Value Premium

Is there a reliable benefit from conventional value investing (based on the book-to-market value ratio)? these blog entries relate to the value premium.

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Small and Value Stocks Less Risky for Long-term Investors?

Is risk for long-term investors different from that for short-term investors? In his July 2014 paper entitled “Rethinking Risk (II): The Size and Value Effects”, Javier Estrada examines the riskiness of small stocks versus large stocks and value (high book-to-market ratio) stocks versus growth stocks based on conventional and unconventional metrics. Each year during 1927 through 2013, he makes initial investments of $100 in Fama-French small, large, value and growth stock portfolios and holds for 20 or 30 years to generate distributions of 68 or 58 terminal wealths for each style, respectively. He then calculates the following metrics for these two sets of portfolios:

  • Mean (average) of terminal wealths by style.
  • Median (midpoint) of terminal wealths by style.
  • Average of the standard deviations of annual returns (SDD) by style.
  • Standard deviation of the terminal wealths (SDE) by style.
  • Lower‐tail Terminal Wealth (LTWx), the average terminal wealth in the lower x% of the distribution of terminal wealths (with x% being 1%, 5% or 10%) by style.
  • Upper‐tail Terminal Wealth (UTWx), the average terminal wealth in the upper x% of the distribution of terminal wealths (with x% again being 1%, 5% or 10%) by style.

SDD is most like conventional risk (volatility), while the other metrics focus unconventionally on terminal wealth. Using annual gross total returns for Fama‐French U.S. style portfolios during 1927 through 2013, he finds that: Keep Reading

Cyclical Behaviors of Size, Value and Momentum in UK

Do the behaviors of the most widely accepted stock market factors (size, book-to-market or value, and momentum) vary with the economic trend? In the June 2014 version of their paper entitled “Macroeconomic Determinants of Cyclical Variations in Value, Size and Momentum premium in the UK”, Golam Sarwar, Cesario Mateus and Natasa Todorovic examine differences in the sensitivities of UK equity market size, value and momentum factor returns (premiums) to changes in broad and specific economic variables. They define the broad economic state each month as upturn (downturn) when the OECD Composite Leading Indicator for the UK increases (decreases) that month. They also consider contributions of six specific variables to economic trend: GDP growth; unexpected inflation (change in CPI); interest rate (3-month UK Treasury bill yield); term spread (10-year UK Treasury bond yield minus 3-month UK Treasury bill yield); credit spread (Moody’s U.S. BBA yield minus 10-year UK government bond yield); and, money supply growth. They lag economic variables by one or two months to align their releases with stock market premium measurements. Using monthly UK size, value and momentum factors and economic data during July 1982 through December 2012, they find that: Keep Reading

Value-Momentum Switching Based on Value Premium Persistence

Can investors exploit monthly persistence in the value premium for U.S. stocks? In his February 2014 paper entitled “Exploiting Factor Autocorrelation to Improve Risk Adjusted Returns”, Kevin Oversby investigates whether investors can exploit the fact that the Fama-French model high-minus-low (HML) value factor exhibits positive monthly autocorrelation (persistence). The HML factor derives from the difference in performance between portfolios of stocks with high and low book-to-market ratios. Prior published research indicates that the value premium concentrates in small firms, so he focuses on stocks with market capitalizations below the NYSE median. His test strategies each month invest in capitalization-weighted small value (small growth or small momentum) Fama-French portfolios when the prior-month sign of the HML factor is positive (negative). The strategies additionally retreat to a risk-free asset (such as U.S. Treasury bills) if the prior-month return for the test strategy is negative. Using HML factor values and monthly portfolio returns for small value, small growth and small momentum Fama-French portfolios, he finds that: Keep Reading

Testing Size, Value and Momentum Return Predictors

Do commonly used indicators reliably predict stock size, value and momentum strategy returns? In the June 2014 version of his paper entitled “A Comprehensive Look at Size, Value and Momentum Return Predictability”, Afonso Januario examines the abilities of 17 fundamental and technical indicators and indicator combinations to anticipate returns for these three factors. He defines factor portfolios based on market capitalization (size), book-to-market ratio (value) and return from 12 months ago to one month ago (momentum), reformed monthly, as follows:

  1. Size = (SmallValue+SmallNeutral+SmallGrowth)/3 - (BigValue+BigNeutral+BigGrowth)/3
  2. Value = (SmallValue+BigValue)/2 – (SmallGrowth+BigGrowth)/2
  3. Momentum = (SmallWinners+BigWinners)/2 – (SmallLosers+BigLosers)/2

He selects the 17 indicators (such as book-to-market ratio, dividend yield, earnings-price ratio, return on equity, lagged return, short interest and implied volatility) from prior published research on predictive variables. He measures indicator values each month as the averages only for stocks in long or short sides (and the spread between them) of each of the above three factor portfolios. He applies linear regressions at monthly and annual frequencies to determine whether an indicator is more effective than the historical average factor portfolio return in predicting future factor portfolio returns. Using relevant sets of data for a broad sample of relatively liquid U.S. stocks from initial set availability (ranging from 1950 to 1995) through 2012, he finds that: Keep Reading

Value vs. Growth with Trend/Momentum Filters

Do relative momentum and trend filters operate differently on value and growth stocks? In their May 2014 paper entitled “When Growth Beats Value: Removing Tail Risk from Global Equity Momentum Strategies”, Andrew Clare, James Seaton, Peter Smith and Stephen Thomas investigate the effects of relative momentum and trend filters on portfolios of developed and emerging market broad, value and growth stock indexes. Their relative momentum filter each months picks either the top five indexes (Mom5) or top quarter of indexes (Mom25%) based on volatility-adjusted past 12-month return (return divided by standard deviation of monthly returns) at the end of the prior month. Their trend filter each month invests in an index or U.S. Treasury bills (T-bills) according to whether the index is above or below its 10-month simple moving average (SMA10) at the end of the prior month. Using monthly levels of broad, value and growth stock indexes for 23 developed country markets (since 1976) and 21 emerging country markets (since 1998) through 2012, they find that: Keep Reading

Mocking Momentum Myths

What about all those criticisms of momentum investing (such as high turnover/trading frictions and crash-proneness)? In the May 2014 draft of their paper entitled “Fact, Fiction and Momentum Investing”, Clifford Asness, Andrea Frazzini, Ronen Israel and Tobias Moskowitz summarize research on the momentum anomaly and rebut ten criticisms (myths) of momentum investing. Specifically, they address claims that momentum profitability is too small, too volatile/crash-prone, works mostly on the problematic short side, works well only among small stocks and does not survive trading frictions. They focus on a “standard” definition of momentum as the past 12-month return, skipping the most recent month‘s return (to avoid microstructure and liquidity biases). Using results from widely circulated and debated academic papers and data from Kenneth French‘s website, they conclude that: Keep Reading

Equity Premiums Overgrazed?

Are investors exhausting the potential of stocks? In his May 2014 presentation packages entitled “Has The Stock Market Been ‘Overgrazed’?” and “Momentum Has Not Been ‘Overgrazed’”, Claude Erb investigates the proposition that sanguine research and ever easier access to investments are exhausting U.S. stock market investment opportunities. In the first package, he focuses on trends in the overall equity risk premium, the size effect and the value premium. In the second, he focuses on momentum investing. Using U.S. stock market and equity factor premium returns and contemporaneous U.S. Treasury bill yields during 1926 through 2013, he concludes that: Keep Reading

Big Three Factors across Countries

Are there parallels at the country stock market level of the size, value and momentum effects observed for individual stocks? In their January 2014 paper entitled “Value, Size and Momentum across Countries”, Adam Zaremba and Przemysław Konieczka investigate country-level value, size and momentum premiums. They measure these factors at the country level as:

  • Value (V): book-to-market ratio of country stocks aggregated via the weighting scheme used to construct the country stock index at the time of portfolio formation.
  • Size (S): total market capitalization of country stocks at the time of portfolio formation.
  • Long-Term Momentum (LTM): country index return during the 12 months before portfolio formation.
  • Short-Term Momentum (STM): country index return during the month before portfolio formation.

They calculate these factors using either MSCI equity indexes (47 indexes available at the beginning of the sample period) or local stock indexes (only 24 indexes available at the beginning of the sample period). They measure the country-level premium for each factor as the return on an equally weighted portfolio that is each month long (short) the 30% of countries with the highest (lowest) expected returns for that factor. They fully collateralize short sides with reserves in the risk-free rate. They also calculate a total market return as the capitalization-weighted average return across all country markets. They perform calculations separately in U.S. dollars, euros and yen. Using monthly firm/stock data for listed stocks as available within 66 countries from the end of May 2000 through November 2013, and contemporaneous Fama-French model U.S. factors, they find that: Keep Reading

Equity Investing Based on Liquidity

Does the variation of individual stock returns with liquidity support an investment style? In the January 2014 update of their paper entitled “Liquidity as an Investment Style”, Roger Ibbotson and Daniel Kim examine the viability and distinctiveness of a liquidity investment style and investigate the portfolio-level performance of liquidity in combination with size, value and momentum styles. They define liquidity as annual turnover, number of shares traded divided by number of shares outstanding. They hypothesize that stocks with relatively low (high) turnover tend to be near the bottom (top) of their ranges of expectation. Their liquidity style thus overweights (underweights) stocks with low (high) annual turnover. They define size, value and momentum based on market capitalization, earnings-to-price ratio (E/P) and past 12-month return, respectively. They reform test portfolios via annual sorts into four ranks (quartiles), with initial equal weights and one-year holding intervals. Using monthly data for the 3,500 U.S. stocks with the largest market capitalizations (re-selected each year) over the period 1971 through 2013, they find that: Keep Reading

Style Performance by Calendar Month

The Trading Calendar presents full-year and monthly cumulative performance profiles for the overall stock market (S&P 500 Index) based on its average daily behavior since 1950. How much do the corresponding monthly behaviors of the various size and value/growth styles deviate from an overall equity market profile? To investigate, we consider the the following six exchange-traded funds (ETF) that cut across capitalization (large, medium and small) and value versus growth:

iShares Russell 1000 Value Index (IWD) – large capitalization value stocks.
iShares Russell 1000 Growth Index (IWF) – large capitalization growth stocks.
iShares Russell Midcap Value Index (IWS) – mid-capitalization value stocks.
iShares Russell Midcap Growth Index (IWP) – mid-capitalization growth stocks.
iShares Russell 2000 Value Index (IWN) – small capitalization value stocks.
iShares Russell 2000 Growth Index (IWO) – small capitalization growth stocks.

Using monthly dividend-adjusted closing prices for the style ETFs and S&P Depository Receipts (SPY) over the period August 2001 through December 2013 (150 months, limited by data for IWS/IWP), we find that: Keep Reading

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