Insight

Risk and Reward Quarterly Update

December 19, 2024
Invesco
Risk and Reward Quarterly Update

Firms within the same economic cluster frequently see correlated share price movements and are characterized by delayed momentum spillover. Using two distinct approaches for grouping companies – sell-side analyst coverage and industry classification – we explore how these interconnected dynamics can be harnessed to boost investment performance.

No security exists in complete isolation – each is directly or indirectly linked to others. A common explanation for the occurrence of delayed momentum spillover is the ‘limited attention hypothesis’: When facing an influx of information about a particular stock, individuals struggle to process the information fully and may need time to realize its relevance for other, related stocks.1  As a consequence, these may underreact initially, creating opportunities out of past information.  

The strength of linkage signals lies in their ability to offer additional insights beyond what is available from conventional information sources. Unlike conventional data, which is often limited to a specific region, sector, industry, or market-cap group, linkage signals draw from a broader range of contexts. They encapsulate information absent from traditional momentum signals and offer a distinct perspective that can enhance predictive accuracy. 

We’ll construct two alpha signals based on analyst coverage and industry classification, which show strong performance across various markets, both individually and in combination. The analyst coverage signal captures stocks that are connected through shared coverage by sell-side analysts, while the industry classification signal identifies stocks based on their classification within the same industry. The two signals are constructed using a comprehensive global dataset from December 1996 to March 2023 and cover a significant portion of the global large-cap market.2

About risk

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Footnotes

  • 1

    Cp. Ang (2014). Equity market-neutral strategies should not be confused with long/short equity strategies, even though there are similarities (Nafia et al., 2023). In contrast to market-neutral strategies, long-short strategies typically share the equity market’s fluctuations because managers often have unequal sums invested in their long and short positions, generally favoring long positions to participate in long-term market gains.
  • 2

    At this stage, investors could consider stripping out unrewarded risks such as market and sector/industry biases inherent in generic factors (see Protchenko, Ikeda, and Roscovan, 2023).

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