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Fama & Freedom 3½ Factor Model

Fama & Freedom 3½ Factor Model. Scott Gavlick Todd Hoskin Edward Kim. Small-Value Portfolio Strategy. Screening US Securities Common Stock Excluding American Depository Receipts (ADR’s) Questionable Returns Small Capitalization Less Coverage/Public Information Less Market Efficiency

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Fama & Freedom 3½ Factor Model

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  1. Fama & Freedom 3½ Factor Model Scott Gavlick Todd Hoskin Edward Kim

  2. Small-Value Portfolio Strategy • Screening • US Securities • Common Stock • Excluding American Depository Receipts (ADR’s) • Questionable Returns • Small Capitalization • Less Coverage/Public Information • Less Market Efficiency • Higher Growth Potential

  3. Approach • Equally-Weighted Investments • Monthly Rebalancing • Assumes NO Transaction Costs • Benchmark is the S&P500

  4. Factors • Value Factors • Operating Income / Enterprise Value • Operating Income / Net Assets • Technical Factors • Momentum – 1-year return, lagged 1 month • Volume Moving Average – difference between the daily average over the last 5 days and the daily average over the past year, scaled by the latter

  5. Factor Assessment

  6. Factor Assessment

  7. Factor Assessment

  8. Scoring Based upon subjective review of Heat Map output.

  9. 3 ½ Factor Portfolio Heat Map Results

  10. Investment Strategy – 1986 to 2005

  11. Investment Strategy – Shorter Timeframes

  12. One-Factor Tier 5 Portfolio Returns

  13. One-Factor Tier 5 Portfolio Returns FAF 3½ Factor Model Operating Income to Enterprise Value Operating Income to Net Assets Momentum Volume

  14. Conclusions • Go Long • Long Strategy Produces the Best Results • Even When Not the Best Returning Tier, Still Returns Positive Results • Model Weaknesses • Fails to Forecast Periods of Large Gains in the Short Tier (especially 1999 & 2003) • Given Monthly Rebalancing Transaction Costs will be Significant • Further Study • Benchmark Against Small Stock Returns vs. S&P500

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