Interfractile Migration Tracking: Duke Investment Analytics

Interfractile Migration Tracking
Duke Investment Analytics
Claudio Aritomi
Sam Ding
Mak Pitke
Marcus Shaw
Brian Wachob
Summary
 Identify a “Primary Factor” for Use as a Basis
Univariate Sort
 Define and Quantify Interfractile Migration (IM)
 IM Trending
 IM Volatility
 Study Sequential Sorts on Primary Factor, then IM
 Define Trading Strategies
 Test Out-of-Sample
 Conclusions
 Recommendations For Further Research
Note that this text-intensive version of the slide deck is an extended version intended for
independent study. A condensed version is intended for presentation purposes.
Purpose of Study
“Investigate whether interfractile migration

tracking can improve performance in a sort-
based stock selection strategy.”
A Note To Those Reading This Slide
Deck…
The notes that accompany these slides

(viewable in PowerPoint edit mode) contain
additional information that is not entirely
conveyed in the slides themselves. Please
examine these notes when considering the
research presented here.
Interfractile Migration - Definition
 Define 2 metrics to quantify “interfractile migration” (IM)
 Interfractile Migration Trending (IMT)
 over recent periods, measure the trend of each stock’s
movements through fractiles of the primary factor

 Interfractile Migration Volatility (IMV)
 over recent periods, measure the volatility of each
stock’s movements through fractiles of the primary factor

 Define fractile resolution (with respect to primary factor)
 We used 10 fractiles (deciles), as segregated by
Factset’s UDECILE() function.
Identify a Basis Univariate Sort
Candidates:
 Dividend Yield
 Book-to-Price
 Historical (Trailing) Earnings Yield
 Forward Earnings Yield
 I/B/E/S Mean Next Twelve Months
 I/B/E/S Mean FY1
 I/B/E/S Median NTM, FY1
 I/B/E/S Median FY2
 Implied Cost of Capital
Methodology
 FactSet quintile sorts
 Monthly rebalancing, 1-month holding period
 In-sample period: 1/31/87-11/31/01*
 Out-of-sample period: 12/31/01-12/31/04
 Universe
 US-listed NYSE, NASDAQ, AMEX
 Top 60% by market cap
 Convention: Low factor values are always assigned

to low-numbered fractiles
When historical data necessary to evaluate the univariate sorting factor for a
given stock is unavailable, that stock is excluded from the universe for that
backtest date.
* Note that using 31 as the last day of the month when specifying the date range in Factset is necessary—even when there is
no 31st day of the specified month. If not used in this way, lagged variables may not work properly in alpha tester.
Results of Univariate Sorts
The following slides present some data
evaluating the performance of selected
univariate sorts.
A far more detailed array of data sets and

analyses evaluating these univariate
sorts (and others) are contained in the
Excel workbook files accompanying this
PowerPoint presentation.
Dividend Yield - Quintile Performance
Returns & Alpha
Annualized Return, % -- Div. Yld VW Univariate Factor Performance Alpha, Monthly % -- Div. Yld VW Univariate Factor Performance
25.0
0.70
Value-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile
Annualized Return, % -- Div.Yld. EW Univariate Factor Performance Alpha, Monthly % -- Div.Yld. EW Univariate Factor Performance
25.0
0.70
Equal-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile
Annualized Return Alpha

Dividend Yield - Quintile Performance
Volatility & Beta
Std. Dev. of Monthly Returns -- Div.Yld. VW As Univariate Sort Factor Beta, on Market (S&P 500) -- Div.Yld. VW As Univariate Sort Factor
8.00 1.40
7.00
Value-Weighted
1.20
6.00
1.00
5.00
0.80
4.00
0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile
Std. Dev. of Monthly Returns -- Div.Yld. EW As Univariate Sort Factor Beta, on Market (S&P 500) -- Div.Yld. EW As Univariate Sort Factor
8.00 1.40
Equal-Weighted
7.00
1.20
6.00
1.00
5.00
0.80
4.00
0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile
Std. Dev. of Monthly Returns Beta on Market (S&P 500)

1/
31 log2 Cum Return
/1
-3
-2
-1
0
1
2
3
4
98
7
1/
31
/1
98
8
1/
31
/1
98
F1
FN
9
1/
FN-F1
31
Bmark
/1
99
0
1/
31
/1
99
1
1/
31
/1
99
2
1/
31
/1
99
3
1/
31
/1
99
4
1/
31
/1
99
5
1/
31
/1
99
6
1/
31
/1
99
7
1/
31
/1
99
8
1/
31
/1
99
9
1/
Div.Yld. VW -- Time Series, Cumulative Performance
31
/2
00
0
1/
31
/2
00
1
0
1
2
3
4
-3
-2
-1
Cumulative
log2 Cum Return for FN-F1 Only

Dividend Yield – F5-F1 Time Series, VW
Dividend Yield – F5-F1 Time Series, EW
Cumulative
Div.Yld. EW -- Time Series, Cumulative Performance

3.5 3.5
F1
FN
Bmark
2.5 FN-F1 2.5

1.5 1.5
log2 Cum Return
0.5 0.5
-0.5 -0.5
-1.5 -1.5
-2.5 -2.5
7
1
98
98
98
99
99
99
99
99
99
99
99
99
99
00
00
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/2
/2
31
31
31
31
31
31
31
31
31
31
31
31
31
31
31
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
Dividend Yield – F5-F1 Time Series All Fractiles, 12-Month Windows
Fractiles, Year-By-Year Returns -- Div.Yld. VW Fractile Returns, Trailing 12 Mos. -- Div.Yld. VW
70% 100%
Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

Computed by Multiplicatively Aggregating Monthly Returns Over 12-Mo. Windows
F1 F1-Bmark
F2-Bmark
Value-Weighted
60% F2
80% F3-Bmark
F3
F4-Bmark
F4 F5-Bmark
50%
F5 60% F5-F1
40%
40%
30%
20%
20%
0%
10%
-20%
0%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-10% -40%
-20% -60%
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1 /1
1/1
1/1
1/1
1 /1
1/1
1/1
1/1
1 /1
1/1
1 /2
1/2
-30%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
Fractiles, Year-By-Year Returns -- Div.Yld. EW Fractile Returns, Trailing 12 Mos. -- Div.Yld. EW

70% 100%
F1-Bmark
F1 F2-Bmark
Computed by Multiplicatively Aggregating Monthly Returns Over 12-Mo.
Equal-Weighted
60% F2 F3-Bmark
80%
F3 F4-Bmark
F4 F5-Bmark
50% F5-F1
F5 60%
40%
40%
30%
20%
Windows
20%
0%
10%
-20%
0%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 -40%
-10%
-20% -60%
8
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/2
1/2
-30%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
Year-By-Year Trailing Twelve Months
Incremental Share of All Returns Per Unit X (Density) Incremental Share of All Returns Per Unit X (Density)
0
2
4
6
8
10
12
14
0
1
2
3
4
5
6
7
8
9
10
-0.26 -0.27
-0.25 -0.26
-0.24 -0.25
-0.23 -0.24
-0.22 -0.23
-0.21 -0.22
-0.2 -0.21
-0.19 -0.2
-0.18 -0.19
-0.17
Cumulative
Cumulative
-0.18
Incremental
Incremental
-0.16 -0.17
-0.15 -0.16
-0.14 -0.15
-0.13 -0.14
-0.12 -0.13
-0.11 -0.12
-0.1 -0.11
-0.09 -0.1
-0.08 -0.09
-0.07 -0.08
-0.06 -0.07
-0.05 -0.06
-0.04 -0.05
-0.03 -0.04
-0.02 -0.03
-0.01
0 -0.02
0.01 -0.01
0.02 0
0.03 0.01
0.04 0.02
0.05 0.03
0.04
Monthly Return, Bin Upper Limit

0.06
0.07 0.05
0.08 0.06
0.09 0.07
0.1 0.08
0.11 0.09
0.12 0.1
Monthly Returns
0.13 0.11
0.14 0.12
0.15 0.13
0.16 0.14
0.17 0.15
Div.Yld. EW -- FN-F1 Portfolio: Monthly Returns Distribution

Div.Yld. VW -- FN-F1 Portfolio: Monthly Returns Distribution
0.18 0.16
0.19 0.17
0.2 0.18
0.21 0.19
0.22 0.2
Inf Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%
Cumulative Share of All Returns Cumulative Share of All Returns
0
2
4
6
8
10
12
14
0
1
2
3
4
5
6
7
8
9
10
-0.3 -0.32
-0.29 -0.31
-0.28 -0.3
-0.27 -0.29
-0.26 -0.28
-0.25 -0.27
-0.24 -0.26
-0.23 -0.25
-0.22 -0.24
-0.21 -0.23
Cumulative
Cumulative
Incremental
Incremental
-0.2 -0.22
-0.19 -0.21
-0.18 -0.2
-0.17 -0.19
-0.16 -0.18
-0.15 -0.17
-0.14 -0.16
-0.13 -0.15
-0.12 -0.14
-0.11 -0.13
-0.1 -0.12
-0.09 -0.11
-0.08 -0.1
-0.07 -0.09
-0.06 -0.08
-0.05 -0.07
-0.04 -0.06
-0.03 -0.05
-0.02 -0.04
-0.01 -0.03
0 -0.02
0.01 -0.01
0.02 0
0.03 0.01
ln Monthly Return, Bin Upper Limit
0.04 0.02
0.05 0.03
0.06 0.04
0.07 0.05
0.08 0.06
0.09 0.07
0.1 0.08
0.11 0.09
0.12 0.1
0.13 0.11
ln Monthly Returns
0.14 0.12
0.15 0.13
0.16 0.14
Div.Yld. EW -- FN-F1 Portfolio: ln Monthly Returns Distribution
Div.Yld. VW -- FN-F1 Portfolio: ln Monthly Returns Distribution
0.17 0.15
0.18 0.16
0.19 0.17
Dividend Yield – F5-F1 Returns Distributions
0.2 0.18
Inf Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%
Equal-Weighted Value-Weighted
Dividend Yield – F5-F1 Returns Distributions
Summary Statistics
Value-Weighted
Equal-Weighted
Monthly Returns ln Monthly Returns
Book to Price - Quintile Performance
Returns & Alpha
Annualized Return, % -- B/P VW Univariate Factor Performance Alpha, Monthly % -- B/P VW Univariate Factor Performance
25.0
0.70
Value-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile
Annualized Return, % -- B/P EW Univariate Factor Performance Alpha, Monthly % -- B/P EW Univariate Factor Performance
25.0
0.70
Equal-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile

Book to Price - Quintile Performance
Volatility & Beta
Std. Dev. of Monthly Returns -- B/P VW As Univariate Sort Factor Beta, on Market (S&P 500) -- B/P VW As Univariate Sort Factor
8.00
1.20
7.00
Value-Weighted
1.00
6.00
0.80
5.00
4.00 0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile
Std. Dev. of Monthly Returns -- B/P EW As Univariate Sort Factor Beta, on Market (S&P 500) -- B/P EW As Univariate Sort Factor
8.00
1.20
Equal-Weighted
7.00
1.00
6.00
5.00 0.80
4.00
0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile

Book to Price - F5-F1 Time Series, VW
Cumulative
B/P VW -- Time Series, Cumulative Performance

3.6 3.6
F1
FN
3 Bmark 3
FN-F1
2.4 2.4

1.8 1.8
log2 Cum Return
1.2 1.2
0.6 0.6
0 0
-0.6 -0.6
-1.2 -1.2
7
1
98
98
98
99
99
99
99
99
99
99
99
99
99
00
00
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/2
/2
31
31
31
31
31
31
31
31
31
31
31
31
31
31
31
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
31 log2 Cum Return
/1
-2
-1
0
1
2
3
4
98
7
1/
31
/1
98
8
1/
31
/1
98 F1
FN
9
1/
FN-F1
31
/1 Bmark
99
0
1/
31
/1
99
1
1/
31
/1
99
2
1/
31
/1
99
3
1/
31
/1
99
4
1/
31
/1
99
5
1/
31
/1
99
6
1/
31
/1
99
7
1/
31
/1
99
8
1/
31
/1
99
9
B/P EW -- Time Series, Cumulative Performance
1/
31
/2
00
0
1/
31
/2
00
1
Book to Price - F5-F1 Time Series, EW
Cumulative
0
1
2
3
4
-2
-1

Book to Price – F5-F1 Time Series All Fractiles, 12-Month Windows
Fractiles, Year-By-Year Returns -- B/P VW Fractile Returns, Trailing 12 Mos. -- B/P VW

150%
60% F1-Bmark
F1
F2-Bmark
55%
Value-Weighted
F2 125% F3-Bmark
50% F3 F4-Bmark
45% F4 F5-Bmark
100%
F5 F5-F1
40%
35% 75%
30%
25% 50%
20%
Windows
15% 25%
10%
5% 0%
0%
-5% 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 -25%
-10%
-15% -50%
-20%
-25% -75%
-30%
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/2
1/2
-35%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
Fractiles, Year-By-Year Returns -- B/P EW Fractile Returns, Trailing 12 Mos. -- B/P EW

150%
60% F1-Bmark
F1
F2-Bmark
Equal-Weighted
55% F2 125% F3-Bmark
50% F3 F4-Bmark
45% F4 F5-Bmark
100%
40% F5 F5-F1
35% 75%
30%
25% 50%
20%
Windows
15% 25%
10%
5% 0%
0%
-5% 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 -25%
-10%
-15% -50%
-20%
-25% -75%
-30%
8
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/2
1/2
-35%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
0
2
4
6
8
10
12
14
0
2
4
6
8
10
12
14
16
-0.37 -0.17
-0.36
-0.35 -0.16
-0.34
-0.33 -0.15
-0.32 -0.14
-0.31
-0.3 -0.13
-0.29
-0.28 -0.12
-0.27 -0.11
-0.26
Cumulative
Cumulative
Incremental
Incremental
-0.25 -0.1
-0.24
-0.23 -0.09
-0.22 -0.08
-0.21
-0.2 -0.07
-0.19
-0.18 -0.06
-0.17
-0.16 -0.05
-0.15 -0.04
-0.14
-0.13 -0.03
-0.12
-0.11 -0.02
-0.1 -0.01
-0.09
-0.08 0
-0.07
-0.06 0.01
-0.05 0.02
-0.04
-0.03 0.03
-0.02
-0.01 0.04
0
0.01 0.05

0.02 0.06
0.03
0.04 0.07
0.05
0.06 0.08
0.07 0.09
0.08
0.09 0.1
0.1
Monthly Returns
0.11 0.11
0.12 0.12
0.13
0.14 0.13
B/P EW -- FN-F1 Portfolio: Monthly Returns Distribution

B/P VW -- FN-F1 Portfolio: Monthly Returns Distribution
0.15
0.16 0.14
0.17 0.15
0.18
0.19 0.16
0.2
0.21 0.17
0.22
Inf Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%
0
2
4
6
8
10
12
14
0
2
4
6
8
10
12
14
16
-0.48 -0.18
-0.47
-0.46 -0.17
-0.45
-0.44 -0.16
-0.43
-0.42 -0.15
-0.41
-0.4 -0.14
-0.39
-0.38 -0.13
-0.37
-0.36 -0.12
Cumulative
Cumulative
-0.35
Incremental
Incremental
-0.34 -0.11
-0.33
-0.32 -0.1
-0.31
-0.3 -0.09
-0.29
-0.28 -0.08
-0.27
-0.26 -0.07
-0.25
-0.24 -0.06
-0.23
-0.22 -0.05
-0.21
-0.2 -0.04
-0.19
-0.18 -0.03
-0.17
-0.16 -0.02
-0.15
-0.14 -0.01
-0.13
-0.12 0
-0.11
-0.1 0.01
-0.09
-0.08 0.02
-0.07
-0.06 0.03
-0.05
-0.04 0.04
-0.03
-0.02 0.05
-0.01
0 0.06
0.01
0.02 0.07
0.03
0.04 0.08
0.05
0.06 0.09
0.07
0.08 0.1
0.09
0.1 0.11
ln Monthly Returns
0.11
Book to Price – F5-F1 Returns Distributions
0.12
B/P EW -- FN-F1 Portfolio: ln Monthly Returns Distribution
B/P VW -- FN-F1 Portfolio: ln Monthly Returns Distribution
0.13 0.12
0.14 0.13
0.15
0.16 0.14
0.17
0.18 0.15
0.19
0.2 Inf
Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%
Book to Price – F5-F1 Returns Distributions
Summary Statistics
Value-Weighted
Equal-Weighted
Trailing Earnings Yield - Quintile Performance
Returns & Alpha
Trailing Twelve Months Earnings Yield (TEY)
Annualized Return, % -- TEY VW Univariate Factor Performance Alpha, Monthly % -- TEY VW Univariate Factor Performance
25.0
0.70
Value-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile
Annualized Return, % -- TEY EW Univariate Factor Performance Alpha, Monthly % -- TEY EW Univariate Factor Performance
25.0
0.70
Equal-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile

Trailing Earnings Yield - Quintile Performance
Volatility & Beta
Std. Dev. of Monthly Returns -- TEY VW As Univariate Sort Factor Beta, on Market (S&P 500) -- TEY VW As Univariate Sort Factor
8.00
1.20
Value-Weighted
7.00
1.00
6.00
0.80
5.00
4.00 0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile
Std. Dev. of Monthly Returns -- TEY EW As Univariate Sort Factor Beta, on Market (S&P 500) -- TEY EW As Univariate Sort Factor
8.00
1.20
Equal-Weighted
7.00
1.00
6.00
0.80
5.00
4.00 0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile

Trailing Earnings Yield - F5-F1 Time Series, VW
Cumulative
TEY VW -- Time Series, Cumulative Performance
3.75 3.75
F1
FN
3 Bmark 3
FN-F1

2.25 2.25
log2 Cum Return
1.5 1.5
0.75 0.75
0 0
-0.75 -0.75
-1.5 -1.5
7
1
98
98
98
99
99
99
99
99
99
99
99
99
99
00
00
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/2
/2
31
31
31
31
31
31
31
31
31
31
31
31
31
31
31
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
Trailing Earnings Yield - F5-F1 Time Series, EW
Cumulative
TEY EW -- Time Series, Cumulative Performance
3.75 3.75
F1
FN
3 Bmark 3
FN-F1

2.25 2.25
log2 Cum Return
1.5 1.5
0.75 0.75
0 0
-0.75 -0.75
-1.5 -1.5
7
1
98
98
98
99
99
99
99
99
99
99
99
99
99
00
00
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/2
/2
31
31
31
31
31
31
31
31
31
31
31
31
31
31
31
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
Trailing Earnings Yield - F5-F1 Time Series
All Fractiles, 12-Month Windows
Fractiles, Year-By-Year Returns -- TEY VW Fractile Returns, Trailing 12 Mos. -- TEY VW

200%
F1-Bmark
F1
80% 175% F2-Bmark
Value-Weighted
F2
F3-Bmark
F3
150% F4-Bmark
F4 F5-Bmark
60% F5 F5-F1
125%
100%
40%
75%
Windows
50%
20%
25%
0%
0%
-25%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-50%
-20%
-75%
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1 /1
1/1
1/1
1/1
1/2
1/2
-40%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
Fractiles, Year-By-Year Returns -- TEY EW Fractile Returns, Trailing 12 Mos. -- TEY EW

200%
F1-Bmark
F1
F2-Bmark
Equal-Weighted
80% F2 175%
F3-Bmark
F3 F4-Bmark
150%
F4 F5-Bmark
60% F5 F5-F1
125%
100%
40%
75%
Windows
50%
20%
25%
0%
0%
-25%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-50%
-20%
-75%
8
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/2
1/2
-40%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
0
2
4
6
8
10
12
14
16
18
20
0
2
4
6
8
10
12
14
-0.4 -0.26
-0.39 -0.25
-0.38
-0.37 -0.24
-0.36 -0.23
-0.35 -0.22
-0.34
-0.33 -0.21
-0.32 -0.2
-0.31 -0.19
-0.3 -0.18
-0.29
-0.28 -0.17
Cumulative
Cumulative
Incremental
Incremental
-0.27 -0.16
-0.26 -0.15
-0.25
-0.24 -0.14
-0.23 -0.13
-0.22 -0.12
-0.21
-0.2 -0.11
-0.19 -0.1
-0.18 -0.09
-0.17
-0.16 -0.08
-0.15 -0.07
-0.14 -0.06
-0.13
-0.12 -0.05
-0.11 -0.04
-0.1 -0.03
-0.09 -0.02
-0.08
-0.07 -0.01
-0.06 0
-0.05 0.01
-0.04
-0.03 0.02
-0.02 0.03
-0.01 0.04
0
0.01 0.05
0.02 0.06

0.03 0.07
0.04
0.05 0.08
0.06 0.09
0.07 0.1
0.08
0.09 0.11
0.1 0.12
0.11 0.13
0.12
Monthly Returns
0.13 0.14
0.14 0.15
0.15 0.16
0.16 0.17
0.17
TEY EW -- FN-F1 Portfolio: Monthly Returns Distribution

TEY VW -- FN-F1 Portfolio: Monthly Returns Distribution
0.18 0.18
0.19 0.19
0.2 0.2
0.21
0.22 0.21
0.23 0.22
0.24 0.23
0.25
Inf Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%
0
2
4
6
8
10
12
14
16
18
20
0
2
4
6
8
10
12
14
-0.52 -0.31
-0.51 -0.3
-0.5
-0.49 -0.29
-0.48 -0.28
-0.47
-0.46 -0.27
-0.45 -0.26
-0.44 -0.25
-0.43
-0.42 -0.24
-0.41 -0.23
-0.4
-0.39 -0.22
-0.38
Cumulative
Cumulative
-0.21
Incremental
Incremental
-0.37 -0.2
-0.36
-0.35 -0.19
-0.34 -0.18
-0.33
-0.32 -0.17
-0.31 -0.16
-0.3 -0.15
-0.29
-0.28 -0.14
-0.27 -0.13
-0.26
-0.25 -0.12
-0.24 -0.11
-0.23 -0.1
-0.22
-0.21 -0.09
-0.2 -0.08
-0.19
-0.18 -0.07
-0.17 -0.06
-0.16
-0.15 -0.05
-0.14 -0.04
-0.13 -0.03
-0.12
-0.11 -0.02
-0.1 -0.01
-0.09
-0.08 0
-0.07 0.01
-0.06 0.02
-0.05
-0.04 0.03
-0.03
0.04
-0.02
-0.01 0.05
0 0.06
0.01 0.07
0.02
0.03 0.08
0.04 0.09
0.05
0.06 0.1
0.07 0.11
0.08 0.12
0.09
0.1 0.13
0.11 0.14
0.12
ln Monthly Returns
0.13 0.15
0.14
TEY EW -- FN-F1 Portfolio: ln Monthly Returns Distribution
TEY VW -- FN-F1 Portfolio: ln Monthly Returns Distribution
0.15 0.16
0.16 0.17
0.17 0.18
0.18 0.19
0.19
0.2 0.2
0.21 0.21
0.22
Inf Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%

Trailing Earnings Yield - F5-F1 Returns Distributions
Trailing Earnings Yield - F5-F1 Returns Distributions
Summary Statistics
Value-Weighted
Equal-Weighted
Forward Earnings Yield
 Four different definitions of forward earnings
A. Mean I/B/E/S earnings forecast for “Next Twelve Months”
B. Mean I/B/E/S earnings forecast for “Next Twelve Months”.
If this data is unavailable, mean I/B/E/S earnings forecast
for the current fiscal year is used instead.
C. Median I/B/E/S earnings forecast for “Next Twelve
Months”. If this data is unavailable, median I/B/E/S
earnings forecast for the current fiscal year is used
instead.
D. Median I/B/E/S earnings forecast for forward fiscal year
number 2.
 We backtested our univariate screening and sorting

methodology using each of these definitions to contribute the
numerator to our earnings yield computation.
 Performance across these four factor definitions is similar.
 Median analyst earnings estimates appear preferable to
means.
 Definition C appears to generate the best quintile sorts.
 Still, closer scrutiny of the results pertaining to these four
definitions is warranted and there still remains ample room for
improvement in these factor definitions. We leave this for
future research.
 We choose to focus our analysis on the backtest results using

definition C for Forward Earnings Yield:
 Median I/B/E/S earnings forecast for “Next Twelve
Months”. If this data is unavailable, median I/B/E/S
earnings forecast for the current fiscal year is used
instead.
Forward Earnings Yield - Quintile Performance
Returns & Alpha
Forecast Next 12 Mos. Earnings Yield (FEY)
Annualized Return, % -- FEY VW Univariate Factor Performance Alpha, Monthly % -- FEY VW Univariate Factor Performance
25.0
0.70
Value-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile
Annualized Return, % -- FEW EW Univariate Factor Performance Alpha, Monthly % -- FEW EW Univariate Factor Performance
25.0
0.70
Equal-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile

Forward Earnings Yield - Quintile Performance
Volatility & Beta
Std. Dev. of Monthly Returns -- FEY VW As Univariate Sort Factor Beta, on Market (S&P 500) -- FEY VW As Univariate Sort Factor
9.00 1.40
8.00
Value-Weighted
1.20
7.00
1.00
6.00
5.00 0.80
4.00 0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile
Std. Dev. of Monthly Returns -- FEW EW As Univariate Sort Factor Beta, on Market (S&P 500) -- FEW EW As Univariate Sort Factor
9.00 1.40
Equal-Weighted
8.00
1.20
7.00
1.00
6.00
5.00 0.80
4.00 0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile

Forward Earnings Yield - F5-F1 Time Series, VW
Cumulative
FEY VW -- Time Series, Cumulative Performance
4 2
F1
FN
3 Bmark 1.5
FN-F1

2 1
log2 Cum Return
1 0.5
0 0
-1 -0.5
-2 -1
-3 -1.5
7
1
98
98
98
99
99
99
99
99
99
99
99
99
99
00
00
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/2
/2
31
31
31
31
31
31
31
31
31
31
31
31
31
31
31
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
Forward Earnings Yield - F5-F1 Time Series, EW
Cumulative
FEY EW -- Time Series, Cumulative Performance
4 2
F1
FN
3 Bmark 1.5
FN-F1

2 1
log2 Cum Return
1 0.5
0 0
-1 -0.5
-2 -1
-3 -1.5
7
1
98
98
98
99
99
99
99
99
99
99
99
99
99
00
00
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/2
/2
31
31
31
31
31
31
31
31
31
31
31
31
31
31
31
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
Forward Earnings Yield - F5-F1 Time Series
All Fractiles, 12-Month Windows
Fractiles, Year-By-Year Returns -- FEY VW Fractile Returns, Trailing 12 Mos. -- FEY VW

96% 225%
F1-Bmark
F1
200% F2-Bmark
Value-Weighted
84% F2
F3-Bmark
F3 175% F4-Bmark
72% F4 F5-Bmark
F5 150% F5-F1
60%
125%
48% 100%
75%
Windows
36%
50%
24%
25%
12%
0%
0% -25%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-12% -50%
-75%
-24%
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1 /1
1 /1
1/1
1/1
1/1
1/1
1/1
1 /1
1/1
1/1
1/1
1/1
1/2
1/2
-36%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
Fractiles, Year-By-Year Returns -- FEY EW Fractile Returns, Trailing 12 Mos. -- FEY EW

96% 225%
F1 F1-Bmark
Equal-Weighted
F2 200% F2-Bmark
84%
F3-Bmark
F3
175% F4-Bmark
72% F4
F5-Bmark
F5 150% F5-F1
60%
125%
48% 100%
75%
Windows
36%
50%
24%
25%
12%
0%
0% -25%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-12% -50%
-75%
-24%
8
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/2
1/2
-36%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
0
2
4
6
8
10
12
14
16
0
2
4
6
8
10
12
14
16
-0.43 -0.26
-0.42 -0.25
-0.41
-0.4 -0.24
-0.39 -0.23
-0.38 -0.22
-0.37 -0.21
-0.36
-0.35 -0.2
-0.34 -0.19
-0.33 -0.18
-0.32
-0.31 -0.17
-0.3 -0.16
Cumulative
Cumulative
Incremental
Incremental
-0.29 -0.15
-0.28 -0.14
-0.27
-0.26 -0.13
-0.25 -0.12
-0.24 -0.11
-0.23
-0.22 -0.1
-0.21 -0.09
-0.2 -0.08
-0.19 -0.07
-0.18
-0.17 -0.06
-0.16 -0.05
-0.15 -0.04
-0.14
-0.13 -0.03
-0.12 -0.02
-0.11 -0.01
-0.1 0
-0.09
-0.08 0.01
-0.07 0.02
-0.06 0.03
-0.05
-0.04 0.04
-0.03 0.05
-0.02 0.06
-0.01
0 0.07
0.01 0.08
0.02 0.09

0.03 0.1
0.04
0.05 0.11
0.06 0.12
0.07 0.13
0.08
0.09 0.14
0.1 0.15
0.11 0.16
0.12
Monthly Returns
0.13 0.17
0.14 0.18
0.15 0.19
0.16 0.2
0.17
FEY EW -- FN-F1 Portfolio: Monthly Returns Distribution

FEY VW -- FN-F1 Portfolio: Monthly Returns Distribution
0.18 0.21
0.19 0.22
0.2 0.23
0.21 0.24
0.22
0.23 0.25
0.24 0.26
0.25 0.27
0.26
Inf Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%
0
2
4
6
8
10
12
14
16
0
2
4
6
8
10
12
14
16
-0.58 -0.31
-0.57 -0.3
-0.56
-0.55 -0.29
-0.54 -0.28
-0.53
-0.52 -0.27
-0.51 -0.26
-0.5
-0.49 -0.25
-0.48 -0.24
-0.47
-0.46 -0.23
-0.45 -0.22
-0.44 -0.21
-0.43
Cumulative
Cumulative
Incremental
Incremental
-0.42 -0.2
-0.41 -0.19
-0.4
-0.39 -0.18
-0.38 -0.17
-0.37
-0.36 -0.16
-0.35 -0.15
-0.34
-0.33 -0.14
-0.32 -0.13
-0.31
-0.3 -0.12
-0.29 -0.11
-0.28 -0.1
-0.27
-0.26 -0.09
-0.25 -0.08
-0.24
-0.23 -0.07
-0.22 -0.06
-0.21
-0.2 -0.05
-0.19 -0.04
-0.18
-0.17 -0.03
-0.16 -0.02
-0.15
-0.14 -0.01
-0.13 0
-0.12 0.01
-0.11
-0.1 0.02
-0.09 0.03
-0.08
-0.07 0.04
-0.06 0.05
-0.05
-0.04 0.06
-0.03 0.07
-0.02
-0.01 0.08
0 0.09
0.01
0.02 0.1
0.03 0.11
0.04 0.12
0.05
0.06 0.13
0.07 0.14
0.08
0.09 0.15
0.1 0.16
0.11
0.12
ln Monthly Returns
0.17
0.13 0.18
0.14
FEY EW -- FN-F1 Portfolio: ln Monthly Returns Distribution
FEY VW -- FN-F1 Portfolio: ln Monthly Returns Distribution
0.15 0.19
0.16 0.2
0.17
0.18 0.21
0.19 0.22
0.2
0.21 0.23
0.22 0.24
0.23 Inf
Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%

Forward Earnings Yield - F5-F1 Returns Distributions
Forward Earnings Yield - F5-F1 Returns Distributions
Summary Statistics
Value-Weighted
Equal-Weighted
Implied Cost of Capital - Idea
 Idea: Base a univariate sorting factor on an
estimation of implied cost of capital.
 Implied cost of capital should be a far more
comprehensive relative valuation metric than earnings
yield, dividend yield, or book-to-price.
 Earnings yield can be viewed as an extremely
simplified expression of implied cost of equity.
 Common valuation models can be simplified to yield
the following relations if extreme over-simplifying
assumptions are made (i.e. firms have reached steady-
state and will not grow)
E1 E1
P0  re 
re P0
re is the cost of equity, which can be equated to cost of capital if another extreme over-
simplifying assumption is made: all firms are 100% equity financed.
Implied Cost of Capital - Implementation
 A residual income (i.e. “abnormal earnings”) valuation
model can serve as the basis for estimating an
implied cost of equity, re, for each firm (based on the
market capitalization observed in the market).
 Estimates of leverage and cost of debt, rd, for each
firm can be integrated with the residual income model
to estimate implied cost of capital for each firm.
 All firms could be ranked on implied cost of capital.
The firms with the highest implied cost of capital
might be considered undervalued (long candidates).
Those with the lowest implied cost of capital might be
considered overvalued (short candidates).
Implied Cost of Capital - Limitations
 It is obviously false to assert that the implied cost of
capital for all firms should be equivalent in
expectation.
 However, the assertion is similarly flawed for the
other valuation metrics previously examined
(earnings yield, dividend yield, book-to-price).
 Still, an advantageous informational advantage
seems to have been found (for forward earnings
yield, for example)
 Differing expected future growth rates and patterns,
payout ratios, and capital structures are sources of
differing expected earnings yield. Implied cost of
capital can take all of these firm-specific features into
account.
Implied Cost of Capital -
Industry-Normalization?
 The implied cost of capital for each firm
should theoretically reflect the inherent risk of
its underlying assets, ra.
 Thus, it probably makes more sense to

compare any given firm’s implied cost of
capital against that of other firms in the same
industry. Of course, by the same logic,
industry normalization might improve
performance of other valuation metrics such
as earnings yield, dividend yield, and book-to-
price.
Implied Cost of Capital -
Implementation Challenges
 Estimating even implied cost of equity (let alone
implied cost of capital) for each firm requires numeric
methods.
 FactSet’s Alpha Testing module does not appear
capable of implementing the necessary algorithms.
 Time limits did not permit us to write our own code to
replicate the functionality of FastSet’s Alpha Testing
and implement numeric methods to solve for implied
cost of capital.
 However, we believe we have determined that the
implementation of this backtest is possible with FQL
(FactSet Query Language) and even in Excel via
Visual Basic and the FastSet Excel Plug-In.
“Implied Cost of Capital” -
Ours Is A Weak Approximation
 Though we present the idea here, we did not implement a
strong evaluation of implied cost of capital as a univariate
sorting factor.
 We did implement an extreme simplification of the idea using
the following relation to grossly approximate implied cost of
equity:
E1  re B0 (1 g  )( E1  re B0 )
P0  B0  1 re  ( re  g  )(1 re )
Note that we chose 5.5% as the nominal terminal growth rate, g∞, for all firms.
 This relation could be implemented in FactSet’s Alpha Testing

because it is solvable for re by the quadratic equation.
 Note that though we have called this “implied cost of capital,” it
is in truth a highly over-simplified implementation of what is
typically meant by “implied cost of capital.” This implementation
does little more than achieve a reasonable integration of forward
earnings yield and book-to-price into one metric.
“Implied Cost of Capital” ≡ ICC
Two methods of calculation
 Recognizing that our “implied cost of capital” had become little
more than an integration of forward earnings yield and book-
to-price into a single metric, we experimented with two
definitions of forward earnings (denoted E1 in the preceding
slide):
1. ICC1: Median I/B/E/S earnings forecast for “Next Twelve Months”.
If this data is unavailable, median I/B/E/S earnings forecast for
the current fiscal year is used instead (as in FEY definition C).
2. ICC2: Median I/B/E/S earnings forecast for forward fiscal year
number 2 (as in FEY definition D). (Idea/justification: Use the
most forward earnings forecast to extrapolate into perpetuity
even though this earnings estimate should be discounted more
heavily.)
 The following slides focus on the backtest results using ICC1

(definition 1 for E1).
 This definition was chosen because backtest results were
similar across both definitions for ICC, but definition 1 is
more theoretically valid in the highly simplified valuation
expression presented in the previous slide.
ICC1 - Quintile Performance Returns & Alpha
Annualized Return, % -- ICC VW Univariate Factor Performance Alpha, Monthly % -- ICC VW Univariate Factor Performance
25.0
0.70
Value-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile
Annualized Return, % -- ICC EW Univariate Factor Performance Alpha, Monthly % -- ICC EW Univariate Factor Performance
25.0
0.70
Equal-Weighted
20.0 0.50
0.30
15.0
0.10
10.0
-1- -2- -3- -4- -5-

-0.10
5.0
-0.30
0.0
-1- -2- -3- -4- -5- -0.50
Fractile Fractile

ICC1 - Quintile Performance Volatility & Beta
Std. Dev. of Monthly Returns -- ICC VW As Univariate Sort Factor Beta, on Market (S&P 500) -- ICC VW As Univariate Sort Factor
8.00
1.20
Value-Weighted
7.00
1.00
6.00
0.80
5.00
4.00 0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile
Std. Dev. of Monthly Returns -- ICC EW As Univariate Sort Factor Beta, on Market (S&P 500) -- ICC EW As Univariate Sort Factor
8.00
1.20
Equal-Weighted
7.00
1.00
6.00
0.80
5.00
4.00 0.60
3.00
0.40
2.00
0.20
1.00
0.00 0.00
-1- -2- -3- -4- -5- -1- -2- -3- -4- -5-
Fractile Fractile

1/
31 log2 Cum Return
/1
0.8
1.6
2.4
3.2
-1.6
-0.8
0
4
98
1/ 7
31
/1
98
1/ 8
31
/1
98 F1
1/ 9 FN
31
FN-F1
/1 Bmark
99
1/ 0
31
/1
99
1/ 1
31
/1
99
1/ 2
31
/1
99
1/ 3
31
/1
99
1/ 4
31
/1
99
1/ 5
31
/1
99
1/ 6
31
/1
99
1/ 7
31
/1
99
1/ 8
31
/1
99
ICC1 - F5-F1 Time Series, VW
1/ 9
ICC VW -- Time Series, Cumulative Performance
31
/2
00
1/ 0
31
/2
00
1
0
2
Cumulative
0.4
0.8
1.2
1.6
-0.8
-0.4

1/
31 log2 Cum Return
/1
0.8
1.6
2.4
3.2
-1.6
-0.8
0
4
98
1/ 7
31
/1
98
1/ 8
31
/1
98 F1
1/ 9 FN
31
FN-F1
/1 Bmark
99
1/ 0
31
/1
99
1/ 1
31
/1
99
1/ 2
31
/1
99
1/ 3
31
/1
99
1/ 4
31
/1
99
1/ 5
31
/1
99
1/ 6
31
/1
99
1/ 7
31
/1
99
1/ 8
31
/1
ICC1 - F5-F1 Time Series, EW
99
1/ 9
ICC EW -- Time Series, Cumulative Performance
31
/2
00
1/ 0
31
/2
00
1
Cumulative
0
2
0.4
0.8
1.2
1.6
-0.8
-0.4

ICC1 – F5-F1 Time Series All Fractiles, 12-Month Windows
Fractiles, Year-By-Year Returns -- ICC VW Fractile Returns, Trailing 12 Mos. -- ICC VW

80% 175%
F1-Bmark
F1
F2-Bmark
150%
Value-Weighted
F2
F3-Bmark
F3
F4-Bmark
60% F4 125% F5-Bmark
F5 F5-F1
100%
40%
75%
50%
Windows
20%
25%
0%
0%
-25%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-50%
-20%
-75%
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1 /1
1/1
1/1
1/1
1/1
1/1
1/1
1 /1
1 /1
1/1
1 /2
1/2
-40%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
Fractiles, Year-By-Year Returns -- ICC EW Fractile Returns, Trailing 12 Mos. -- ICC EW

80% 175%
F1 F1-Bmark
Equal-Weighted
F2 150% F2-Bmark
F3 F3-Bmark
60% F4-Bmark
F4 125%
F5-Bmark
F5
F5-F1
100%
40%
75%
50%
Windows
20%
25%
0%
0%
-25%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-50%
-20%
-75%
8
1
98
98
99
99
99
99
99
99
99
99
99
99
00
00
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/1
1/2
1/2
-40%
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
1/3
0
2
4
6
8
10
12
14
16
18
0
2
4
6
8
10
12
14
16
18
-0.37 -0.21
-0.36 -0.2
-0.35
-0.34 -0.19
-0.33 -0.18
-0.32 -0.17
-0.31
-0.3 -0.16
-0.29 -0.15
-0.28 -0.14
-0.27
-0.26 -0.13
Cumulative
Cumulative
Incremental
Incremental
-0.25 -0.12
-0.24 -0.11
-0.23
-0.22 -0.1
-0.21 -0.09
-0.2 -0.08
-0.19
-0.18 -0.07
-0.17 -0.06
-0.16 -0.05
-0.15
-0.14 -0.04
-0.13 -0.03
-0.12 -0.02
-0.11
-0.1 -0.01
-0.09 0
-0.08 0.01
-0.07
-0.06 0.02
-0.05 0.03
-0.04 0.04
-0.03
-0.02 0.05
-0.01 0.06
0 0.07
0.01
0.08

0.02
0.03 0.09
0.04 0.1
0.05 0.11
0.06
0.07 0.12
0.08 0.13
0.09 0.14
0.1
Monthly Returns
0.11 0.15
0.12 0.16
0.13 0.17
0.14
ICC EW -- FN-F1 Portfolio: Monthly Returns Distribution

ICC VW -- FN-F1 Portfolio: Monthly Returns Distribution
0.15 0.18
0.16 0.19
0.17 0.2
0.18
0.19 0.21
0.2 0.22
0.21 0.23
0.22
Inf Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%
0
2
4
6
8
10
12
14
16
18
0
2
4
6
8
10
12
14
16
18
-0.46 -0.24
-0.45 -0.23
-0.44
-0.43 -0.22
-0.42 -0.21
-0.41
-0.4 -0.2
-0.39 -0.19
-0.38
-0.37 -0.18
-0.36 -0.17
-0.35
-0.34 -0.16
Cumulative
Cumulative
Incremental
Incremental
-0.33 -0.15
-0.32
-0.31 -0.14
-0.3 -0.13
-0.29 -0.12
-0.28
-0.27 -0.11
-0.26 -0.1
-0.25
-0.24 -0.09
-0.23 -0.08
-0.22
-0.21 -0.07
-0.2 -0.06
-0.19
-0.18 -0.05
-0.17 -0.04
-0.16 -0.03
-0.15
-0.14 -0.02
-0.13 -0.01
-0.12
-0.11 0
-0.1 0.01
-0.09
-0.08 0.02
-0.07 0.03
-0.06
-0.05 0.04
-0.04 0.05
-0.03 0.06
-0.02
-0.01 0.07
0 0.08
0.01
0.02 0.09
0.03 0.1
0.04
0.05 0.11
0.06 0.12
0.07
0.08 0.13
0.09 0.14
ICC1 – F5-F1 Returns Distributions
0.1 0.15
0.11
ln Monthly Returns
0.12 0.16
ICC EW -- FN-F1 Portfolio: ln Monthly Returns Distribution
ICC VW -- FN-F1 Portfolio: ln Monthly Returns Distribution
0.13 0.17
0.14
0.15 0.18
0.16 0.19
0.17
0.18 0.2
0.19 0.21
0.2
Inf Inf
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
100%
ICC1 – F5-F1 Returns Distributions Summary Statistics
Value-Weighted
Equal-Weighted
Univariate Sorts - Summary
FEY_C
ICC2
ICC1
FEY_D
FEY_B
TEY
FEY_A
B/P
Div.Yld.
Selected Primary Factor
 Definition C was chosen
 Even though our backtesting results slightly
favor ICC as a univariate sort factor
(especially in value-weighted portfolios), we
selected FEY as the primary (basis) factor
upon which to experiment with interfractile
migration tracking.
 FEY was selected because its performance
was similar to that of ICC, but its interpretation
is more intuitive and its use in financial
analyses more widespread.
 Define 2 metrics to quantify “interfractile migration” (IM)
 Interfractile Migration Trending (IMT)
 over recent periods, measure the trend of each stock’s
movements through fractiles of the primary factor

 Interfractile Migration Volatility (IMV)
 over recent periods, measure the volatility of each
stock’s movements through fractiles of the primary factor

 Define fractile resolution (with respect to primary factor)
 We used 10 fractiles (deciles), as segregated by
Factset’s UDECILE() function.
Red Dot Stock IM Trending, IMT = 0
IM Volatility, IMV = 0
10
9
8
7
Primary Factor
6
Deciles
5
4
3
2
1
0
-11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0
Lagged Months
Green Circle Stock IMT is highly positive
IMV is moderate
10
9
8
7
Primary Factor
6
Deciles
5
4
3
2
1
0
-11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0
Lagged Months
Black X Stock IMT is only slightly positive
IMV is moderate
10
9
8
7
Primary Factor
6
Deciles
5
4
3
2
1
0
-11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0
Lagged Months
Blue Square Stock IMT is negligible
IMV is very high
10
9
8
7
Primary Factor
6
Deciles
5
4
3
2
1
0
-11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0
Lagged Months
Interfractile Migration - Quantification
We implemented two variants of each metric
 IMT
 SMA3(PFD)-SMA12(PFD)
 Trailing triangular-weighted average of
previous 11 ΔPFD’s   (2(11121 n)  (PFD  PFD )
n 0
i ,n i , n 1
n  10
 IMV
 Mean of previous 11 |ΔPFD|’s
 Trailing triangular-weighted average of
previous 11 |ΔPFD|’s
PFDi,t – “Primary Factor Decile”; the decile into which a stock is
binned when sorted on the primary factor
Note that we used some special techniques to estimate IMT and IMV for stocks that were missing primary factor (forward earnings
yield) data in some periods within the last 12 months. Refer to our report for more details.
Interfractile Migration - Illustration
To illustrate, let’s focus on these two particular
variants of our IM metrics:
IMT: SMA3(PFD)-SMA12(PFD)
IMV: Mean of previous 11 |ΔPFD|’s
Note that we also applied our alternate definitions of IMT and IMV, but at least upon a
first look at charts illustrating performance across the 15 sub-fractiles, there does not
appear to be significant additional information contributed by these alternate definitions.
Interfractile Migration - Illustration
We studied both equal-weighted and value-weighted portfolios.
IMT Equal-Weighted IMT Value-Weighted
25.0
25.0
20.0
20.0
15.0
Annualized Return
15.0
Annual Return
10.0 10.0
5.0 5.0
0.0 0.0
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15- -1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
Fractile Fractile
IMV Equal-Weighted IMV Value-Weighted

25.0
25.0
20.0
20.0
Annualized Return
15.0
Annualized Return
15.0
10.0 10.0
5.0 5.0
0.0 0.0
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15- -1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
Fractiles Fractile
Findings are roughly similar across both intra-fractile weighting

schemes. Thus, in these slides we focus on value-weighted portfolios.
Liquidity issues tend to make these more easily implementable.
Refer directly to Excel source files for details of performance in equal-weighted portfolios.
Interfractile Migration - Implementation
We analyze IM factor performance within each
Forward Earnings Yield (FEY) quintile:
 Two-step sequential sort
 1st Sort: Quintiles on primary factor (FEY)
 2nd Sort: Sub-Trintiles on IMT or IMV
Interfractile Migration Trending
Raw Mean Geometric Annualized Return
25.0
20.0
Annualized Return
15.0
10.0
5.0
0.0
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
Fractile
Market Risk-Adjusted Monthly Alpha
0.60
0.40
0.20
0.00
Alpha
-0.20
-0.40
-0.60
-0.80
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
Fractile
Standard Deviation of Monthly Returns (Sigma)
8.00
7.00
6.00
Std. Dev. of Monthly Returns (Sigma)
5.00
4.00
3.00
2.00
1.00
0.00
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
Fractile
Interfractile Correlation
 High correlations between high and low IMT fractiles (1 vs. 3; 4

vs. 6) suggest low variance spread trade strategy.
 Lower correlations between high and low FEY fractiles (1,2,3 vs.
13,14,15) suggest higher variance spread trade strategy.
IMT – Trading Strategies
 Control Portfolio
 Long the 3 high FEY fractiles (13,14,15)
 Short the 3 low FEY fractiles (1,2,3)
 IMT Isolation for Low FEY Portfolio

 Long the low IMT fractiles in low FEY quintiles (1,4)
 Short the high IMT fractiles in low FEY quintiles (3,6)
 Hybrid Portfolio
 Long fractiles 13,14,15,1
 Short fractiles 2,3,6
When building simulated portfolios that combine fractiles, value-weighting was used
within fractiles. However, within a multi-fractile long (or short) portfolio, each fractile was
equally weighted with monthly rebalancing. This methodology was implemented solely for
computational convenience and could be reconsidered in an alternate analysis.
IMT – Hybrid Portfolio Composition
 Various combinations of the 15 sub-fractile portfolios were
considered and examined as candidate “hybrid portfolios.”
 Qualitative justification of long{13, 14, 15, 1} / short{2, 3, 6}
 Fractiles 2, 3, and 6 showed the lowest raw mean returns
and alphas in-sample.
 Fractile 1 is highly correlated with fractiles 2, 3, and 6, but
with a higher mean return. It is more highly correlated with
the aggregated short fractiles than fractile 4 (and less
correlated with its fellow long fractiles 13, 14, and 15).
 Of course, low correlations among all-long or all-short
portfolio positions result in desirable lower overall volatility.
The same is true for high correlations between hedge
portfolio positions.
Note that we experimented with portfolio optimization techniques in search of an optimal
hybrid portfolio definition, paying special attention to the non-normal nature of monthly
fractile return distributions. More focus could be given to these methods in future studies.
Refer to source spreadsheets for more detail pertaining to assorted experimental
candidate hybrid portfolios.
IMT – Trading Strategies
1.75 3.5
13,14,15 - 1,2,3; Control: FEY Long/Short

1.5 3
1,13,14,15 - 2,3,6; Hybrid
1,4 - 3,6; IMT Isolation
1.25 SP500 2.5
1 2
log2 Cum Returns for SP500 Only

0.75 1.5
log2 Cum Returns
0.5 1
0.25 0.5
0 0
-0.25 -0.5
-0.5 -1
-0.75 -1.5
Dec-87 Dec-88 Dec-89 Dec-90 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01
Interfractile Migration Volatility
25.0
20.0
Annualized Return
15.0
10.0
5.0
0.0
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
Fractile
0.60
0.40
0.20
0.00
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
Alpha
-0.20
-0.40
-0.60
-0.80
-1.00
Fractile
Standard Deviation of Monthly Returns (Sigma)
8.00
7.00
6.00
Std. Dev. of Monthly Returns (Sigma)
5.00
4.00
3.00
2.00
1.00
0.00
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
Fractile
Interfractile Correlation
 High correlations between high and low IMT fractiles (1 vs. 3; 4

vs. 6) suggest low variance spread trade strategy.
 Lower correlations between high and low FEY fractiles (1,2,3 vs.
13,14,15) suggest higher variance spread trade strategy.
IMV – Trading Strategies
 Control Portfolio
 Long the 3 high FEY fractiles (13,14,15)
 Short the 3 low FEY fractiles (1,2,3)
 IMV Isolation for Low FEY Portfolio

 Long the high IMV fractiles in low FEY quintiles (3,6)
 Short the low IMV fractiles in low FEY quintiles (1,4)
 Hybrid Portfolio
 Long fractiles 3,13,14,15
 Short fractiles 1,2,4
When building simulated portfolios that combine fractiles, value-weighting was used
within fractiles. However, within a multi-fractile long (or short) portfolio, each fractile
was equally weighted with monthly rebalancing.
IMV – Hybrid Portfolio Composition
 Various combinations of the 15 sub-fractile portfolios were
considered and examined as candidate “hybrid portfolios.”
 Qualitative justification of long{3, 13, 14, 15} / short{1, 2, 4}
 Fractiles 1, 2, and 4 showed the lowest raw mean returns
and alphas in-sample.
 Fractile 3 is highly correlated with fractiles 1, 2, and 4, but
with a higher mean return. It is more highly correlated with
each of these short fractiles than fractile 6 (and less
correlated with its fellow long fractiles 13, 14, and 15).
 Of course, low correlations among all-long or all-short
portfolio positions result in desirable lower overall volatility.
The same is true for high correlations between hedge
portfolio positions.
Note that we experimented with portfolio optimization techniques in search of an optimal
hybrid portfolio definition, paying special attention to the non-normal nature of monthly
fractile return distributions. More focus could be given to these methods in future studies.
Refer to source spreadsheets for more detail pertaining to assorted experimental
candidate hybrid portfolios.
IMV – Trading Strategies
1.75 3.5

1.5 3
3,13,14,15 - 1,2,4; Hybrid
1.25 3,6 - 1,4; IMV Isolation 2.5
SP500
1 2
log2 Cum Returns or SP500 Only

0.75 1.5
log2 Cum Returns
0.5 1
0.25 0.5
0 0
-0.25 -0.5
-0.5 -1
-0.75 -1.5
7
1
-8
-8
-8
-9
-9
-9
-9
-9
-9
-9
-9
-9
-9
-0
-0
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
D
D
In-Sample Summary
IM Trading Strategies
Out of Sample – IMT
24.0
20.0
16.0
12.0
Annualized Return
8.0
4.0
0.0
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
-4.0
-8.0
Fractile
1.60
1.20
0.80
Alpha
0.40
0.00
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
-0.40
-0.80
Fractile
0.50 1.00
1,13,14,15 - 2,3,6; Hybrid
1,4 - 3,6; IMT Isolation
SP500
0.00 0.00
log2 Cum Returns SP500 Only

log2 Cum Returns
-0.50 -1.00
OUT OF
SAMPLE
-1.00 -2.00
-1.50 -3.00
-2.00 -4.00
Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec-
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
Out of Sample – IMV
24.0
20.0
16.0
12.0
Annualized Return
8.0
4.0
0.0
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
-4.0
-8.0
Fractile
1.60
1.20
0.80
Alpha
0.40
0.00
-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15-
-0.40
-0.80
Fractile
0.75
1.00
0.50
3,13,14,15 - 1,2,4; Hybrid
0.50
0.25
3,6 - 1,4; IMV Isolation
SP500
0.00 0.00
log2 Cum Returns SP500 Only

-0.25
-0.50
log2 Cum Returns
-0.50 OUT OF
SAMPLE -1.00
-0.75
-1.00 -1.50
-1.25
-2.00
-1.50
-2.50
-1.75
-2.00 -3.00
Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec-
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
Conclusions
 Among the valuation-based univariate screens
examined, Forward Earnings Yield and ICC were the
best. For unrebalanced FEY long F5 - short F1,
monthly alpha = .87%.
 A secondary sequential sort on IM trending (or
volatility) appeared to add information (in-sample)
regarding returns in low FEY quintiles.
 IM-based enhanced trading strategies looked
promising in-sample. Improved variance and total
returns over the control strategy looked possible.
Conclusions
 Out of sample, these trading strategies
underperformed.
 Perhaps the patterns observed in-sample
were mere data artifacts.
 Alternately, perhaps the 2002-2004 period
happens to be a poor period for these IM-
based strategies within FEY sorts. Perhaps
the pattern observed in-sample will re-
emerge in future months.
Recommendations For Future Research
 Monitor continuing out-of-sample IMT and IMV
performance for Forward Earnings Yield
 Examine IM-based sorts in other Primary Factors
(besides FEY– perhaps on an improved implied cost
of capital factor, or an industry-normalized factor, or a
non-valuation-based factor)
 Examine sensitivity to IM metric definitions (i.e.
lengths of trailing periods, weightings, and fractile
resolution).
 Study a combination of trending and volatility elements
of IM into a single sorting factor.
 Study a third IM metric definition: IM Permanence–
weighted (?) trailing average of differences with current
n 0
 n)
fractile membership. Maybe:   (2(11
121
n  10
i ,0

 ( PFD  PFD )
i , n 1

 Incorporate transaction costs into analysis
Recommendations For Future Research
 Rigorously implement backtesting of implied cost of capital as a
univariate factor sort.
 Introduce industry-normalization to definitions of basis univariate
sorting factors (seems especially pertinent for these valuation-
ratio-grounded metrics).
 Study more closely any rebalancing effects on these long/short
portfolios.
 Apparent rebalancing effects observed in this study suggest
that there may exist “factor momentum” where factor
portfolio performance in a given month is predictive of factor
portfolio performance in the subsequent month.
 Implementation of these analyses in a regression-based
framework rather than fractile sorts would enable better
integration into multivariate stock selection models as well as
additional factor performance diagnostics.
Also, refer to slide notes for specific suggested improvements to our
screening and sorting methodologies as executed in this analysis.

Interfractile Migration Tracking: Duke Investment Analytics

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Interfractile Migration Tracking

Duke Investment Analytics

“Investigate whether interfractile migration

The notes that accompany these slides

movements through fractiles of the primary factor

stock’s movements through fractiles of the primary factor

 Convention: Low factor values are always assigned

A far more detailed array of data sets and

-1- -2- -3- -4- -5-

-1- -2- -3- -4- -5-

Annualized Return Alpha

Std. Dev. of Monthly Returns Beta on Market (S&P 500)

log2 Cum Return for FN-F1 Only

Div.Yld. EW -- Time Series, Cumulative Performance

log2 Cum Return for FN-F1 Only

Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

Monthly Return, Bin Upper Limit

Div.Yld. EW -- FN-F1 Portfolio: Monthly Returns Distribution

Cumulative Share of All Returns Cumulative Share of All Returns

Cumulative Share of All Returns Cumulative Share of All Returns

-1- -2- -3- -4- -5-

-1- -2- -3- -4- -5-

Annualized Return Alpha

Std. Dev. of Monthly Returns Beta on Market (S&P 500)

B/P VW -- Time Series, Cumulative Performance

log2 Cum Return for FN-F1 Only

log2 Cum Return for FN-F1 Only

Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

Monthly Return, Bin Upper Limit

B/P EW -- FN-F1 Portfolio: Monthly Returns Distribution

Cumulative Share of All Returns Cumulative Share of All Returns

Cumulative Share of All Returns Cumulative Share of All Returns

-1- -2- -3- -4- -5-

-1- -2- -3- -4- -5-

Annualized Return Alpha

Std. Dev. of Monthly Returns Beta on Market (S&P 500)

log2 Cum Return for FN-F1 Only

log2 Cum Return for FN-F1 Only

Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

80% 175% F2-Bmark

Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

Monthly Return, Bin Upper Limit

TEY EW -- FN-F1 Portfolio: Monthly Returns Distribution

Cumulative Share of All Returns Cumulative Share of All Returns

Cumulative Share of All Returns Cumulative Share of All Returns

 We backtested our univariate screening and sorting

 We choose to focus our analysis on the backtest results using

-1- -2- -3- -4- -5-

-1- -2- -3- -4- -5-

Annualized Return Alpha

Std. Dev. of Monthly Returns Beta on Market (S&P 500)

log2 Cum Return for FN-F1 Only

log2 Cum Return for FN-F1 Only

Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

Computed by Multiplicatively Aggregating Monthly Returns Over a Trailing 12-Mo. Window

Monthly Return, Bin Upper Limit

FEY EW -- FN-F1 Portfolio: Monthly Returns Distribution

Cumulative Share of All Returns Cumulative Share of All Returns

Cumulative Share of All Returns Cumulative Share of All Returns

 Thus, it probably makes more sense to

 This relation could be implemented in FactSet’s Alpha Testing