Wes Gray is a no-holds-barred researcher who’s always looking to uncover investment strategies that are actually useful in making investors money.
He joins us this week on Tradestreaming Radio to discuss some of his recent research on expert community, SumZero and Joel Greenblatt’s Magic Formula, and lots more.
Listen to the FULL program
About Wes Gray
After serving in Iraq with the Marines, Wes got his Ph.D. in finance at the University of Chicago and became a finance professor at Drexel University. In his “spare time” he launched Empirical Finance, LLC, an investment management that turns academic insight into investment performance.
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the place where smart investors come to learn directly from experts. We
help bubble up tools, tips and technologies to help you make better,
smarter investment decisions. And today’s guest on the program helps me to
do that. Today we have Wes Gray on the show. He is a Professor of Finance
at Drexel University, he’s also behind a new website called
TurnkeyAnalyst.com. He also has a private investment firm that invests
directly in some of the strategies that he investigates.
I like Wes because he sacrifices sacred cows, he looks at, at research with a very, very objective focus and he’s not afraid to actually look for actionable,
tradable strategies, as opposed to just focusing on Ivory tower type stuff.
I hope you enjoy this program, hope you enjoy all my programs which you can
find on my website TradeStreaming.com. You can find the archives there. We
also provide transcripts for most of the programs. So come on over, check
it out, sign up for our free email list. You can also find this program on
iTunes and our archives on iTunes, as well.
So go over there, leave us a rating or ranking, let other people know if you’re finding value in this show. We appreciate your listening. We have thousands of new people joining every month now to the program, so thank you. I’m internally grateful for you and I appreciate your time. I know you guys are busy and I hope that this is providing some value for you. So check you out soon and enjoy the program. Okay, Wes. Can you introduce yourself?
Wes: Yeah. My name’s Wes Gray. I’m currently an Assistant Professor of
Finance at Drexel University and also run two [inaudible 01:44], one is
TurnkeyAnalyst.com and then another one is [PureCharge], which is a
investment managed business.
Zack: So, is it hard to keep those two things separate?
Wes: Not really. The job at Drexel is primarily do research on financial
markets. Actually, we get a lot of complementary, what I do for TurnKey I
also do for our investment which is research on financial markets, so a lot
of times, they fuel each other. We may be trading on here or researching
something that we want to implement and then, as we get into it, we’re
like, “Wow. This is really interesting. This hasn’t been discussed in
academic literature, so we should write a paper about it.” Or I’ll be doing some
focused trade on academics, I’m like, “Wow. This is really interesting, and
we do a few twists and turns and it can be something that’s very useful for
training on or writing about, or what have you. So I think there’s kind of
a nice synergy between the two.
Zack: It’s almost like you have your own built in laboratory to test out some
trading theories?
Wes: I’m sorry. Say it again.
Zack: So it’s almost like you have your own personal laboratory to test some
of this stuff?
Wes: Yeah, pretty much. We work with a couple family options and we’ve got a
lot of people work for us, helping doing research and pro-. Yeah, we come
up with good ideas. I’m almost look at our entire firm as just an R&B shop,
essentially. So, we got an idea, we’ll test it or if we got ideas we tested
and we can either test on our real monies, see if it actually works. If it
does, then yeah, [inaudible 03:28] write something up and maybe try to get some
publicity from it by publishing an article or just sharing our knowledge.
Zack: What I like about, I don’t know too much about Investment Shop
obviously, but from what you’re doing publicly on TurnKey Analyst, I like
your approach where you, it’s like a no non-sense, no BS type approach
where you’re not necessarily comfortable with just accepting status quo. I
remember one piece in particular that you did that stands out in my mind,
is when you looked at the Magic Formula and so, in some way Joel
Greenblatt’s been given a free pass from our entire industry and you
weren’t able to replicate his results, were you?
Wes: No, I wasn’t and big picture at TurnKey Analyst is what I call our, my
for passion business, not the for profit. And the more I [hear] there in the
mission statement is what I call democratized quant. Because I just think
people, if they understood a little bit about quantitative financing, that
they’d make better portfolio decisions and understanding a little bit more
what they’re actually investing in and one of the things that we know that
everyone really enjoys, and I think they should, is Greenblatt’s Book where
he outlines this really [inaudible 04:45] concept of, look at quality, look at price, take the best combination and go buy those stocks. And I actually really
like Joel Greenblatt’s work and everything and I don’t think he meant to do
it, but in his book he has these crazy returns where it says it’s like 31
percent CAGR from, I don’t know, what was it? 88?
Zack: Twenty years, or something.
Wes: It’s kind of insane, so it was like, “All right.” Go back, [inaudible 05:14]
thousands of [inaudible 05:17] every [inaudible 05:18] under the sun. And we just couldn’t imagine a, but the reality is I don’t think that he would disagree with our results, because we’re at the [inaudible 05:29] Congress last, was it last October in New York, and he gave one of the presentations. He showed his returns, the [inaudible 05:39] portfolio returns, because he had an updated data thing. It really wasn’t exactly like the returns that we posted on TurnKey Analyst. And it was no mention of the 31 percent CAGR anymore. So I don’t know if they maybe redone those results when they came out of like, well actually, we made a mistake.
Perhaps you would never want to publicly admit, you just kind of let it
slide under. But, well, that’s just, that’s how it rolls. Everyone makes
mistakes and, or maybe it’s just a lucky fluke. The [inaudible 06:09] when they did those portfolios in the top 30 stocks and you equal weight them, which gives
you some diversification, but there could be, maybe one stock you happen to
get, I don’t know, Apple in there at the exact right time, that just in
itself could potentially drive results. I don’t know if they could drive it
like that but, who knows. Bottom line is that [inaudible 06:36]
Zack: It still performed pretty well though, right?
Wes: Yeah. I know, exactly. But that’s the main thing. I think people may
have misinterpreted, where does [Ashley Greenbaum], because I think Greenbaum
does a huge service for society and investors to give them access to do the
Magic Formula, not worry about picking stocks and paying maybe even higher
fees than they would in other venues. And I think the system would work and
just as he mentions in his book, in his book, it’s common sense, it’s [inaudible 07:08], it’s not going to give you a nice Madoff return. [inaudible 07:14] on the long term, so that’s certainly the case, maybe add to town what [inaudible 07:19] planned, anywhere from 200-500 basis points over long, long holding [inaudible 07:26]. Which is great. I just think that people shouldn’t expect to get 15 or 20 percent over market over a long time period, because the mathematics of that just would make everyone Warren Buffet really quick.
Zack: I thought you had a great piece also out about SumZero. We’ve had Divya
Narendra on the show and I interviewed him for my book. For our guests who
don’t know, SumZero is like an exclusive expert network comprised of
somewhere between 5000-6000 buy-side analysts. It’s a closed network, they
don’t share their stuff outside yet, but you looked at the returns there
and I know there’s been some work previously on the value investor’s club
[inaudible 08:10] that performance there. What’d you find with SumZero?
Wes: SumZero we, to put it in a nutshell, we, they [inaudible 08:17] their long ideas. We were looking at short term price reactions trying to assess if what these guys write about, does it actually have any market impact in a reliable sense. [inaudible 08:30] on the long side, they do, it’s obviously concentrated in smaller stocks where you’d expect that to happen. It would be reasonable to think that somewhere on SumZero’s system about GE and all of a sudden the stock moves 10 percent. But if you wanted us to talk about averages, and you want to look across the whole spectrum, it looks like we get a typical
bounce over the first three or four weeks of around two to three percent,
and it’s the [inaudible 08:58] reliable, it’s actually there in the data so I don’t know if it’s what you call [inaudible 09:03], or what do you want to call it, but whatever’s happening, these stocks are certainly moving based on the information that Divya, SumZero reports.
Zack: And it’s a tradable strategy where you could get in theoretically after
the pick is made on the site?
Wes: Yeah, certainly. There’s a drift effect where, I’m just looking at the
chart here. Let me pull it up. The papers on [inaudible 09:26] are in, if you want to check it out, but it looks like [inaudible 09:30], or two, you get, these are, again, average statistics and these were also abnormals, controlling for what, just the overall market did. And [inaudible 09:41] till you get a percent or two but then you get a drift so if you go out to 45 days, they have a cumulative abnormal return of over four percent, so let’s say you waited a week even, you could still theoretically capture another two percent of, I guess we’ll call it Alpha. And I guess the idea would be there is [inaudible 10:02] you had real information, either they had real information or its inside investors should be [inaudible 10:10] information. It’s not going to happen immediately, they’re going to want to go do their own [inaudible 10:17], slowly build position. So that had to be a reason why it has this lag effect. If you wanted to do it systematically, you could obviously, anytime an idea hits you’d want to buy in, try to minimize your market impact [inaudible 10:37] trading, and then just ride the wave a little bit. Again, it’s concentrated in smaller names are getting, a lot of times you get the big bounces and you know if you’re trading small names, it doesn’t take too much for you to become the bounce. So it’s a self defeating process.
Zack: So, it’s great, it’s sort of like throwing the door open on a lot of
things that were considered, taboo is probably too strong of a word, but
it’s a fresh objective approach. What other things are you working on that
are, well even, you don’t have to tell us exact pieces but what else are
you interested in? Where’s your research going to lead you in the future?
Wes: One of the [inaudible 11:16] my [self] and my RA who now works with us, and he’s PhD student at Drexel, one thing we’ve noticed, because we’ve tested, like I said, we’ve back tested it, you name it, we’ve back tested it. We’ve done it long short, done a long only, short only and one of the things that we notice is that a lot of times in academic research or even in practitioner publications, there’s this concept of Alpha. An Alpha is really just your right of regression of your returns against some rich factors and they were meant to soak up the rich exposures you’re actually taking with that strategy.
And waterier remaining kind of excess or that’s your Alpha, but one of the things we noticed is people don’t really think about draw downs a lot. People in practitioner land do a lot because you actually care about [inaudible 12:06], what we notice is that almost every single long short strategy out there, no matter how good it is, Momentum’s a perfect example where you make money for a long, long time and Momentum just do a long short system, but the problem is, and there’s a ton of Alpha in the regressions but the draw downs on it puts you into bankruptcy every so often.
We think this is a pretty systematic thing where no matter what system, what strategy, it may look like a low risk, unbelievable opportunity, we actually get the monthly returns and you calculate the draw down, almost all of them inevitably have at least an opportunity where you lose 50 percent of your capital. And obviously you’re running along short hedge fund and you may bang out your 10, 15 percent a year but [inaudible 12:57] 50 percent draw down you’re not going to be in the business anymore. So it’s kind of an interesting aspect of long short [inaudible 13:05] typically that a lot of people never think about because they just look at the Alpha as the man or the annual returns or what have you but a lot of times, there’s a lot of risk when you capture what’s not in a year period but it’s in like a three month stretch where, and it could just be [inaudible 13:23]. So we’re working on that.
Zack: How does some of your work impact individual investors? Obviously, if
you’re looking, you’re democratizing quant, professionals I’m sure really
get a lot of value out of some of your research. Is there applications
towards the retail investor, the individual investor for some of this
stuff?
Wes: Yeah. I think one of the most interesting pieces I’ve ever seen and I
actually wrote a little blurb on it, it was done by Greenblatt where he
highlights this whole point that, when they did the Magic Formula, they
wrote the book and they created this inves-, where you could either do it
by yourself or you could do it as the automated system.
Zack: Formula Investing?
Wes: What’s that?
Zack: Formula Investing, his firm?
Wes: Exactly. The Formula Investing, and the funny thing is when they went
back and they backed up to the guys that ran the firm or investing by
themselves and the ones that just did it purely with the computer. When
people did it by themselves, they actually underperformed the computer and
now, [inaudible 14:24] probably is, and that’s because we run these things, is [inaudible 14:28] the actual names that drop out of the Magic Formula. A lot of the names are atrocious, like especially right now you see a lot of these for profit educations, you see gain stop, you used to see Blockbuster, all these businesses where they, they had their day in the sun but then you think about, “God, why would we want to own it?”
That is literally what I think drives a lot of the great returns on those systems, but the problem is when, and while I’m getting into this round of [the point 07:26], why we do stuff that’s good for retail investors is, retail investors, if they can get beyond the individual gains, if they want to be a quant and use the tools then, we provide those sort of tools and they need to actually be a quant, because the minute you try to be a quant and then you go in and meddle with the names, you’re like, “Well, I don’t like for profit [??], because obviously it’s going bankrupt because of the administration [hates] and blah blah.”
The problem is that you’re going to kick out a lot of the names end up driving all the returns. The reason they’re cheap is because everyone’s thinking like that, that’s also the reason why you’re going to probably end up [inaudible 15:37] returns on them, is because people beating them down so much. So one of the things that, I hope, that a research does and what TurnKey’s all about is saying, “Hey, if you’re going to do quant, just do it and don’t think about the individual names as much, just think about the process and what’s going into it and just take a leap of faith.”
And if you don’t want to do that, then go be standard, fundamental investor where you go do your D side and do your homework, know everything about a company, in case you’re looking at bets, but make sure you take them very well because, you’re going to have to ride on only a few stocks. Or you can [inaudible 16:17] third alternative, if you can’t do what it takes to be a good fundamental investor, you can’t do what it takes to be a good quant investor, just [punt on both] and go to Vanguard and buy SP 500 index fund.
Zack: I’m so happy you said that because, not the last piece, but the piece
about Greenblatt because I wrote about this exactly in my book. I read in
an interview somewhere with him and people were questioning why he put the
Magic Formula online, he wrote a book explaining it all and someone asked
and they said, “Well, once you put it online, don’t you think, sort of the
Alpha’s going to go away,” to whatever opportunities are there are going to get
arbitraged away? He said, “No way because individual investors can’t stick
to quant strategies.” And so true, right? From a behavioral point of view?
Wes: Exactly. It’s so hard and every time you’re not [inaudible 17:09], obviously we’re trained, that’s what our game is but we rarely think [inaudible 17:16], if you didn’t really have faith in quant and you didn’t believe in it, it’d be so tempting to try to go in here and ferret out what you really want to hold, but then you just really destroy the whole point of quant which is to pull out, emotion, behavioral problems that all of us have. Yeah, it’s, I don’t know. I hope we can try to emphasize to people that the whole benefit of this is being objective and just doing it, because if you start meddling in, now you’re
going to start suffering from your behavioral biases everyone has. Hopefully
we can get a process going through my research and the blog and what you do
on your website and stuff.
Zack: I think I read somewhere also that you served in Iraq, is that true?
Wes: Yeah. I was in, serving in the Marine Corps for four years. I was an
Intelligence Officer and I got opportunity to live with Iraqis, with [inaudible 18:14]. It was an interesting experience, I was part of the We Stand Up So They Can stand Down, and I have a book on the subject, if you Google that, it’s
called Embedded.
Zack: Oh yeah? You wrote a book on it?
Wes: Yeah. I wrote a book. Like I said, it’s called Embedded. Wasn’t a New
York Times best seller but it was, it was, the basic thesis of the book is,
when I went in, I was actually pretty gung ho and thought, “Hey, this is a
great opportunity.” My basic realization coming from that place was that
culture matters. There’s actually a really good book that’s titled that
and, in my opinion, culture is everything and you can walk a horse to water
and say, “Hey, this is a good way to do it,” but if their way is better and
who’s to say their way is not better, they’re not going to change, so I just
feel like we waste a lot of time and resources and money on a lot of
international escapades that, [inaudible 19:19] bankrupt, I’m sort of sounding Ron Paul. I actually kind of believe the guy, it makes so much sense after living through it, I’m like, “God. What the hell are we doing in these places?” I could go on a whole other interview on foreign policy but [inaudible 19:39]
Zack: That’s awesome. I don’t want to touch politics with a 10 foot pole. One
question I ask all participants on the show is, you’re doing tons of
research and you’re incredibly prolific, I have to hand it to you. I love
reading everything you write. Where do you go for your own research? If
you’re thinking about investing on your own, are there resources online or
offline that you find particularly useful?
Wes: Yeah. There’s a guy’s website, it’s CXO Advisory. It’s really good. I
search around [inaudible 19:19] all the time. I got a team of guys that works for me, that’s their job is to just go search the web and follow professor websites and Google around constantly, just trying to catalog everything that’s out there. Actually, one thing we do, some stuff we obviously keep in house but the vast majority [inaudible 20:29] world, if you, you have to pitching my own book. Kind of like the [inaudible 20:34] guys. It’s free.
You can just log onto TurnKey then you set up an account. We have a little module called Academic Alpha and it’s literally our database where it summarizes in easy to understand format, what a particular research piece says. You can obviously Google for the paper and go read in more detail. I think we’ve got like 80 or 90 papers up there where, if you just want to see 80 or 90 ideas that could potentially make you money, we have them up there and, again, fulfill its mission statement of marketizing quant and it’s, I think it’s a great place to
learn and we just provide it because we’re already doing all of it and just
want to [inaudible 21:18].
Zack: And you have a premium version of your website also? Something people
pay for?
Wes: We have, we have [DocuPay], we have a readers distribution contract with
Merchant. Right now we set it up where it’s, we used to have to do a flat
fee, which was killing us, so now we set it up on a revenue sharing basis.
Basically, if you want to get more access to the data from the long short
and actually use the tool for smaller names and this sort of stuff, then we
have it starting, think it’s like 30 bucks a month, or something like that.
But most of the material, especially like the research and ideas and the
baseline stream capabilities on big stocks, it’s free. We just have to
charge some sort of amount to cover our baseline costs. For people that
want to actually really churn on the database, because server space also
it’s not that expensive, but we’re not a non profit, we got to at least not
lose money on TurnKey. So for people that really want to use it and hammer
on the databases and servers a lot more, that’s why we have it bifurcated
out where it’s free and then there’s the pay guys.
Zack: I guess, one last question I have and we can end on this, it gets back
to a question I asked you initially is, if there’s some type of conflict of
interest, and I’m not trying to dig up dirt or anything, but the fact that
you have one foot in the commercial world and one foot in the research
world, if you find something that’s very useful, you may not publish that
right way or you may not publish that forever. Is that a new model?
Wes: It’s actually a very old model and BioTech’s been doing it for, I don’t
know, a long time. Look at Cambridge, Massachusetts, that’s exactly just a
perfect, in Stanford, Palo Alto, same thing and it’s actually like what the
academic is supposed to be. That’s why the government funds academic
institutions because they’re supposed to help provide research and capability
that theoretically makes the world better off and develops better products.
It’s weird to me that no one’s ever done that, and a lot of people actually
have, I think, now, just built the same sort of model in, with finance.
It’s not a pure science but it’s the same concept, you can do an R&D in
academia and then you write your paper, publish a lot of it but for a lot
of stuff that may be really spectacular, why not go try to make a few bucks
off of it? The reality is that doesn’t happen now, because as Greenblatt said, most of it’s out there in the public domain, it’s just the problem is quant, it
sounds easy on paper, but to actually do it in practice is not easy and
there’s with execution, communication, data, your behavioral problems, I
wouldn’t say it’s a conflict of interest, I’d say it’s just a model that’s
pretty much been out there in every single other subject, just finance
hasn’t really grown with the concept, I guess. I’m not really sure why but
that’s what our firm’s all about is this arbitrage between the two worlds.
Zack: I think that’s awesome. Wes Gray, thanks so much for joining us. I
appreciate your time.
Wes: No problem, Zack. Appreciate your time and have a great day.
More resources
- Turnkeyanalyst.com
- Do Buy-Side Recommendations Have Investment Value (recent paper we discussed)
- How Magic is the Magic Formula? (another of Wes’s research projects)