Style Portfolios Research Articles

The Crash Risks of Style Investing: Can They Be Internationally Diversified?

The crash risks of momentum tend to be higher than those of size and value. International diversification lowers the crash risks of size and value but not momentum. The authors examined the conditional correlations and return co-exceedances of style portfolios across countries and found that this difference in the effect of diversification is due to the left (right) tails of momentum (size and value) portfolios being more correlated than the right (left) tails across countries.

Gender, style diversity, and their effect on fund performance

This paper examines the performance of 358 European diversified equity mutual funds controlling for gender diversity. Fund performance is evaluated against funds’ designated market indices and representative style portfolios. Consistently with previous studies, proper statistical tests point to the absence of significant differences in performance and risk between female and male managed funds. However, perverse market timing manifests itself mainly in female managed funds and in the left tail of the returns distribution. Interestingly, at fund level there is evidence of significant overperformance that survives even after accounting for funds’ exposure to known risk factors. Employing a quantile regression approach reveals that fund performance is highly dependent on the selection of the specific quantile of the returns distribution; also, style consistency for male and female managers manifests itself across different quantiles. These results have important implications for fund management companies and for retail investors’ asset allocation strategies.

Momentum in Australian style portfolios: risk or inefficiency?

AbstractMomentum strategies have been reported to be successful across a range of different markets and asset classes. Three possible explanations for momentum have been hypothesised: risk, return continuation and excessive co‐movement of stock returns compared with dividends. Lewellen (2002) adds to this literature by providing evidence of strong momentum returns in style portfolios that can be explained by negative cross‐serial correlation, a result which supports the excess co‐movement hypothesis. We report robust evidence of style momentum in the Australian market and use the Jegadeesh and Titman (1995) return decomposition to show that this momentum strategy is predominately explained by positive autocorrelation. Our results support the return continuation hypothesis and confirm Chen and Hong's (2002) assertion that Lewellen's (2002) explanation of style momentum returns does not stand up out‐of‐sample.

The Crash Risks of Style Investing: Can They Be Internationally Diversified?

Motivated by the growth in the popularity of style investing and the concern for extreme events among investors, we examine the tail risks of style investing in different countries. For the G7 countries over the 1981-2010 period, we evaluate whether portfolios with different size, value, or momentum tilts — the SMB (small minus big), HML (high minus low), and UMD (past winners minus past losers) portfolios — experience different crash risks, and whether these risks can be mitigated through international diversification. We find that the crash risks of momentum tend to be higher than those of size and value, where crash risks are measured by return skewness and expected shortfall. International diversification lowers the crash risks of size and value further, but has only limited effects on momentum. Specifically, a diversified, world UMD portfolio (equal-weighted portfolio of the G7 countries) tends to be more left-skewed and has a more negative expected shortfall than the momentum portfolios of individual countries. By contrast, the world SMB and HML portfolios tend to have less negative skewness and expected shortfall than their country-specific counterparts. By examining the conditional correlations and return coexceedances of style portfolios across countries, we find that the extreme negative returns on UMD in different markets tend to occur together, whereas those on SMB and HML tend to be country-specific. In fact, for SMB and HML, it is the right-tail events that tend to be more global in nature. These results suggest that the difference in the effect of international diversification is due to the left (right) tails of momentum (size and value) portfolios being more correlated than their right (left) tails across countries.

Do liquidity and idiosyncratic risk matter? Evidence from the European mutual fund market

This paper examines the interaction of idiosyncratic risk, liquidity and return across time in determining fund performance, as well as across investment style portfolios of European mutual funds. This study utilizes a unique data set including returns for equity mutual funds registered in six European countries. Overall, using monthly data, we find that both liquidity and idiosyncratic risk are relevant in determining mutual fund returns. Our results are robust across different model specifications. We show that model specifications up to six factors are useful as these risk factors capture different aspects in the cross-section of mutual funds returns. The evidence regarding mutual funds subgroups is strongly in favor of the significance of liquidity, and idiosyncratic risk to a lesser extent, as risk factors. Even if liquidity and idiosyncratic risk are considered at the same time, one factor is not significantly decreasing the importance of the other factor.

Time-varying regional and global integration and contagion: Evidence from style portfolios

We examine the time varying nature of integration and the patterns of contagion of asset portfolios over five recent crisis periods including the global financial crisis and the European debt crisis. We investigate a large sample of 30,838 common stocks from thirty one markets across the globe establishing the key differences in the transmission of shocks between country, and firm-level characteristic constructed or style portfolios. Our findings point to distinct differences in the impact on integration and level of contagion from each crisis. Style portfolios exhibit notably shifts in both global and regional integration between states. There is widespread evidence of contagion effects during the global crisis while the impact of the Mexican and Asian crises is limited to regional effects.

Portfolio constituency rules and the value premium in the small-cap space

Purpose – Market-based value style equity portfolios do not systematically outperform market-based growth style equity portfolios, despite considerable academic research that suggests that they should. This is an unresolved puzzle in the long lineage of work on this topic. The purpose of this paper is to question whether portfolio constituency rules employed by active growth and value equity investment managers might explain this puzzle. Design/methodology/approach – The authors use the traditional research design and methodology of Fama and French (1993) to ensure comparability of results to prior research. Further, the authors adapt the return decomposition method of Keim (1999) to specifically answer the question in the research. Findings – The authors find that restrictive constituency rules that omit the smallest, most illiquid stocks improve the performance of both value and growth stock portfolios. However, the authors find the impact of constituency rule restrictions on portfolio returns to be asymmetric with respect to value and growth in the small-cap investment space. Growth portfolios benefit from these changes more than value portfolios. Consistent with prior research, the authors find that value and growth style portfolios constructed from more liquid equities to be void of a statistically significant value-minus-growth return premium. The authors suggest these results might go a long way in explaining why market-based growth fund returns generally equal those of their value fund counterparts over time. Originality/value – The research question central to the research, the value equity premium, has been investigated by researchers around the world over the last 20 years. The 20 year lineage of global published research on the value equity premium does, however, contain several unresolved questions. The paper specifically asks why the premium, long observed in global equity market returns, does not appear in market-based passive or active equity portfolios. This puzzle exists at the heart of the origins of the return premium itself and has serious implications for investment practitioners. If the matter cannot be reconciled, then market participants might rightly view the entire 20 year lineage of published research as irrelevant. The paper is one of few that has now extended the long lineage of research to its application in real markets.

Portfolio Constituency Rules and the Value Premium in the Small-Cap Space

Market-based value style equity portfolios do not systematically outperform market-based growth style equity portfolios, despite considerable academic research that suggests that they should. This is an unresolved puzzle in the long lineage of work on this topic. We ask whether portfolio constituency rules employed by active growth and value equity investment managers might explain this puzzle. We find that restrictive constituency rules that omit the smallest, most illiquid stocks improve the performance of both value and growth stock portfolios. However, we find the impact of constituency rule restrictions on portfolio returns to be asymmetric with respect to value and growth in the small-cap investment space. Growth portfolios benefit from these changes more than value portfolios. Consistent with prior research, we find that value and growth style portfolios constructed from more liquid equities to be void of a statistically significant value-minus-growth return premium. We suggest these results might go a long way in explaining why market-based growth fund returns generally equal those of their value fund counterparts over time.

Investment Style and Performance: Evidence for International Equity Mutual Funds

In this paper we study the performance and performance persistence of international equity mutual funds with a focus on fund investment styles. Using a best-fit index methodology, we sort funds yearly based on the style dimensions of size and value/growth, as well as on regional categories (Europe, Pacific and emerging markets). In doing so, we find that (i) the performance of international funds clearly differs regarding style and regional categories, (ii) based on a five-factor alpha, most international style portfolios exhibit performance persistence, and (iii) top performing SMID-cap portfolios and top performing emerging market portfolios show significant and positive alphas. Moreover, using a conditional five-factor alpha as alternative ranking criteria further improves the prediction of future international fund performance.

Measuring Alpha in the Fund Management Industry: Do Female Managers Perform Better?

This paper examines the performance of 358 European diversified equity mutual funds controlling for gender differences. Fund performance is evaluated against funds’ designated market indices and representative style portfolios. Consistently with previous studies, no significant differences in performance and risk are found between female and male managed funds. However, perverse market timing manifests itself mainly in female managed funds and in the left tail of the returns distribution. Interestingly, at fund level there is evidence of significant overperformance that survives even after accounting for funds’ exposure to known risk factors. Employing a quantile regression approach reveals that fund performance is highly dependent on the selection of the specific quantile of the returns distribution; also, style consistency for male and female managers manifests itself across different quantiles. These results have important implications for fund management companies and for retail investors’ asset allocation strategies.

Study on the Market Risk Measurement of the Style Portfolios in Stock Markets Based on EVT-t-Copula Model

For the presence of non-normal distribution characteristics in the financial assets returns, the model of AR(1)-GJR(1,1) is used to characterize the marginal distribution of the style assets in China stock market. The Copula function is introduced to analyze the dependency structure between the six style assets, combined with the marginal distributed residual sequences. And the joint return distribution of the style portfolios is simulated, combined with extreme value theory and Monte Carlo simulation method. Then the market risks (VaR and CVaR) of the style portfolios in China stock markets are obtained. The results of the study show that the generalized Pareto distribution Model can well fit the non-normal distribution characteristics such as peak and fat tail in the style assets returns.

Orthogonalized factors and systematic risk decomposition

Abstract In the context of linear multi-factor models, this study proposes an egalitarian, optimal and unique procedure to find orthogonalized factors, which also facilitates the decomposition of the coefficient of determination. Importantly, the new risk factors may diverge significantly from the original ones. The decomposition of risk allows one to explicitly examine the impact of individual factors on the return variation of risky assets, which provides discriminative power for factor selection. The procedure is experimentally robust even for small samples. Empirically we find that even though, on average, approximately eighty (sixty-five) percent of style (industry) portfolios’ volatility is explained by the market and size factors, other factors such as value , momentum and contrarian still play an important role for certain portfolios. The components of systematic risk, while dynamic over time, generally exhibit negative correlation between market , on one side, and size , value , momentum and contrarian , on the other side.

Measuring Alpha in the Fund Management Industry: Do Female Managers Perform Better?

This paper examines the performance of 358 European diversified equity mutual funds controlling for gender differences. Fund performance is evaluated against funds' designated market indices and representative style portfolios. Consistently with previous studies, no significant differences in performance and risk are found between female and male managed funds. However, perverse market timing manifests itself mainly in female managed funds and in the left tail of the returns distribution. Interestingly, at fund level there is evidence of significant overperformance that survives even after accounting for funds' exposure to known risk factors. Employing a quantile regression approach reveals that fund performance is highly dependent on the selection of the specific quantile of the returns distribution; also, style consistency for male and female managers manifests itself across different quantiles. These results have important implications for fund management companies and for retail investors' asset allocation strategies.

Cross-asset Style Momentum

Previous studies have demonstrated style momentum within equity markets. This paper reports significant momentum profits among style portfolios of multiple asset classes, showing that style momentum is not merely an equity market phenomenon, but a cross-asset phenomenon. A decomposition of profits reveals that profits are mostly attributable to positive autocorrelations of style returns. We interpret this result as being more consistent with underreaction models than with excess comovement and performance chasing models.

Momentum in Style Portfolios: Risk or Inefficiency?

Momentum is a pervasive asset-pricing anomaly that has been shown to exist in a number of markets and asset classes. Three possible explanations for momentum have emerged in the literature; risk, positive autocorrelation and negative cross-serial correlation. Lewellen (2002) adds to this literature by providing evidence of strong momentum returns in style portfolios that can be explained by negative cross-serial correlation. However, a critique of this explanation by Chen and Hong (2002) argues that it is driven by the methodology used to decompose momentum returns and the in-sample negative autocorrelation within the market. Our paper examines style momentum in a market that exhibits positive auto-correlation across our sample period. We use an alternative empirical framework and test whether style momentum may be explained by different phenomena when the formation and investment periods are varied. We report no evidence to support negative cross-serial correlation but evidence to support momentum in style portfolios that can be explained by autocorrelation over short horizons, supporting the under-reaction hypothesis. However, we show that autocorrelation decreases when longer periods are used to form portfolios, resulting in expected returns substantively explaining returns over a 12-month horizon.

Cross-Sector Style Analysis Of Global Equities Based On The Fama And French Three-Factor Model

Although the ability of the Fama and French (1993) 3-factor model in explaining style-based portfolio returns have been widely tested, no such test has been conducted on sector-based portfolios. The study conducted by Hsieh and Hodnett (2011) indicate that the resource sector yields significant abnormal returns under the capital asset pricing model (CAPM) over the period from 1999 to 2009. In addition, the book value-to-market ratio and market capitalization are found to have pervasive effects on the pricing of sector returns for global equities. Motivated by this insight, we undertake to test the ability of the Fama and French (1993) 3-factor model in explaining the variations in the global sector returns. Our test results indicate that the market risk premium is the most significant factor that drives the returns in all sectors under review. Although the positive abnormal returns of the resource sector dissipates under the 3-factor model, the industrial sector and the information technology (I.T.) sector yield abnormal returns under the 3-factor model. Unlike the empirical findings on the style portfolios, the signs and statistical significance of the exposures to the value and size risk premiums are not consistent across all sectors. This finding suggests that sector exposures are more unique and distinctive compared to the style portfolios. It could be argued that since most of the style portfolios are directly related to the value and size anomalies, any factor model that incorporates risk premiums on these anomalies would significantly explain the style portfolio returns. However, the ability of such factor model in explaining returns on portfolios formed using methodologies other than style anomalies, such as sector portfolio returns, would be questionable. Taking into account the rising global integration, sector allocation might be more effective in terms of global active portfolio management or international diversification than style allocation and country allocation.

Do Liquidity and Idiosyncratic Risk Matter?: Evidence from the European Mutual Fund Market

This paper examines the interaction of idiosyncratic risk, liquidity and return across time in determining fund performance, as well as across investment style portfolios of European mutual funds. This study utilizes a unique data set including returns for equity mutual funds registered in six European countries. Overall, using monthly data, we find that both liquidity and idiosyncratic risk are relevant in determining mutual fund returns. Our results are robust across different model specifications. We show that model specifications up to six factors are useful, these risk factors capture different aspects in the cross-section of mutual funds returns. The evidence regarding mutual funds subgroups is strongly in favor of the significance of liquidity, and idiosyncratic risk to a lesser extent, as risk factors. Even if liquidity and idiosyncratic risk are considered at the same time, one factor is not significantly decreasing the importance of the other factor.

On Horizon Effects and Microstructure Bias in Average Returns and Alphas

We characterize linkages between average returns calculated at different horizons. Theoretically, when stocks incorporate information slowly, average short-horizon returns are downward biased. Buy-and-hold strategies can amplify the effect. In contrast, existing theories analyze price noises that are independent of fundamentals, and buy-and-hold portfolio returns are unaffected. We document horizon effects as large as 10% annualized in daily and monthly style portfolios and international indices. Slow reaction to market information, identified by gradually declining lagged betas, is an important cause. These findings have natural consequences for performance evaluation.

Risk adjustment and momentum sources

We show that the conventional procedure of risk adjustment by running full-sample time-series Fama–French three-factor regressions is not appropriate for momentum portfolios because the procedure fails to allow for the systematic dynamics of momentum portfolio factor loadings. We propose a simple procedure to adjust risks associated with the Fama–French three factors for momentum portfolios. Using our proposed method, the Fama–French three factors can explain approximately 40% of momentum profits generated by individual stocks and nearly all of momentum returns from style portfolios.

Value-at-Risk optimization using the difference of convex algorithm

Value-at-Risk (VaR) is an integral part of contemporary financial regulations. Therefore, the measurement of VaR and the design of VaR optimal portfolios are highly relevant problems for financial institutions. This paper treats a VaR constrained Markowitz style portfolio selection problem when the distribution of returns of the considered assets are given in the form of finitely many scenarios. The problem is a non-convex stochastic optimization problem and can be reformulated as a difference of convex (D.C.) program. We apply the difference of convex algorithm (DCA) to solve the problem. Numerical results comparing the solutions found by the DCA to the respective global optima for relatively small problems as well as numerical studies for large real-life problems are discussed.