Equity Premium
Governments are largely insulated from market forces. Companies are not. Investments in stocks therefore carry substantial risk in comparison with holdings of government bonds, notes or bills. The marketplace presumably rewards risk with extra return. How much of a return premium should investors in equities expect? These blog entries examine the equity risk premium as a return benchmark for equity investors.
July 12, 2023 - Aesthetic Investments, Equity Premium
Do exchange-traded funds selecting stocks based on environmental, social, and governance characteristics (ESG ETF) typically offer attractive performance? To investigate, we compare performance statistics of eight ESG ETFs, all currently available, to those of simple and liquid benchmark ETFs, as follows:
- iShares MSCI USA ESG Select ETF (SUSA), with SPDR S&P 500 ETF Trust (SPY) as a benchmark.
- iShares MSCI KLD 400 Social ETF (DSI), with SPY as a benchmark.
- iShares ESG MSCI EM ETF (ESGE), with iShares MSCI Emerging Markets ETF (EEM) as a benchmark.
- iShares ESG Aware MSCI EAFE ETF (ESGD), with iShares MSCI EAFE ETF (EFA) as a benchmark
- iShares ESG MSCI USA ETF (ESGU), with SPY as a benchmark.
- Nuveen ESG Small-Cap ETF (NUSC), with iShares Russell 2000 ETF (IWM) as a benchmark.
- Vanguard ESG U.S. Stock ETF (ESGV), with SPY as a benchmark.
- Vanguard ESG International Stock ETF (VSGX), with Vanguard FTSE All-World ex-US Index Fund ETF (VEU) as a benchmark.
We focus on average return, standard deviation of returns, reward/risk (average return divided by standard deviation of returns), compound annual growth rate (CAGR) and maximum drawdown (MaxDD), all based on monthly data. Using monthly dividend-adjusted returns for all specified ETFs since inceptions and for all benchmarks over matched sample periods through June 2023, we find that: Keep Reading
July 11, 2023 - Equity Premium, Volatility Effects
Is the ability of the VIX percentile threshold rule described in “Using VIX and Investor Sentiment to Explain Stock Market Returns” to explain future stock market excess return in-sample readily exploitable out-of-sample? To investigate, we test a strategy (VIX Percentile Strategy) that each month holds SPDR S&P 500 ETF Trust (SPY) or 3-month U.S. Treasury bills (T-bills) according to whether a recent end-of-month level of the CBOE Volatility Index (VIX) is above or below a specified inception-to-date (not full sample) percentage threshold. To test sensitivities of the strategy to settings for its two main features, we consider:
- Each of 70th, 75th, 80th, 85th or 90th percentiles as the VIX threshold for switching between T-bills and SPY.
- Each of 0, 1, 2 or 3 skip months between VIX measurement and strategy response.
We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as essential performance metrics and use buy-and-hold SPY as a benchmark. We do not quantify frictions due to switching between SPY and T-bills for the VIX Percentile Strategy. Using end-of-month VIX levels since January 1990 and dividend-adjusted SPY prices and T-bill yields since January 1993 (SPY inception), all through May 2023, we find that: Keep Reading
June 29, 2023 - Equity Premium
A subscriber requested measurement of a “premium” associated with stocks of innovative technology firms by looking at the difference in returns between the following two exchange-traded funds (ETF):
Using monthly dividend-adjusted closing prices for these ETFs during March 1999 (limited by QQQ) through May 2023, we find that: Keep Reading
June 14, 2023 - Equity Premium, Volatility Effects
Are low volatility stock strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider eight of the largest low volatility ETFs, all currently available, in order of longest to shortest available histories:
- Invesco S&P 500 Low Volatility Portfolio (SPLV) – the 100 stocks from the S&P 500 Index with the lowest realized volatility over the past 12 months, reformed quarterly. The benchmark ETF for SPLV is SPDR S&P 500 (SPY).
- iShares Edge MSCI Min Vol USA (USMV) – seeks to track an index composed of U.S. equities that, in the aggregate, have lower volatility characteristics relative to the broader U.S. equity market. The benchmark ETF for USMV is iShares Russell 3000 (IWV).
- iShares Edge MSCI Min Vol EAFE (EFAV) – seeks to track an index composed of developed market equities that, in the aggregate, have lower volatility characteristics relative to the broader developed equity markets, excluding the U.S. and Canada. The benchmark ETF for EFAV is iShares MSCI EAFE Index (EFA).
- iShares Edge MSCI Min Vol Emerging Markets (EEMV) – seeks to track an index composed of emerging market equities that, in the aggregate, have lower volatility characteristics relative to the broader emerging equity markets. The benchmark ETF for EEMV is iShares MSCI Emerging Markets Index (EEM).
- iShares Edge MSCI Min Vol Global (ACWV) – seeks to track an index composed of developed and emerging market equities that, in the aggregate, have lower volatility characteristics relative to the broader developed and emerging equity markets. The benchmark ETF for ACWV is iShares MSCI ACWI (ACWI).
- Invesco S&P International Developed Low Volatility Portfolio (IDLV) – the 200 least volatile stocks of the S&P Developed excluding U.S. and South Korea LargeMid Cap BMI Index over the past 12 months, reformed quarterly. The Index is computed using net return, which withholds taxes applicable to non-resident investors. The benchmark ETF for IDLV is Vanguard FTSE All-Wld ex-US ETF (VEU).
- Invesco S&P MidCap Low Volatility Portfolio (XMLV) – the 80 out of 400 medium-capitalization stocks from the S&P MidCap 400 Index with the lowest realized volatility over the past 12 months, reformed quarterly. The benchmark ETF for XMLV is SPDR S&P MidCap 400 (MDY).
- Invesco S&P SmallCap Low Volatility Portfolio (XSLV) – the 120 out of 600 small-capitalization stocks from the S&P SmallCap 600 Index with the lowest realized volatility over the past 12 months, reformed quarterly. The benchmark ETF for XSLV is SPDR S&P 600 Small Cap (SLY).
We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). Using monthly returns for the low volatility stock ETFs and their benchmark ETFs as available through May 2023, we find that: Keep Reading
June 9, 2023 - Calendar Effects, Equity Premium, Momentum Investing, Size Effect, Value Premium, Volatility Effects
What characteristics of U.S. equity factor return series are most relevant to respective factor performance? In his May 2023 paper entitled “The Cross-Section of Factor Returns” David Blitz explores long-term average returns and market alphas, 60-month market betas and factor performance cyclicality for U.S. equity factors. He also assesses potentials of three factor rotation strategies: low-beta, seasonal and return momentum. Using monthly returns for 153 published U.S. equity market factors, classified statistically into 13 groups, during July 1963 through December 2021, he finds that:
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June 8, 2023 - Equity Premium
Do the stocks that dominate shareholder wealth-building (accounting for share price changes, dividends, repurchases/new share issuances and investor money flows) increasing concentrate within a small pool? In his May 2023 paper entitled “Shareholder Wealth Enhancement”, Hendrik Bessembinder identifies the stocks with the largest increases and largest decreases in shareholder wealth since 1926. He examines the degree to which increases in shareholder wealth concentrate among stocks over time. Using monthly data (including delisting returns) for 28,114 publicly traded U.S. common stocks and contemporaneous 1-month U.S. Treasury bill yield as a benchmark during 1926 through 2022, he finds that:
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May 24, 2023 - Equity Premium, Momentum Investing
Are stock and sector momentum strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider nine momentum-oriented equity ETFs, all currently available, in order of longest to shortest available histories:
We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). We assign broad market benchmark ETFs according to momentum fund descriptions. Using monthly dividend-adjusted returns for the nine momentum funds and respective benchmarks as available through April 2023, we find that: Keep Reading
May 19, 2023 - Equity Premium, Volatility Effects
Are exchange-traded funds (ETF) focused on Initial Public Offerings of stocks (IPO) attractive? To investigate, we consider three of the largest IPO ETFs and one recent Special Purpose Acquisition Company (SPAC) ETF, all currently available with moderate trading volumes, in order of longest to shortest available histories:
We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). For all these ETFs, we use SPDR S&P 500 (SPY) as the benchmark. Using monthly returns for the IPO ETFs and SPY as available through April 2023, we find that:
Keep Reading
May 17, 2023 - Equity Premium, Sentiment Indicators
What kind of return patterns are typical of beginnings and ends of equity bull and bear markets? In his April 2023 paper entitled “Investor Overreaction: Evidence From Bull and Bear Markets”, Valeriy Zakamulin examines return patterns of U.S. stock market bull and bear states as a way to decide when investors tend to overreact. He uses the S&P 500 Index as a proxy for the U.S. stock market. He applies a pattern recognition algorithm to: (1) identify index peaks and troughs; and, (2) ensure that a full bear-bull cycle lasts at least 16 months and bear or bull states last at least 5 months, unless the index rises or falls by more than 20%. He then standardizes the duration of each market state to 10 intervals and assumes that the bull or bear return evolves quadratically with state age. Because the available sample is relatively small, he applies bootstrapping to enhance reliability of findings. Using monthly S&P 500 Index returns (excluding dividends) during January 1926 through December 2022, he finds that: Keep Reading
May 2, 2023 - Economic Indicators, Equity Premium
What are current estimates of equity risk premiums (ERP) and risk-free rates around the world? In their April 2023 paper entitled “Survey: Market Risk Premium and Risk-Free Rate used for 80 countries in 2023”, Pablo Fernandez, Diego García de la Garza and Javier Acin summarize results of a March 2023 email survey of international economic professors, analysts and company managers “about the Risk-Free Rate and the Market Risk Premium (MRP) used to calculate the required return to equity in different countries.” Results are in local currencies. Based on 3,812 specific and credible premium estimates spanning 80 countries for which there are at least six estimates, they find that: Keep Reading