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Value And Momentum In Sports Betting

By Jack Vogel As noted through our previous posts, we are big proponents of Value investing and Momentum investing strategies. We even highlight the best way to combine value and momentum . However, there is a new paper by Toby Moskowitz, titled “ Asset Pricing and Sports Betting ,” which examines how size, value and momentum affect sports betting contracts: I use sports betting markets as a laboratory to test behavioral theories of cross-sectional asset pricing anomalies. Two unique features of these markets provide a distinguishing test of behavioral theories: 1) the bets are completely idiosyncratic and therefore not confounded by rational theories; 2) the contracts have a known and short termination date where uncertainty is resolved that allows any mispricing to be detected. Analyzing more than a hundred thousand contracts spanning two decades across four major professional sports (NBA, NFL, MLB, and NHL), I find momentum and value effects that move betting prices from the open to the close of betting, that are then completely reversed by the game outcome. These findings are consistent with delayed overreaction theories of asset pricing. In addition, a novel implication of overreaction uncovered in sports betting markets is shown to also predict momentum and value returns in financial markets. Finally, momentum and value effects in betting markets appear smaller than in financial markets and are not large enough to overcome trading costs, limiting the ability to arbitrage them away. Some Interesting Points The figure below explains the different price movements which are studied in the paper: The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Here are the T-stats for the momentum betas in the figure below: (click to enlarge) The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Analysis from the paper: A consistent pattern emerges for the Spread and Over/under contracts in every sport, where the momentum betas exhibit a tent-like shape over the three horizons—near zero from open-to-end, significantly positive from open-to-close, and significantly negative from close-to-end, with the initial price movement from open-to-close related to momentum being fully reversed by the game outcome. The patterns for the Moneyline contracts exhibit the same tent-like shape, but are less pronounced, consistent with the Moneyline perhaps being less affected by “dumb” money and more dominated by “smart” money. Then the paper shows the T-stats for the value betas in the figure below: (click to enlarge) The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Analysis from the paper: A consistent pattern is evident from the plots: a value contract’s betting line declines between the open and close and then rebounds between the close and game end, reaching the same level it started at the open. These patterns are consistent with an overreaction story for value, where value contracts, which measure “cheapness”, continue to get cheaper between the open and the close, becoming too cheap and thus rebounding positively when the game ends. This picture is the mirror image of momentum, where value or cheapness is negatively related to past performance, and hence the pictures for momentum and value tell the same story. (Though, recall the measures for value and momentum were only mildly negatively correlated.) Conclusion from the paper: Examining momentum, value, and size characteristics of these contracts, analogous to those used to predict financial market security returns, I find that momentum exhibits significant predictability for returns, value exhibits significant but weaker predictability, and size exhibits no return predictability. The patterns of return predictability over the life of the betting contracts—from opening to closing prices to game outcomes—matches those from models of investor overreaction. The results suggest that at least part of the momentum and value patterns observed in capital markets could be related to similar investor behavior. The magnitude of return predictability in the sports betting market is about one-fifth that found in financial markets, where trading costs associated with sports betting contracts are too large to generate profitable trading strategies, possibly preventing arbitrage from eliminating the mispricing. Our Thoughts: An interesting paper, showing that Value and Momentum work within the sports betting market, but the cost of trading on the signals is too large for profitable trades. This is probably why the “house always wins.” It’s a good thing I watch countless hours of sports to form my own “expert” opinions! Original post

Building A Dividend Stream With The Best U.S. REIT ETF

Summary The uncertainty around the interest rate hike was not resolved in September. The high level of volatility is expected to continue in the coming months as well. Take advantage of the occasional dips to build a position in an income stream ETF. Back in June, after the second quarter of high volatility in the REIT sector, I wrote about the opportunity in U.S. REITs. The latest dip was marked during the first half of September towards the Fed’s decision when we saw both the REITs and utilities dropping dramatically. Since the Fed announced that it is essentially pushing out its decision to a later date, there is no reason to believe that the high volatility is behind us and that we will not see high levels of anxiety towards the Fed’s announcements, the one in October or in December. The volatility in REITs is well seen in this Vanguard REIT Index ETF (NYSEARCA: VNQ ) graph. The ETF hit $72 just after Yellen’s announcement, but in the following couple of weeks, it rallied pretty nicely, closing at $75 on September 25. (click to enlarge) Is it still the best U.S. REIT ETF? The next table compares VNQ to the other 15 ETFs that are focused on U.S. REITs. I marked the top five in each of the categories of dividend yield, management fees and the total return during the last 3 and 5 years in green. (click to enlarge) VNQ was favorable in all of the categories, delivering more than 4% yearly yield at only 0.12% yearly management fees with an impressive 72% return during the recent five years. Throughout 2015, through times of uncertainty and concerns, not only has VNQ continued to pay uninterrupted dividends, but also on top of that it grew its dividends by ~10% compared to the year before. The next graph shows VNQ’s quarterly dividends starting Q1’10 until the recent Q3’15. For Q4’15, I have plugged a $1.1 dividend, which is equal to the one paid back in Q4’14. While the other three dividends this year went up by 10%, it would be very hard to believe that the forth one will not grow, but I always like to be conservative: (click to enlarge) How can we model it forward? The 2015 dividend per share is estimated at $3.13, growing 10% year over year. An investor who wants to build a position during the next 10 years can generate some interesting strategies assuming they are willing to invest in VNQ regularly. What can one expect from this type of investment? First thing, let’s examine the dividend growth rate. Nothing can grow forever at the level of 10%. Moreover, this sector like any other sector is exposed to risks. REIT risks are associated with macroeconomic slowdown, space overflow and rental pricing. For a long-term model, let’s judge the growth rate to be 4-5% per year for the next decade. Model Assumptions Dividend rate: The current VNQ dividend rate is 4.2%. Let’s use it in the first year. Dividend growth rate: If we should pick a number between 4% and 5%, let’s go with 4.5%. Tax rate: Since not every investment can be tax free, let’s assume a 25% tax rate on the dividends. Investment: $1,000 invested per month or $12,000 yearly investment across a time period of ten years. The dividends, net of taxes, are assumed to be reinvested as well. VNQ’s price: The ETF price across the years is highly unknown. In order to mitigate that, let’s look at two scenarios. Scenario 1: VNQ’s yearly prices change at the same pace as the dividend per share. That means that in this scenario the ETF price will go up by 4.5% every year. Scenario 2: VNQ’s price remains at $75, or in other words the investment and reinvestment are taking place through the time of dips in the ETF pricing. Scenario 1 results In this case, where the ETF prices are growing alongside the dividend per share, after ten years, the investor has accumulated a holding of 2,093 VNQ shares. This holding has the potential to generate $9,739 in dividends per year. The investor invested $120,000 and therefore can expect 8.1% return on his investment in the tenth year. An income stream that potentially will continue to grow afterwards. Scenario 2 results In this scenario of flat ETF prices through the ten-year horizon, the amount of accumulated shares is ~30% higher than in scenario 1. The holding is getting to a total of 2,783 shares. It has the potential to generate a yearly income stream of $12,946 per year pre-tax. The following year, if we’re maintaining the same assumptions of reinvestment, the income stream after taxes is expected to exceed the $12,000 threshold. After ten years, the investor had invested $120,000 and expects to receive 10.8% in annual dividend return on his investment. Conclusions The anxiety regarding the interest rate will accompany us in the coming months and years. This will generate great opportunities for the long-term investor who is pursuing an income stream. The REIT sector is expected to grow even if the interest rate will rise. I find VNQ to be the best ETF that focuses on U.S. REITs. The patient investor has the potential to gain significant returns by setting their investment strategy straight. As there is no way to best optimize the entry or time the market, the investor should build a position through several purchases. And lastly, an investor should take advantage of the days of panic. These will be the days that will serve them well in the long run.

Short-Selling: What Are You Optimizing?

Summary What separates investing from gambling? Positive expected value. Short-selling has a negative expected value – more negative than some casino games. What are you optimizing? In theory investing is about optimizing return, but many investors’ behavior suggests they are optimizing/minimizing something else. For some heavy short-sellers, it’s intellectual stimulation. I don’t think short selling is right for me or most investors, but this is just my still-evolving opinion. Full disclosure: I’ve never shorted a stock in my life. As such, I’m probably terribly biased and not credible. Short selling is betting that a stock or security will go down. Instead of buying low and selling high, you first sell high and then buy low. You do so by borrowing someone else’s shares when you initially sell and then replacing those shares later on by buying them. For reasons I will explain in this article, I don’t think most investors, including myself, should engage in short selling. Some should, but even for those for whom short selling (“shorting”) is appropriate, it probably should not be used as a primary strategy. This argument has been hashed out many times. I could repeat what’s been discussed many times. For example, when you engage in shorting your upside is limited and downside unlimited – the unfavorable reverse of going long. Instead, I will focus on what I see as the most important points for me and perhaps where I’ve added some original thought. When you short-sell a stock, the odds are against you What separates investing from gambling? Sure, investing isn’t done in a casino, it’s much more calculated, there’s far more money in it, etc. The biggest difference though, is that when you gamble, there is a negative expected value – the odds are against you. The casino takes a cut. When you invest, there is no golden rule saying it has to be a favorable bet, but equities in the US have been increasing rather consistently for over 150 years (see Jeremy Siegel’s excellent book Stocks for the Long Run ). Studies of “rules-based” systematic investing styles like buying the lowest 10% of the market by EV/EBIT and rebalancing annually will often include the returns of the opposite decile (the highest 10% of the market by EV/EBIT in our example). The idea is that the larger the gap in returns between the two poles, the more predictive value the metric has. So what’s the point? Well when you look at these studies, it’s surprisingly hard to find one where the worst decile is actually delivering negative returns. This is significant because it means that stocks don’t only appreciate substantially on average, it’s also hard to find some that will go down at all. For myself and presumably many other investors, this odds-against-you fact is a total deal breaker. I remember in high school, I would print out the Las Vegas odds of each weeks NFL games and offer to do straight bets with anyone on any game so long as I had the favorite. I was okay with this activity because by picking the favorite without paying for it, I had a positive expected value – even though I didn’t know that term at the time. Several months ago, I was viewing the Ultimate Fighting Championship with family and someone suggested we bet on the fights. We would pool money and bet on who would win the fight and what round (or decision) they would win in The gamble was, on the surface zero-sum. No one was taking a cut of the bets. And I did research. I immediately pulled out my smartphone and looked up the favorite in each fight. I then looked up what percentage of UFC fights end by knockout versus decision. (click to enlarge) 41% of fights go to decision. Assuming a three round fight (most fights are 3 rounds, championship fights are 5), that 41% is significantly higher than the 25% it would be if each outcome were equally likely. So in each fight, I picked the favorite by decision with some confidence that I had a positive expected value. I won three out of the four fights we bet on. My approach to these situations where the game is explicitly zero or positive sum is in stark contrast to negative expected value situations. Casinos take a cut of all bets by structuring games such that odds are slightly in their favor. The lottery usually has a very negative expected value because: the winnings are taxed at the highest federal income rate and by your state as well municipalities take a huge cut (it’s a significant source of revenue for them) the advertised prize is not a present value, it’s usually a long-term annuity – taking the cash up front means getting far less there could be multiple winners that split the winnings, and the probability of this increases when the pot is large and many tickets are sold, offsetting the EV benefit of the higher pot. I’ve never engaged in these sorts of activities and would have a lot of trouble forcing myself to. It is counter to the investor mindset. But short sellers do just this. On average, they will lose money. The expected value is negative. The idea, though, is that by doing deep enough research and being opportunistic enough, they can make the expected value positive. This is tough for me to accept. First, the odds are dramatically against them on the surface. If stocks appreciate 9.5-10% a year in nominal terms, those odds are far worse for the short seller than some casino games. For example, in blackjack, the odds of you winning versus the dealer are 48%. Roulette is something like 47.4%. If stocks are appreciating 9.5-10% that’s the equivalent of ~45%. And that’s just the direct costs. Then there’s taxes, dividends you must pay on the shares you short, borrowing costs on hard to borrow stocks (unfortunately, many of the stocks with the best short cases have the highest borrowing costs because everyone wants to short them). This is somewhat offset by the fact that you can (I believe) use some of the cash you receive from the sale upfront for other things in the interim. I believe this depends on your creditworthiness as perceived by your broker, the size of the short sale relative to your assets, etc. Some brokers may require you to keep the margin in cash, which eliminates this benefit. The bottom-line: short selling is a negative expected value activity, so why do it? What are you optimizing? Value Investors Club is a great site. The quality of research is very high and there are some smart people on it – some of the smartest people in the investment industry, in fact. That’s why it confounds me that some of these investors are so short-focused. Some of these investors have written 25 articles and like 23 of them are shorts. Some of the smartest investors with the highest profiles are also heavy shorters. David Einhorn and Bill Ackman come to mind. Ackman now describes his firm as primarily long but opportunistically short, which may be the case, but historically he’s done a lot of shorting. I have a theory that these investors are attracted to shorting precisely because the expected value is worse than going long. It’s harder. It requires deeper research. It’s intellectually stimulating. It’s exhilarating. These things probably really appeal to smart people with a chip on their shoulders for some reason. But what is investing about? Is the goal of investing to optimize return or optimize intellectual stimulation? Most investors agree verbally that it’s all about return, but most don’t behave that way – and there are other examples. Obsessions over volatility, dividends, minimizing taxes, etc. are all examples of other things I’ve found many investors trying to optimize through their behavior. Buffett has said a few insightful things on this topic: “You don’t get points for difficulty” The mono-linked chain metaphor The one-foot hurdle metaphor It is certainly understandable that for investors capable of analyzing and understanding very difficult situations, it is challenging to focus on easy ones. Conclusions I have some other thoughts like the idea of specialization – maybe an investor, for some reason like a deep skeptical streak, is much better at shorting than going long – but they will have to wait for another post. This article is just me putting my thoughts to paper. At this point, I’m comfortable recommending that most investors (including myself) focus on positive expected value situations to optimize return and that means avoiding short selling.