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OUTPERFORMING STOCK INDICES USING PROXIES FOR RISK AND RETURNS

OUTPERFORMING STOCK INDICES USING PROXIES FOR RISK AND RETURNS. Vashishta Bhaskar Duquesne University Presented at QWAFAFEW September 9, 2014. Introduction. Efficient markets Implications for investors Active equity portfolio management strategies

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OUTPERFORMING STOCK INDICES USING PROXIES FOR RISK AND RETURNS

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  1. OUTPERFORMING STOCK INDICES USING PROXIES FOR RISK AND RETURNS Vashishta Bhaskar Duquesne University Presented at QWAFAFEW September 9, 2014

  2. Introduction • Efficient markets • Implications for investors • Active equity portfolio management strategies • Empirical results of sort by factor methodologies • Expansion of existing quantitative techniques

  3. Efficient Markets • A market in which security prices rapidly reflect all available information • Random walk (short term) • Provide positive return (long term) • Expected Returns are a function of Size, Relative Value (value-growth), Risk and Momentum

  4. Implications for Investors and Money Managers • Risk tolerance • Diversification • Passive investing • Buy & hold portfolios • Indexing

  5. Active Equity Investing • Fundamental Analysis • Top-down • Bottom-up • Technical indicators • Identify Attributes that provide superior returns

  6. Empirical Results of Factor Based Strategies – Sort methodology • Fama-French 1992 study concluded that small market equity portfolios performed better than large equity; • And, higher book-to-market performed better than lower book-to-market.

  7. Adapted from What Works on Wall Street. Size Effect 1952-2003 Adapted from What Works on Wall Street pgs. 61-62 *Market leaders defined as: non-utility, market cap > avg., cf > avg., sales > 50% of avg. from COMPUSTAT.

  8. Returns: Russell Indices 2004-2013

  9. Returns by Cap 250M – 1B1B–5B and > 5B. (1994-2013)

  10. High 100 CAPX and Low 100 CAPX Portfolio Returns by Cap

  11. Small Cap High CAPX – Low CAPX

  12. Why Z – Score? • Expected return from Corporate Bonds = Risk free rate + bond risk premium • Expected Return from Equity = Company specific bond rate + equity risk premium Z score model and calculation provided at the end of this presenation

  13. 50 Stock portfolios based on high and low Z scores

  14. Z Score effects

  15. Summary Statistics - 12/1994-12/2013

  16. Limited conclusions and further research • CAPX is indicative of future returns • Z score can be used as a further discriminant as a proxy for risk • There are additional factors such as value and momentum that can be incorporated in an overall strategy • Scaled CAPX or items such as retention ratio may be useful

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