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Dr. Denis Schweizer Associate Professor of Finance John Molson School of Business, Concordia UniversityMailing address: 1455 de Maisonneuve Boulevard West, Montreal, Quebec H3G 1M8Office: MB 11.305 Telephone: +1(514)-848-2424, ext. 2926Fax: +1(514)-848-4500E-mail: [email protected]
1. Introduction
Investment Analysis
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People
Prof. Dr. Denis Schweizer
Associate Professor of Finance
Office: MB 11.305
Office Hours: Thursday 13:00 – 14:00
Telephone: +1 (514)-848-2424, ext. 2926
E-mail: [email protected]
Since 08/2014 Associate Professor of FinanceConcordia University
09/20011 – 01/2012 Visiting Scholar New York University
Since 04/2011 Investment Committee MemberUniversal Bank, Germany
04/2010 – 11/2012 Board member
Source for Alpha AG, Switzerland
08/2008 – 07/2012 Assistant Professor of Alternative Investments WHU – Otto Beisheim School of Management
06/2005 – 06/2008 Research AssistantEuropean Business School (EBS)
04/2003 – 04/2005 Mathematics Johann Wolfgang-Goethe University
10/1999 – 10/2004 Business Administration Johann Wolfgang-Goethe University
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Learning Outcome Statement
Differences between active and passive investments
Understanding of the different types of market efficiency
Understanding of market anomalies and risk premiums
The usage of Fama-French-Factors for performance evaluation purposes
Differentiation of traditional and alternative investments
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Agenda
I. Active versus Passive Investing
II. Anomalies and Risk Premiums
II. Differences between Alternative and Traditional Asset Classes
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What People Think of Active Fund Managers
Active fund managers enjoy a strong marketingedge over passive managers
Many attain celebrity status and their opinions on what the market is doing are highly sought after bythe media
Great faith is often placed in their abilities, and
what they do is often portrayed as glamorous
Some fund managers are paid seven figure salariesand bonuses and are often aggressively headhuntedby rival groups
Above all, active fund managers are usually
perceived to be “interesting” For instance, John Paulson, a well known hedge
fund manager, received $ 3,7 bn. in 2008 forshorting the mortgage market
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What People Think of Passive Fund Managers
Passive fund managers are seen as the “nerds” ofthe investment business
Their performance objective is only to match
an index
All they ever talk about is tax efficiency, costminimization, diversification, asset allocation andbuy and hold investing. Where is the fun in that?
Passive fund managers claim to have no specialinsights into what the market is going to do. Theyhave no clever strategy that they intend to employto “beat the market” by a large margin, often
recommending investors “stay the course” and holda diversified portfolio through thick and thin
Above all, passive fund managers are usually
perceived to be “boring”
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Active Funds were Underperforming in Eight
out of Nine Style Categories
Active funds versus index
Why is the disadvantage for small caps lower?
Growth Blend Value
102 funds
Large Category average 17.89%
Cap Index benchmark 19.92%
(S&P 500 growth)
Index advantage +203BP
63 fundsCategory average 18.14%
Mid Index benchmark 19.52%
Cap (Russel mid-cap growth)
Index advantage +138BP
33 funds
Category average 17.12%Small Index benchmark 13.01%Cap (Russel 2000 growth)
Index advantage -411BP
126 funds
Category average 15.60%
Index benchmark 17.55%
(S&P 500)
Index advantage +195BP
36 fundsCategory average 14.10%
Index benchmark 16.29%
(Russel mid-cap)
Index advantage +219BP
22 funds
Category average 12.99%Index benchmark 13.73%(S&P 600 growth)
Index advantage +74BP
129 funds
Category average 13.37%
Index benchmark 14.70%
(S&P 500 value)
Index advantage +133BP
48 fundsCategory average 12.77%
Index benchmark 13.96%
(Russel mid-cap value)
Index advantage +119BP
23 funds
Category average 11.74%Index Benchmark 12.91%
(Russel 2000 value)
Index advantage +117BP
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Active Funds were Underperforming in 82.9% of
the Time
“Using Morningstar’s fund
database, we examined theperformance of more than 2,000active U.S. equity funds during the
15-year period from July 1, 1998 to June 28, 2013. Result: only 25.6%of the active funds currently inexistence outperformed theirbenchmarks.” (S&P Indices versus Active Funds Scorecard)
Source: Ferri and Benke (2013) A Case for Index Fund Portfolios
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Active Funds Did Not Outperform on Average
10 10.18
19.22
5.8
9.03
21.43
12.35
15.27
22.4
0
5
10
15
20
25
Growth Fund Core Funds Value Funds
Large-Cap Mid-Cap Small-Cap
Average annual percentage of active funds that beat their S&P Benchmark
Source: S&P Indices versus Active Funds Scorecard (SPIVA) 10-year average ending in 2012
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Seeking Explanations… Are Actively Managed
Funds just Less Risky?
Risk/return profiles of passive and active investments
Source: TAM Asset Management, Inc, “Investment Policy Guidelines & Strategies Within the Context of The Prudent Investor Rule”
14,50%
16,90%
12,70%
17,80%
0,00%
2,00%
4,00%
6,00%
8,00%
10,00%
12,00%14,00%
16,00%
18,00%
20,00%
Return Standard Deviation
Average annual returns and standard deviations for the S&P500and 7,125 U.S. domestic mutual funds (1991-2001)
S&P 500 Average Active Mutual Fund
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Seeking Explanations… Are Active Funds
Performing Better in Downturns?
52%
63%
71%
0%
10%
20%
30%
40%
50%
60%
70%
80%
2001 96-01 91-01
U.S. equity mutual funds outperformedby the S&P500 Index
71%
59%
69%
0%
10%
20%
30%
40%
50%
60%
70%
80%
2001 96-01 91-01
European equity mutual fundsoutperformed by the MSCI Europe
Index
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Seeking Explanations… Are There some
Consistent Outperformers?
Continuous outperformance by some fund managers?
Source: Frank Russell Australia, data by Morningstar
25%
10%
0% 0%0%
5%
10%
15%
20%
25%
30%
1997 1989 1999 2000
What percentage of the top 25% of the equity mutual funds in 1997 belonged tothe top quartile in the subsequent year?
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Passive and Active Investment Strategies of
Investment Funds
40%
60%
Breakdown of funds for institutionalinvestors
Passive Active
Individuals hold 47.9% of the market in 1980 and only 21.5% in 2007
This decline is matched by an increase in the holdings of open-end mutual funds, from4.6% to 32.4%
10%
90%
Breakdown of publicly offered
Passive Active
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Why Underperformance? - Efficient Markets
Three forms of informational market efficiency
Given that the semi-strong form holds,asset managers cannot obtain a“competitive advantage” in terms of
information gathering and insight
derivation. Their performanceobjective is only to match an index.
Is this deliberate mediocrity
bordering on negligence?
Asset managers can hence onlysystematically beat the market if they
obtain insider information Insider trading is illegal in most
countries!
Strong form:
• All available
information is
fully reflected
in the currentprice
• Prices follow a
random walk
and not even
insiders can
predict share
pricedevelopment
Semi-strong
form:
• All publicly available
information is
fully reflected
in the current
price
• Fundamental
analysis isuseless
Weak form:
• All infor-
mation on
past price
behavior is
fully reflected
in share prices• Technical
analysis is
useless
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What Is an Efficient Market? (1/2)
Standard and Poor’s Indexfor a five-year period orplaying a coin-tossinggame for five years?
Random Walk - stock
price change unpredictably Actually stock prices
follow a “submartingale”:
Expected price ispositive over time
Positive trend andrandom around thetrend
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What Is an Efficient Market? (2/2)
What could you do if you
find a significant positiveautocorrelation?
Which asset classes couldhave a positiveautocorrelation?
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Cumulative Abnormal Returns Before Minority
Buyout Attempts: Target Companies
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Stock Price Reaction to CNBC Reports
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Why Underperformance?
Simple Mathematics
Even if markets are not efficient, the average perfor-mance of all investors will equal the market return
The market return is the weighted average of passivereturns plus active returns
If the index funds have the same pre-fee return asthe market, then the average active investor will
also have the same pre-fee return
This is a zero sum game, the average return of allactive investors before costs is necessarily going toequal the average return of the market
A trading gain for one active investor must be aloss for another one
Active investment is usually more expensive than
passive investment so active funds, as a group, will do worse than index funds after fees
No amount of trading or research will change that.Some will outperform, but as a group they will
underperform
E i f I di id l M l F d Al h
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Estimates of Individual Mutual Fund Alphas,
1993 - 2007
The performance of mutual managers is broadly consistent with market efficiency
Most mutual managers do not do better than the passive strategy
There are, however, some notable superstars:
Peter Lynch, Warren Buffett, John Templeton, George Soros etc.
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What to Do?
US public stock-and-bond markets are generally considered to be the mostefficient marketplaces in the world (semi-strong efficiency)
Information in the public market is easy to acquire, in contrast to alternative
assets, where information is often very difficult to acquire
Differences between the top quartile and bottom quartile performance in relatedPrivate Equity / Hedge Fund strategies can be as much as 25% - whereas thedifference is about 1 to 5% for the traditional asset classes
Finding the “talent” or “skill” gains importance!
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The Cost of Active Investing
Investors spend 0.67% of the value of all NYSE, Amex, and NASDAQ stocks each year
trying to beat the market
If the expected real return on U.S. equity is roughly 6.7%, the society's capitalized cost ofprice discovery is about 10% of the current value of the equity market – conservativeestimation
Average annual Hedge Fund fee of4.26% and 6.52% for Funds ofHedge Funds
Hedge Fund fees on US equity rose2.8 billion in1996 to 25 billion in
2007 Hedge Funds absorb two-thirds of
the reduction in the other costs ofinvesting
Source: French (2008) JoFSource: French (2008) JoF
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The Cost of Active Investing (cont.)
The cost of active investing is 7 billion in
1980, 30.5 billion in 1993, and 101.8billion in 2006
Thus, in 2006 investors searching forsuperior returns in the US stock marketconsume more than 330 $ in resources forevery man, woman, and child in the
United States The market is willing to pay on average
0.67% over time – which is time persistent
Why is the market willing to pay
Hedge Fund managers these high
fees? What is the economic role of Hedge
Funds?
What might happen when nobody is
willing to invest actively?
Source: French (2008) JoF
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Agenda
I. Active versus Passive Investing
II. Anomalies and Risk Premiums
II. Differences between Alternative and Traditional Asset Classes
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Are Share Prices Driven by Fundamental Data?
Price Chart EM TV (re-named to Constantin Medien AG)
D t d A li i Fi i l M k t
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Documented Anomalies in Financial Markets
(Incomplete Selection)
Size Effect (Small Firm Effect) Small companies (in terms of market capitalization) have shown higher risk-adjusted returns
P/E-(M/B-)Effect
Companies with comparably low P/E-Ratio (low Market to Book Ratio), commonly known as
value stocks, have shown higher returns
Dividend Yield-Effect
The stock return increases with the dividend yield
January Effect/Turn of the Year-Effect
„Past“ research : Stock returns in January are higher compared to all other month
Contemporary research: End of year rally
End-of-Month-Effect
First month halves bring higher returns than the second
Change of Exchange Segment Effect
Change of market segment or newly listing in an equity index shows price effects
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Returns for 10 Size-Based Portfolios, 1926 – 2012
Ret rns for 10 Book To Market Ratio 1963
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Returns for 10 Book-To Market Ratio, 1963 –
2012
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Jensen‘s Alpha
Jensen‘s Alpha shows in comparison to a (passive) benchmark the under- or over-performance (excess returns) achieved by active management
Jensen‘s Alpha is widely used to compare the performance of e.g. investment strategies or
mutual funds
Technically Jensen’s Alpha measures the risk -adjusted excess return of a portfoliocompared to its benchmark
= −
+ , ∙ −
Calculation of Jensen‘s Alpha with Fama French
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Book-to-Market Ratio
Low Medium High
Marktkapi-
talisierung
Small S/L S/M S/H
Big B/L B/M B/H
Jensen‘s Alpha does not account for risk premiums for small companies („small caps“)
and value stock
Adjusting Jensen‘s Alpha with the so called SMB (Small Minus Big) and HML (HighMinus Low) Factors:
= 3
∙ + + ℎ − 3
∙ ( + + ℎ)
HML value− in comparision to growth stocks =
12
∙ + −12
∙ ℎ + ℎ
The risk-adjustment is done under consideration of Beta (systematic risk), SMB- and HML-factors:
= − + , ∙ − + , ∙ +,∙
Calculation of Jensen‘s Alpha with Fama-French
Factors
Jensen‘s Alpha: Historische Prämien der Fama
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Jensen s Alpha: Historische Prämien der Fama-
French Faktoren
Book-to-Market Ratio
Low Medium High
Marktkapi-talisierung
Small S/L S/M S/H
Big B/L B/M B/H
Usage of Fama French Factors to Assess the
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0
50
100
150
200
250
28.06.2004 28.06.2005 28.06.2006 28.06.2007 28.06.2008 28.06.2009 28.06.2010 28.06.2011 28.06.2012
DB PLATINUM IV-CROCI US-R1C CRSP firms
Usage of Fama-French Factors to Assess the
Performance of Investment Products
Illustrative example how Fama-French factors are applied to assess the performance of theDeutsche Bank PLATINUM IV — CROCI U.S.
Price chart comparison of the CRSP Equally Weighted Index to the CROCI
Obviuosly the CROCI „outperformed“ the CRSP Index at the end of the observation period
Is it really true if true if control for systematic risk (Beta) and Fama-French Factors?
Fama-French CROCI.xlsm
Comparision of standard“ CAPM and Fama
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Comparision of „standard CAPM- and Fama-
French-Regression
"Standard" CAPM-Regression
Beta Alpha
t-Statistic 94.0984 0.3497
Coefficient 0.9508 0.00005
CROCI‘a Alpha is positive, but
statistically not different from
zero − < 1.96 The expected Alpha Return per
year is about 1.15% (0.00005 x
250 (trading days))
The Beta-Factor (systematic
risk) is 0.9508 and lower than
the systematic of theBenchmark CRSP
As a result, the CROCI is moredefensive compared to the
benchmark CRSP, based on the
Beta factor
Fama-French Regression
HML SMB Beta Alpha
t-Statistic -0.1883 -5.8869 86.3252 0.9407
Coefficient -0.0047 -0.0336 0.9595 0.00013
The annual alpha of the CROCI is about XXX% andtherefore XXX compared to the CAPM-Regression, but
statistically XXX different from zero
The Beta-Factor XXX
The coefficient for the SMB-Factor is XXX and statistically
XXX from zero
Der SMB-coefficient indicates an XXX weight of bigcompanies (because of the negative coefficient)
The expected annual XXXperformance related to the SMB-
Factor is about XXX% = (SMB-coefficient [ XXX ] x (SMB-
Factor [ XXX ] x number of month [ XXX ])
Der HML-coefficient statistically XXX from zero
Fama-French CROCI.xlsmStart date June 29th, 2004 and ending date June 27th, 2013
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Agenda
I. Active versus Passive Investing
II. Anomalies and Risk Premiums
II. Differences between Alternative and Traditional Asset Classes
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Alternative Investments as an Asset Class
“An alternative investment (AI) is any asset that
is not a publicly-traded stock, bond or mutual fund”
Alternative Investments show...
... a low correlation with traditional asset classes ... a wide dispersion of returns in the Alternative Investment Strategies
The key to success are the managers’ skills
What happened during the financial market crisis?
What is a Hedge Fund / Private Equity / Commodity Manager? What is an asset class?
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Characteristics of Alternative Investments
Private Equity refers to investments in companies not listed on any stock exchange(private companies)
Is this still true?
Private Equity managers will normally use privileged sources of information or resourcesto achieve a favorable acquisition, develop the acquired company and then sell theinvestment with (hopefully) an “appropriate” return
There are two major investment styles: “venture capital” and “buyout”
Private Equity
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Characteristics of Alternative Investments
Hedge Funds refer to privately organized, low regulated investment vehicles, that usually
specialize on a certain investment style No regulation?
Managers are usually renowned traders, or experienced fund managers
Hedge Funds usually have absolute return strategies aiming at positive returns in all market
conditions What does it mean?
Hedge Funds have no (few) investment constraints, can use short-selling techniques,derivatives, and leverage What about mutual Funds?
Hedge Funds
Termination and Special Features of Alternative
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Termination and Special Features of Alternative
Investments
Money market investments, bonds, stocks and mutual fund investments are termed“traditional” investments
Traditional investments usually feature the following properties: High dependence on movements of the financial markets
Is this still true for the current financial market crisis?
Traditional investments go up and down in accordance to the market development
High liquidity – usually vendible daily
High transparency (official daily price quotes, obligations for publication, researchactivities, credit ratings)
Strong regulation, comprehensive supervision (exceptions are e.g. pink sheet)
Traditional Investments
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Definition: Asset Class
Practical categorization of investment objects (e.g. stocks, bonds etc.) Practicability of the categorization complies with various criteria, for example:
Expected return
Risk (type and amount)
Correlations
Liquidity
Further categorization in sub-classes (e.g. stocks USA, stocks Europe)
Definition „Asset Class“:
Congeneric assets with homogenous risk and return profiles to each other (high internal
correlation) and heterogeneous risk and return profiles to other assets (low externalcorrelation), but without an explicitly co-moving development.
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Categorization in “Super Classes” (Greer 1997)
1. Capital Assets
Have a continuous value development /claim on the futurecash flows
3. Store of Value Assets
Assets for theconservation of
values / requiresownership andpossession
Super classes
2. Consumable and
transformable assets
To which aneconomic value isassigned / economicinputs
Greer, Robert, 1997, What is an Asset Class, Anyway?, Journal of Portfolio Management 23, 86-91.
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A
Survey of the Alternative Investments Universe
Alternative Investments Universe
AI Strategies AI Assets
Equity HedgedPrivate Equity
Relative Value
Event Driven
Global Macro
Managed Futures
(CTAs)
Hybrid Investments
Buyouts
Restructuring
ExpansionFinancing
Physical Assets
Agricultural Area
Timberland
Real Estate
Commodities
Artwork, Wine...
Securitized Prd. Traditional AI
Convertible
Bonds
High Yield Bonds
Emerging Markets
REITInsurance Linked
Products
CBOs
Cat Bonds
CLOs
Venture CapitalMBS
This is one of many possible categorizations, many others are available!