Twelve years ago Stanford professor Joseph Piotroski effectively demolished the Fama and French argument that the excess returns reaped by value investors should be thought of as a risk premium. Fama and French, like others before them, had rightly observed that a significant proportion of value stocks are actually “value traps”: bad firms headed for a worse future, cheap because they deserved to be. From this they concluded that value investors were simply being paid a higher return for the higher risks they incurred.

Piotroski dug deeper and found a very different story. (more…)

We’re not sure what a good bankruptcy is but especially bad bankruptcies tend to follow one of two patterns. In the first a viable business is hastily liquidated rather than being reorganized, often because the secured creditors want to get out fast and run roughshod over other stakeholders.  The other bad pattern is that the managers who ran the company aground in the first place control the process, are insufficiently punished, and end up back in control of the re-orged company ready to do it all over again.

The solution: (more…)

After considering almost 500 research papers, Whitebox Advisors, the $2.3 billion investment advisory based in Minneapolis, today chose the top 10 finalists for its $25,000 prize for the best financial research paper of 2011.  The winner will be announced at a luncheon for guests and invited press on June 19^th, 2012 in New York City. (more…)

Click here to read the new edition of The Whitebox Advisor, called “The Era of Incumbency.” An excerpt:

Beyond regulation, beyond the diminished stature of Wall Street, beyond the absence of new sources of liquidity to repower investor exuberance, there is a more fundamental reason that the IPO craze and all it represented will not come back: the center of action in the economy has shifted away from the small new firm with the big idea toward the big established firm in the market for modest improvements to the big idea.We have left the era of the upstart; we have entered the era of incumbency. (more…)

Hedge funds are commonly critiqued for engaging in a “herding” mentality, augmenting price momentum, driving markets further from equilibrium, and making market crises more severe rather than arbitraging mis-pricings back toward sanity.  A new study from Blerina Reca, Richard Sias and H.J. Turtle takes a close look at the data and finds this perception far less true of hedge funds than of other institutions. In fact, the authors claim, the “herding propensity” of institutional traders that are not hedge funds’ is eight times that of hedge funds. Non-hedge funds are far more likely to engage in momentum trading and non-hedge funds have significantly more overlap in their portfolios and their over-weighted positions than do hedge funds. All this is not to say hedge funds do not overlap; they do. But even when they do, hedge fund overlap appears to have a positive relationship with returns (that is, where hedge funds overlap, they tend to make money) while non-hedge fund overlap has a clear inverse relationship with returns (where non-hedge fund institutions overlap, they tend to lose money).

CEOs who behave recklessly in their private lives (drive drunk, get tickets for speeding, that sort of thing) are markedly more likely to engage in or tolerate fraudulent behavior in their firms. CEOs who live high on the hog (buy expensive houses, big boats, etc.) are not any more likely than frugal executives to commit fraud, but they are more likely to create a culture in which financial errors and even fraud occur.

A nicely argued and occasionally profound summary of the arguments for human judgment in investing; It also made us aware of some empirical work vindicating active management that we had not seen before.

-RV

The authors argue, persuasively, that the ten year drought in the IPO market has not been driven primarily by increased regulatory burdens (Sarbanes Oxley, Reg. FD) as many have argued, nor simply by the deflation of investor exuberance, another popular explanation.  Instead the lack of enthusiasm for IPOs, especially of small firms, appears to be… (more…)

The launch of the Whitebox Mutual Funds leads this Advisor Emporium article in Financial Advisor magazine. To read the whole article, click here.

This is an admirably careful study of hedge fund performance from January 1995 through December 2009.  Using the Lipper TASS database of some 13,000 funds living and dead, and eliminating non-dollar funds, funds of funds, and funds that reported gross, pre-fee returns, Ibbotson and  colleagues were left with some 6,000 funds. Correcting for survivorship bias and backfill bias (the tendency for funds to start reporting returns after a hot year) the team found that hedge funds in the sample on average yielded positive alpha every year except (more…)

Behavioral Finance has made a huge investment in identifying “systemic biases” that might explain enduring anomalies in financial markets. The admirable goal has been to define the particular bias that best explains a given anomaly, from the closed end fund puzzle to investor preference for dividends to the Royal Dutch-Shell phenomenon in which two identical share classes with different names  display persistent price differences. Now Philip Maymin of NYU-Polytechnic comes along with an argument both theoretical and empirical that says all that work might not matter. (more…)

A new edition of the Whitebox Advisor is available. An excerpt:

…along comes a professor. The professor proclaims that he will prove “if A then B.” Surprising no one, he succeeds. His proof is rigorous and correct, just as one would expect from a man who has any number of degrees to his name and even better gets to pick A, plus gets to assume that A is the case and therefore has nothing to prove except that “A implies B,” which he also gets to pick.

Next the professor, with becoming modesty, admits what we already know: (more…)

Back in 2004 Andy Redleaf and I wrote that U.S. manufacturing would begin to rebound in the next decade, for the simple reason that the 50 year international labor cost arbitrage was just about exhausted. Looking at the data,  we discovered that it takes about 25 years for the latest “super-cheap-let’s-go-build-it-there” emerging industrial economy to lose its effective labor cost advantage over the U.S.  People often miss how fast and fleeting the labor cost edge is because they look at raw wage differentials: a buck per hour in the latest Asian wasteland vs. $20 per hour in Detroit. The raw figures miss two big points.  (more…)

As we comb through submissions to our financial research contest (deadline for submissions is January 31), we’re still trying to bring you the best in daily finance content on the web through our “Selected Readings” column. In the last week, we’ve linked to  interesting articles on Private Equity firms and their impact on job creation, pointed you towards positive and negative indicators for the economy in 2012, and highlighted some of the more eccentric insights and writing on behavioral economics and the economy out there.  Keep your eyes peeled on the right hand column for these updates, and keep your eyes on the center column for our continued effort to bring you the best financial research on the web.