Investment Styles in the European Equity Market
ADVANCES IN QUANTITATIVE ASSET MANAGEMENT, C. Dunis, ed., Kluwer Academic Press, 2000
Posted: 21 Jan 2005
Equity investment styles have been in use for many years in American financial markets. They have proven to be important reference points used in the creation of asset allocation strategies for mutual funds and to coordinate the monthly strategy with the daily stock selection. The formation of a large European stock market affords institutional investors the opportunity to introduce these strategies.
In this paper, equity styles have been shown to exist in the European market and to have a significant contrasting tendency in terms of cumulative returns. In addition, many of the equity investment strategies based on portfolio re-balancing towards a determined style (short long overlay strategies) have been shown to have positive returns.
To illustrate these results, portfolio styles have been firstly determined. This has been accomplished through the classification of the 561 stocks comprising the MSCI into 5 portfolios (quintiles) based on several fundamental indicators (Price to Book Value, Price to Earnings, Price to Cash Flow, Dividend Yield, Earnings Growth, Beta, Size and ROE). We have then calculated the return and turnover rate for each quintile and the percentage of positive movements for each portfolio and for each style strategy.
Another interesting aspect of this paper is the analysis of each portfolio style's return in relation to the principal macroeconomic and European macromarket variables. For each portfolio, estimates of the sensitivity coefficients (betas) have been calculated with respect to each economic variable. A significant contrast of figures has been revealed between the "value" portfolio style (low P/E, low P/B, low P/CF, high DY) and the "growth" portfolio style (high ROE). The economic analysis of the portfolio has been preceded by a correlation analysis on all the economic variables considered significant for the European economy. Then, following recent literature, a multi-factor APT model with variable parameters has been estimated for each portfolio. Both the state space and the ECM forms have been utilized with GARCH disturbances in order to study the existing economic relationship between equity style and macroeconomic and macro-market variables.
Keywords: Investment style, style analysis, European equity market
JEL Classification: C13, C22, E44, G1, G15
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