how these interconnected dynamics can be harnessed to boost investment performance.
No security exists in complete isolation – each is directly or indirectly linked to others. A common explanation for the occurrence of delayed momentum spillover is the ‘limited attention hypothesis’: When facing an influx of information about a particular stock, individuals struggle to process the information fully and may need time to realize its relevance for other, related stocks.1 As a consequence, these may underreact initially, creating opportunities out of past information.
The strength of linkage signals lies in their ability to offer additional insights beyond what is available from conventional information sources. Unlike conventional data, which is often limited to a specific region, sector, industry, or market-cap group, linkage signals draw from a broader range of contexts. They encapsulate information absent from traditional momentum signals and offer a distinct perspective that can enhance predictive accuracy.
We’ll construct two alpha signals based on analyst coverage and industry classification, which show strong performance across various markets, both individually and in combination. The analyst coverage signal captures stocks that are connected through shared coverage by sell-side analysts, while the industry classification signal identifies stocks based on their classification within the same industry. The two signals are constructed using a comprehensive global dataset from December 1996 to March 2023 and cover a significant portion of the global large-cap market.2
About risk
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
We use our quarterly journal, Risk & Reward, to present innovative and timely analysis from our quantitative investment teams.
This edition of Risk & Reward showcases the breadth of our research: from querying subjective expectations to examining sophisticated risk-mitigation strategies for equities and bonds, ESG and sovereign debt restructuring.
Indeed, the timeless idea – introduced to the world by Harry Markowitz in 1952 – of a portfolio with 60% equites and 40% bonds can deliver even better results when combined with a factor and risk overlay.