Finding an investment strategy:

Does active management result in a better return?

E BB 1 , G R O U P 4
I S VA R I , E L I S A B E T H 383701
LE, HOANG 383008
L I , A MY 358088
DE RUITER, WOUTER 310563
Overview
Introduction
Data
Strategies
◦ MV
◦ LPM
◦ Volatility
◦ Momentum & contrarian

Performance & conclusion

Data
No changes in the portfolio
1973/1990 – 2013
Rf = 1 month T-bill
Global factors
Mean-variance strategy
Risk-adjusted return
Yearly
6-73 stocks

17% higher SP for tangency portfolio

Lower return
LPM Strategy
Aim: To perform as good as benchmark with less amount of risk
Optimization:
LPM Strategy
Procedure:
1. Calculate LPM for Individual stocks
2. Determine the required rate of return
=> Expected Return of the benchmark
3. Optimize the weights of individual assets to meet the required return
and all constraints
 LPM Strategy

LPM Strategy - Annual Rebalancing

Benchmark LPM portfolio Market

Average Annual Return % 11.6629 11.8354 7.6663

SD 16.3613 23.1504 16.7287
Sharpe Ratio 0.7128 0.5112 0.4583
LPM Strategy
Results
LPM Strategy

LPM Strategy - Annual Rebalancing – 2007-2013 - Monthly return

Benchmark LPM portfolio Market
Average Monthly Return 0.9227 1.104 0.4589
%
SD 7.2921 6.0581 5.4193
Sharpe Ratio 0.1265 0.1822 0.0847
Volatility strategy
2 Variations: Low Standard deviation and Low Beta
Procedure
1. Rank stocks based on selected measure
2. Go long in top 10

Rebalancing periods:
◦ Monthly
◦ Semi-annually
◦ Annually
 Volatility Strategy
Only annually rebalanced portfolio outperformed the market

Low SD Strategy - Annual Rebalancing

Benchmark SD Portfolio Market
Average Annual Return % 12.0925 12.5803 7.7486
SD 16.6505 3.625 17.4375
Sharpe Ratio 0.7263 3.4704 0.4444

Low Beta Strategy - Annual Rebalancing

Benchmark Beta Portfolio Market
Average Annual Return % 12.0925 11.2994 7.7486
SD 16.6505 3.1223 17.4375
Sharpe Ratio 0.7263 3.6189 0.4444
 Low Beta - Annual
25000

Crisis

20000

15000

10000

5000

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Years

Benchmark Portfolio Market

 Low SD - Annual
35000

30000
Crisis

25000

20000

15000

10000

5000

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Years

Benchmark Portfolio Market

 Volatility Persistence - Annual Portfolio

0.8

0.7

0.6

0.5
Average SD

0.4

0.3

0.2

0.1

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

Years

Quintile 5 Quintile 4 Quintile 3 Quintile 2 Quintile 1

 Volatility Persistence - Monthly Rebalancing

30

25

20
Average SD

15

10

0
1 8 15 22 29 36 43 50 57 64 71 78 85 92 99 106 113 120 127 134 141 148 155 162 169 176 183 190 197 204 211 218 225 232 239 246 253 260 267

Months

Quintile 5 Quintile 4 Quintile 3 Quintile 2 Quintile 1

 Momentum and Contrarian
Momentum
Formation period = Holding period (J = K)
Full Rebalancing and Partial Rebalancing
One month lag
Long winners and short losers
Medium term horizon

Contrarian
Partial Rebalancing
Long losers and short winners
Short term and Long term horizon
Momentum Result
Contrarian Result
CAPM
Beta
SD SD Semi- SD Beta Semi- Beta LPM MV
Annual annual Monthly Annual Monthly Annual
annual
βi -0.0190 0.4450 0.5640 0.0770 0.3810 0.4730 -0.0690 0.5730
αi 12.7280 1.1190 1.1470 10.7010 0.6210 0.6640 12.3660 4.3210
s.e. αi 0.7490 0.5900 0.6860 0.5840 0.4450 0.5260 4.3740 2.4600
zi 16.9890 1.8900 1.6720 18.3030 1.3950 1.2610 2.8260 1.7560
Pr[αi] 0.0000 0.0590 0.0950 0.0000 0.1640 0.2080 0.0070 0.0900

Momentum 9 months Contrarian 36 months Contrarian 60 months

No skip Skip No skip Skip No skip Skip
βi 0.0610 -0.0710 -0.0370 -0.0380 -0.0430 -0.0410
αi 0.3290 0.5080 -0.2590 -0.2720 -0.2450 -0.2350
s.e. αi 0.1800 0.0830 0.0860 0.0860 0.0850 0.0840
zi 1.8210 6.0980 -2.9890 -3.1390 -2.8620 -2.7860
Pr[αi] 0.0690 0.0000 0.0030 0.0010 0.0040 0.0060
 3 Factor Model
Beta
SD Annual SD Semi- SD Beta Semi- Beta LPM MV
annual Monthly Annual Monthly Annual
annual
βm -0.0190 0.4450 0.5640 0.0770 0.3810 0.4730 -0.0690 0.5580
βsmb -0.0820 1.2830 1.2370 -0.0140 0.8800 1.0480 0.0270 0.2660
βhml 0.0200 0.5980 0.4060 -0.0020 0.2440 0.1900 0.4180 0.1580
αi 12.7640 0.7780 0.9020 10.7280 0.4540 0.5190 10.7600 3.7320
s.e. αi 0.7650 0.6410 0.7380 0.6360 0.4870 0.5670 4.3870 2.3180
zi 16.6760 1.2120 1.2210 16.8490 0.9320 0.9150 2.4530 1.6090
Pr[αi] 0.0000 0.2260 0.2230 0.0000 0.3510 0.3610 0.0190 0.1180

Momentum 9 months Contrarian 36 months Contrarian 60 months

No skip Skip No skip Skip No skip Skip
βm 0.061 -0.072 -0.036 -0.051 -0.043 -0.041
βsmb -0.084 -0.223 -0.017 -0.043 -0.001 0.016
βhml 0.057 -0.017 0.058 0.059 0.043 0.049
αi 0.311 0.532 -0.281 -0.292 -0.271 -0.264
s.e. αi 0.18 0.187 0.086 0.085 0.085 0.087
zi 1.729 2.843 -3.24 -3.417 -3.166 -3.013
Pr[αi] 0.085 0.004 0.001 0.001 0.002 0.003
Conslusion
Return
Performance
Transaction costs
Active management?