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Numeric Investors I.p

Numeric Investors l.p.• Founded in 1989 by Langdon Wheeler

– Used firms' earning estimate revision model– Numeric’s momentum model

• Managed tax exempt accounts for pension funds and endowments and fund of fund taxable accounts, off shore funds, and three mutual funds

• Worked on flat asset based fees and performance related fee

Core Aggressive

Mid Cap

Small Cap

Micro CapValue Aggressive

Original Long/Short

Fair Value Long/Short

Products

Investment Strategy

•Core Aggressive

•Midcap Aggressive

•Small Cap Growth

•Micro Cap

•Value Aggressive

Long Only

Rationale for Investing

• Benefits of diversification and Stock Selection• Sector weights almost similar to the index weight• Expected returns a bit higher than the index returns due to good stock selection

Investment Strategy

•Original Long Short

•Fair Value Long Short

Long/Short


Double Alpha Strategy

• Buy good stocks for long position and sell bad stocks for short position of same sector• Eliminates portfolio’s sector specific risk• Risk of long underperforming shorts is the only risk• Allowed Numeric to exploit negative as well as positive information• Allowed Numeric to focus on sectors where insights were greatest• Long/Short portfolios could have any sector weights as the sector specific risk has been mitigated• Higher returns per dollar of investment• Less costs as diversification could be achieved more economically, e.g. Stock index funds and stock-

index futures

Investment Strategy

•Equitized Original Long Short

•Equitized Fair Value Long Short

Equitized Long/Short


Double Alpha Strategy with Exposure to the Market

• Numeric would buy good stocks for long position and sell bad stocks for short position of same sector along with investment in stock index futures equal to 100 % of the portfolio’s net value

• This strategy is for investors who wanted benefits of double alpha strategy along with the exposure to the stock market

• Benefit of good Stock Selection as well as market returns

Long Vs Long/Short-- Risk

Profitable only Share Price of Owned Securities Increased

Mirrored benchmark index and had to own sector stocks without compelling purchases

Sector specific risk

LongCan exploit negative as well as positive information

It can have any sector weights, provided long and short sector exposure matched

Sector specific risk neutralized though stock risk remained

Long/Short

Stock Selection

Momentum Strategy Value

Strategy

Momentum strategy

• Momentum is the empirically observed tendency for rising asset prices to rise further, and falling prices to keep falling

• A trader will take a long position in an asset, which has shown an upward trending price, or short sell a security that has been in a downtrend

• Momentum investors bear significant risk for assuming this strategy, and, therefore, the high returns are a compensation for the risk

• Exploits behavioral shortcomings in other investors, such as – Herd Behavior– Investor over and under reaction– Confirmation bias

Momentum: Numeric Investors I.p.

Estrend Earning Surprise

Momentum score

Estrend: Earning Estimate Revision Trend

• Past changes in analyst’s estimates• Incremental revisions rather than big jumps• Forecast of future consensus by analyzing• Size of revision• Direction of revisions

Earning Surprise

• Considered if actual earning is large relative to dispersion in analyst forecast• Reaction of earning surprise to company’s stock price• Was effective only for days immediate to announcement

Value Strategy

• Investor looks for stock with strong fundamentals - including earnings, dividends, book value, and cash flow - that are selling at a bargain price, given their quality

• Stocks have the potential to increase in share price when the market corrects its error in valuation

• Contradicts Efficient Market Hypothesis (EMH)– Price do not reflect all relevant information

• Disagrees with concept of beta

Value Strategy: Numeric Investors l.p.

• Initially used as ‘Second option’• Stock price are more volatile than underlying company fundamental• Cross sectional regression analysis determined correlation between company’s

certain characteristics and its stock price

Value Strategy: Numeric Investors l.p.

• Initially used as ‘Second option’• Stock price are more volatile than underlying company fundamental• Cross sectional regression analysis determined correlation between company’s

certain characteristics and its stock price

April 29, 1997 Transactions

Numeric ‘s

Position

•Numeric was short in PepsiCo 165,100 shares based on the negative momentum score, which makes it sensitive to any surprise earnings announcement

•Analysts average estimates of earnings were 24 cents per share

What

happened

?

•PepsiCo announced earnings of 27 cents per share

•The momentum score had gone from -0.49 to +1.35

•Value score increased from -0.13 to +.08

Actions

Taken by

Numeric

•Numeric Investors decided to cover 115,500 shares, of which 90,500 shares were covered at a price of $34.43 and the rest would be covered next week at $35.64

•The Stock price of PepsiCo increased to $36.2 in May, 1997 as shown in the Exhibit 14

PepsiCo


Numeric ‘s

Position

•Numeric was significantly long in Stratus Computer shares before the announcements

What

happened

?

•Stratus announced earnings of 62 cents per share as compared to analysts average expectations of 48 cents per share

•Smith Barney analysts revised his 1997 earnings estimate from $2.90 to $3.3 verses the consensus estimate of $2.86

Actions

Taken by

Numeric

•Numeric Investors Analysts calculated the Value score and Momentum Score based on the earnings estimate of $3.15. The Value score increased from 1.63 to 1.79 and Momentum score increased from 1.98 to 2.04

•Numeric Investors found that scores had not gone up sufficiently to justify increasing Numeric’s already significant long positionStratus Computer


Numeric ‘s

Position

•The 4th Quarter results of Micro Warehouse in 1996 were disappointing (EPS of 30 cents as compared to expected EPS of 31 cents)

•The 1997 1st quarter results were also expected to be disappointing

•Numeric was short 334,000 shares

What

happened

?

•Micro Warehouse announced earnings of 23 cents per share as compared to analysts average expectations of 20 cents per share

• Stock price increased by $1.25 in the morning

Actions

Taken by

Numeric

•Numeric Investors covered 100,000 shares, paring the position from 0.6 % to 0.4 % of the portfolio

•After getting the confirmation that the earnings are clean, Numeric covered its remaining short position, while the stock price rose from $15.5 to $17.5

Micro Warehouse


Numeric ‘s

Position

•Numeric was long 108,000 shares

What

happened

?

•PeopleSoft had a jump in share price in lieu of earnings announcement of 14 cents per share against expected earnings of 12 cents per share on April 26, 1997

• The Estrend, Earnings Surprise and Value scores were 0.5, 2.0, and -0.51 respectively

•Stock price increased by $1.125 on April 29, 1997

Actions

Taken by

Numeric

•Numeric Investors bought some shares on April 29 at $43 per share and added more after stock price fell down to $38 per share

•The Stock price rose to $48 per share by May 7, 1997

PeopleSoft

Earnings surprise was high on the basis of new announcementsEstrend score was high on the basis of revised analysts’ estimates


Numeric ‘s

Position

•Numeric was long 288,900 shares

•Numeric Investors wanted to reduce its position from 1.5 % to 0.4% prior to the earnings announcements

•Numeric Investors trimmed its position by 10000 shares

What

happened

?

•The Earnings announcement was 50 cents per share against the expected 47 cents per share

•The momentum score changed from 0.75 to 1.24

•The stock price increased further by May 13, and its score relative to other stocks in the portfolio increased

Actions

Taken by

Numeric

•Numeric Investors increased its long position by 35000 shares on May 13, 1997

Compuware


Numeric ‘s

Position

•Numeric was short 150,00 shares on the basis of low value score (-0.98 on April 28, 1997)

•Numeric Investors wanted to reduce its position from 1.5 % to 0.4% prior to the earnings announcements

•Numeric Investors trimmed its position by 10000 shares

What

happened

?

•The stock price decreased to $36 per share, and value score increased to (-0.67)

•The Stock looked less over priced

Actions

Taken by

Numeric

•Numeric Investors decided to cover 25000 shares, but were able to cover only 15000 shares at $36.125 per share

•Numeric cancelled the remaining order of 10000 shares as the price increased and the stock looked over priced

Nabisco Holdings

Traditional Vs Numeric

Traditional fund managers • Generally go for buy and hold strategy• Generally feel bullish or bearish for a

particular sector and hence take either long or short position on that sector

• Traditional fund managers either go for value or growth investing

• Traditional fund managers trust their analysis very much and hence may or may not go for revisions based on other analysis estimates

Numeric fund mangers

• Went both for long and short positions• Numeric went long and short in the

same sector for hedging against market declines

• They incorporated both types of investing methods through their model

• They relied heavily on Analysts’ estimates and changes & frequency of revision of their estimates through their momentum/value model

Monitoring and Controlling Transaction Cost

Portfolio turnover

•Frequency of transaction

•Higher the portfolio turnover, higher is the transaction cost

•All investment strategies show very high portfolio turnover

Bid-

offer

spread

•Difference between the highest bid price and the lowest asked price

•Larger spread shows lower demand for a particular asset

•Small cap growth has a spread of 60 and large cap value has a spread of 34 showing that demand of large cap is higher

Marke

t Impac

t

•Measure of market liquidity that affects the cost incurred by the trader

•Positive market impact shows increase in stock price while buying leading to additional expenses, vice versa for negative market impact

•Large cap value shows negative and small cap growth shows positive market impact

Opportunity Cos

t

•Cost to trade if unexecuted orders had gone off at the price prevailing when the order was cancelled

•Small cap growth shows higher opportunity cost as compared to large cap value

Was Numeric’s decision to close products to new investment justified?

Numeric’s mission• Be good, not big• Focus on returns not marketing• Limit asset growth to maintain results

Impact of taking new investments• Larger transaction costs• Increased market impact resulting in decreased returns• Not in alignment with the Numeric’s mission

Numeric’s decision to close its products to new investment is justified

Large stocks

High portfolio turnover

Higher market impact

Market Inefficienc

y Systematic Risk

• Value investing success depends on identifying overvalued and undervalued stocks which is possible only in inefficient marketValue

Investing

• Took advantage of market inefficiency with lags of several weeks in information flow regarding earnings surprises and analysts estimates revisions

• Market inefficiency reduced as time frame now compressed to minutes

Momentum Investing

Systemic risk gives return corresponding to it if market is efficientNumeric investors are taking advantage of market inefficiency as returns over and above market returns are achieved constantly

Thank You !