Investment Analysis: Market Efficiency and Stock Investments

Investment Analysis #6

Prepared by Anh Nguyen

Instructed by Dr. Jay Chen

To diversify and maximize their portfolio income, investors could consider event-driven market anomalies, active funds, and passive funds. Let's take a look at different options, their theories, abnormal returns, and risks of these types of ETFs.

1. Event-Driven ETFs: IPO and PKW

IPO is the ticker for the Renaissance IPO ETF, a basket of the largest most liquid U.S.-listed newly public companies. ETF is rebalanced each quarter by including new IPOs and excluding old constituents with float-adjusted market capitalization weighting exceeding 10%. Investing in IPO reduces risk of single stock ownership (Renaissance IPO, n.d.).

PKW is the ticker for Invesco Buyback Achievers ETF, tracking stocks in the U.S. that repurchased at least 5% of their outstanding shares in the previous 12 months. PKW believes that a firm's own managers know their best valuation of its stock and will buy it up if the company is undervalued, assuming they have enough cash. PKW provides investors an easy access to these firms. The risks associated with this idea is that the company might have no potential growth although it is still creating cash in short run. The managers might just repurchase their outstanding shares to increase the company value (PKW, n.d.).

IPO and PKW are two event-driven market anomalies. They are ideas against the Efficient Market Hypothesis (EMH) which states that prices reflect all available information. However, there is no new information for IPOs but stocks could fluctuate greatly with such volatility. Companies could be undervalued and their owners could buy up outstanding shares to increase the market value.

2. Active ETFs: ARKK and TOTL

ARKK is the ticker for the oldest and biggest of the Ark Funds, ARKK Innovation ETF, an actively managed fund tracking-cutting edge and long-term capital firms. They believe that disruptive innovations in any fields such as transportation, automation, artificial intelligence could possibly change the whole world in the future. ARKK's weighting and selection is based on fundamental research and assessment (ARKK ETF, n.d.).

TOTL is the ticker for the SPDR DoubleLine Total Return Tactical ETF. TOTL is an old ETF that maximize total return by actively allocating and selecting traditional and non-traditional fixed income assets. TOTL seeks to outperform the market by tracking high yield bonds and emerging markets debt (SPDR, n.d.).

3. Horse Race

Using Google Sheet, I can pull up monthly returns of six different ETFs: IPO, PKW, ARKK, TOTL, SPY, QQQ and Fama and French's premiums. I could figure out their monthly returns, annual returns, standard deviations, and Sharpe ratios. More details for calculation are attached HERE.

Table 1	Monthly returns	Annual returns	Standard deviations	Monthly sharpe ratio	Annual Sharpe ratio
IPO	1.496	5.181	7.406	0.193	0.667
PKW	0.938	3.249	6.017	0.144	0.500
ARKK	2.525	8.474	9.580	0.256	0.888
TOTL	-0.036	-0.125	0.878	-0.119	-0.414
SPY	1.125	3.899	4.728	0.223	0.774
QQQ	1.675	5.803	3.937	0.408	1.413
Mrt-Rf	1.235	4.279	4.393

Table 1 indicates that ARKK has the highest annual returns and highest risks. However, QQQ's Sharpe ratio is the highest, stating that it yield the highest total returns over systematic risks. IPO and SPY result in relatively same annual returns but SPY is less riskier than IPO in general. TOTL is not doing well in the market with negative returns and risks over the time.

4. Seeking Alpha

Using the same data above, I can run the CAPM and Three-factor Model regressions on the four ETFs: IPO, PKW, ARKK, and TOTL. I could then find alpha and betas under CAMP regressions and abnormal alphas and betas for market risk premiums, small stock premiums, and value stocks premium under Three-factor Model regressions. The detailed calculated numbers are attached in the Google Sheet HERE.

IPO and PKW have negative returns and abnormal returns, both of which are statistically insignificant. That indicates zero returns for IPO and PKW. Both ETFs are under small stocks effects and value stocks effects, but these effects are not doing well in the market recently.

ARKK has positive returns and abnormal returns but these figures are not statistically significant. That also means ARKK does not yield any good returns over the time. ARKK is strongly under small stocks effects. Meanwhile, TOTL results in negative returns and abnormal returns. This is the only statistically significant data, indicating that TOTL actually brings losses and risks for investors.

In short, normal returns and abnormals returns confirm the motto of EMH that people can not beat the market. The market is so powerful in processing the information that passive index funds are safer and yield better turns for investors. Event-driven market anomalies and active trading funds do not expect to yield normal returns and abnormal returns. They actually charge fees into investors' returns, creating a loss in their investments.

I highly recommend go with the market rather than go against the market. Investing in passive index funds such as QQQ and SPY is still a good way to go for ordinary investors.

Reference:

Renaissance IPO ETF. (n.d). In Renaissance Capital The IPO Expert. Retrieved October 26, 2021, from https://www.renaissancecapital.com.

PKW Invesco BuyBack Achievers ETF. (n.d). In ETF.com. Retrieved October 26, 2021, from https://www.etf.com/PKW#efficiency.

ARKK Innovation ETF. (n.d). In ETF.com. Retrieved October 26, 2021, from https://www.etf.com/ARKK#overview.

SPDR DoubleLine Total Return Tactical ETF. (n.d). In State Street SPDR Global Advisor. Retrieved October 26, 2021, from https://www.ssga.com/us/en/intermediary/etfs/funds/spdr-doubleline-total-return-tactical-etf-totl.