September 23, 2019

Black Swans & Factor-based Investments

Black Swans & Factor-based Investments

Though it could be argued that fear is irrational investors fear swan events. The black swan theory is really a metaphor which describes a surprise event which has a major impact and is rationalized together with all hindsight. A recent case is a financial catastrophe, which sounds obvious from today’s view as subprime lending and your house price appreciation was but was impossible to predict.

If the function is going to soon be a surprise, should it be feared by investors? Markets are cyclical and so do not count as black swan events, keep markets are to be expected. How of the epidemic of an Ebola virus that is aerial, a surprising meteor attack, or the rise of a hostile intellect?

It is suspicious if investors need to or may prepare for these types of events. Furthermore, dark swan and events tend to be unique in nature and also affect businesses. Areas in industries such as healthcare or facets like Quality turn out differently than anticipated. Investors would consider businesses like real estate stocks safer but that was not the case during the financial crisis.

We will inquire into the operation of equity factors after swan and major events since 1990. The objective is to just take a walk through history, not to evaluate how to plan the unexpected.


We concentrate on seven factors Value, Size, Momentum, Very Low Volatility, Quality, Growth, and Dividend Yield. The variable portfolios that are long-only consist of 30% of stocks ranked most favorably by the variable definition. Simply stocks with a market capitalization of $1 billion are all included. Portfolios rebalance monthly and transactions incur 10 basis points of costs. Please visit our Factor Guide for its variable definitions.


12 events that had major impacts on the financial and world markets are focused on by us. A few were more positive and improved the lifestyles of countless of people such as the dissolution of the Soviet Union. Others concentrate on single companies such as the bankruptcies of Enron and Lehman Brothers.

It’s worth noting that it is hard to specify what may be predicted swan events. When we specify these as unexpected events, then were the Tohoku earthquake in Japan and the attack on the United States. The majority of the events were expected or could have been anticipated by investors using a certain probability. The 1-2 events will be the next:

  • 1990 Iraq invaded Kuwait
  • 1991 Dissolution of the Soviet Union
  • 1997 Asian Financial Crisis — Re-valuation of Thai Baht
  • 1998 Russian Financial Crisis — Re-valuation of Ruble & Debt Default
  • 2001 9/11 Terrorist Attack on the USA of America
  • 2001 Enron Bankruptcy
  • 2005 Hurricane Katrina from the USA of America
  • 2008 Lehman Brothers Bankruptcy
  • 2011 Tohoku Earthquake & Tsunami in Japan
  • 2015 Greece Debt Crisis — In Arrears to the IMF
  • 20-16 2016 United States Presidential Election
  • 2016 UK Brexit Referendum

We’ll emphasize the operation of equity variable portfolios for a number of the 12 events. The four chosen events will be the 9/11 terrorist attack to the United States of America (2001), the Lehman Brothers bankruptcy (2008), the Tohoku earthquake and tsunami at Japan (2011), and the Brexit referendum in the United Kingdom (2016).


The attack in New York in September 2001 can likely be categorized like being a black swan event as it was a sudden event that struck both on the military and financial centers of the US. Actually, the event seems far more inclined than.

Even the Nasdaq and NYSE markets have shut the occasions after the attack and started somewhat lower when trading stopped. The variable performance in the following days was quite explosive and diverse. Even the dispersion in returns is described with a strong market turning, e.g. airline and hotel stocks sold off sharply in the days after the strike.

We discover that factors followed the current market, but for Dividend Yield variable portfolios, Low Volatility, and the Momentum, which all declined less. It is apparent the other two factors out-performed, although investors devote to the minimal Volatility variable for capital security. The Momentum variable performance can be explained by the industry exposure at that moment, which had over-weights in Consumer Staples and Healthcare as well as underweights in Consumer Discretionary and real-estate stocks. However, the Momentum factor doesn’t exhibit business tilts or so the outperformance during 9/11 should be caused by luck.


This investment bank Lehman Brothers’ bankruptcy could be looked at as the low point of their international catastrophe in 2008 and 2009. The US stock exchange and factor portfolios’ performance was relatively homogenous post the event, which highlights the high value of assets during the economic disaster and lack of diversification opportunities, especially within asset categories. We observe capital preservation traits of the very low Volatility factor portfolio, only as soon as the industry decline accelerated in the weeks afterward.


The stock market lost approximately 15% in the days after the tsunami and the Tohoku earthquake, which triggered damaging the Fukushima atomic plant and made a catastrophe that was following on.

In contrast to this previous two case studies, we can’t see an outperformance of their Low Volatility factor portfolio, and this is clarified by the massive overweights to Telecom and both Utility sectors. Stocks from both of these industries were negatively affected by the natural disaster. The variable generated yields, mainly as a result of vulnerability to profitably and lowly levered Technology stocks.


It was not surprising for its public as the odds showed a decent possibility of their UK exiting the European Union Even though the results of the Brexit referendum has been a surprise to the vast majority of investors outside of the UK.

Subsequent to the referendum results were announced, there is a clear bifurcation between stocks. Small UK organizations are more focused, while their brethren are more export-oriented, thus benefitting from less exchange rate. The Size factor, therefore, showed the worst operation.


We outline the variable and market returns in the month subsequent to this occasion. While some others just like the Greece Debt Crisis took place It’s well worth noting that dates play a significant role for a number of events such as 9/11. Deciding the date is somewhat ambiguous and often challenging.

Investors might have expected that Quality factors and the Low Volatility show the most effective excess returns, however, the investigation reveals the event is posted by a variable performance. Only four out of the 12 events were negative on the industry over the subsequent month.

1 month will be a long time in financial markets and possibly a shorter lookback may provide advice about variable performance pole an event. However, the following one-week returns highlight a performance that is random.

This research note highlights that variable returns were random after events and swan, which indicates the challenges of portfolio positioning when such an occasion could be anticipated by an investor. Diversification across factors and strength classes is probably the ideal solution to plan the expected and unexpected.

“This research note was originally released by the CAIA Association’s AllAboutAlpha site and & factor research site”


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