The Investment Scientist

Archive for May 2020

Berkeley professor Terry Odean published an interesting paper in the Quarterly Journal of Economics in 2001 about how men and women invest differently. It was an empirical study based on stock transaction data in tens of thousands of accounts over a seven year period provided by a brokerage firm.

These investment accounts were either opened by a man or a woman, and were single or joint accounts. Thus there were four account types. An interesting phenomenon emerged from the study: the more a man is in control of an account, the worse the performance. (See net return vs benchmark.)

Here the benchmark is not any composite index, it is simply the return that resulted from no trades being made throughout the whole year. 

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Tax-Loss-Harvesting-Should-Investors-Believe-the-HypeOver the last few weeks, I have been busy 1) rebalancing – including increasing exposure to the digital platform economy I discussed in my past post, 2) migrating from mutual funds to ETFs because of the latter’s tax benefit, and 3) tax loss harvesting.

Today I am gonna discuss tax loss harvesting. So what exactly is tax loss harvesting? It’s basically realizing a capital loss while maintaining the same exposure. For instance, if in your portfolio, there is a US equity fund with a $30k loss, you can sell the fund to realize the loss and buy a substantially similar US equity fund to take its place. This way you maintain the same exposure but book an accounting loss of $30k. This maneuver is called tax loss harvesting.

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images (3)In my economics class at Oxford, I learned a very important concept: technology by and large manifests diminishing returns to scale.

When economists use the term “technology”, they usually mean the method of production, that is, taking labor and capital as inputs, and outputting something valuable. For instance, there is a method by which I deliver my financial advisory service, economists would call that technology. It’s a catch-all term.

Diminishing returns to scale simply mean the bigger you are, the harder it is to make money at the same rate. Take my little practice as an example. It’s just me and my assistant. It can’t be smaller, but it’s super efficient. If we were a 20 person firm, I can’t imagine how I would manage all these people who all have their different agendas and motivations. The firm may make more money in the absolute term, but on a per head basis, it wouldn’t  be as profitable as my little practice. That’s the essence of diminishing returns to scale.

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The Premium
The small cap value premium is a Nobel Prize-winning discovery about the stock market by Eugene Fama and Kenneth French. (Only Fama was awarded the Nobel Prize in 2013.) The original paper “The Cross-Section of Stock Returns” was published in the Journal of Finance in 1992. Using stock market data from 1963 to 1990, Fama and French found that small cap stocks outperform large cap stocks (small cap premium) and value stocks outperform growth stocks (large cap premium). Collectively, they are referred to as the small cap value premium.

Since the paper was published, many researchers have done out-of-sample studies and they found that this market feature persists in the data from 1928 to 1963, in the data from 1990 to as late as 2010, and even in foreign stock markets. So in academic jargon, this is a very robust feature of the market. (See chart below.)

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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