Multi-Factor Sector Based Investment Strategy (MFSS) Team Ichiban: Wei Fu, Dingyi Li, Fei Ni, Taliya Perera, Benjamin Tang 28 th November 2011 STAT 682

Multi-Factor Sector Based Investment Strategy (MFSS)

Team Ichiban:

Wei Fu, Dingyi Li, Fei Ni, Taliya Perera, Benjamin Tang

28th November 2011

STAT 682 Quantitative Financial Analytics STATISTICS

1


Scope:

i.Fund Investment Strategy

ii.Dataset Management Process

iii.Portfolio Selection Mechanism

iv.Benchmarks & Back-testing the Fund’s Strategy

v.Returns and Results

vi.Conclusion

2


Fund Investment Strategy

The Original: O’Shaugnessey Multi-factor Strategy

• Price-to-Earnings (PE) ratio between 0 and 20, then selecting Best One-Year Performers (Top 50).

• Price-to-Book (PB) ratio less than 1, then selecting One-Year Performers (Top 50).

• Price-to-Sales (PSR) ratio less than 1, then selecting One-Year Performers (Top 50).

3



Multi-Factor Sector Based Strategy

• Why did we add Sector Analysis to O’Shaugnessy’s method?

Correlation trades, Proxy trades, Complementary growth, Difference of inter-sector indicator norms.

Growth is under-represented in his model; relative to momentum and value.

• How did we add Sector component into the strategy?

The top 50 stocks in each of the multifactor model are identified.

Sector proportion (Ps) of the top 50 stocks are compared against the (Pu) of the entire universe.

Sectors are then ranked by highest “Ps - Pu”.

4



3 Different MFSS Approaches

• Top 10 stocks using the original approach, plus the top 5 stocks from the highest ranked sector. (Total of 15 stocks).

• Top 15 stocks using the original approach, with stocks in the highest ranked sectors (if any) given double weight.

• Top 3 stocks each from the 5 highest ranked sectors.

5


Scope:






vi.Conclusion

6


Data Management Process

• Wharton Research Data Services (WRDS) - Compustat Fundamentals Annual - CRSP Monthly Stock File

• Annual Returns of Portfolios - Dividends included - Adjusted for AJEX (Splits and Such) - Accounted for data lags (April 1st Rebalancing)

• Other Adjustments/Assumptions - March Month-End price close used. (CAPM assumption of sorts) - Brokerage (1% hit p.a. in 1970s – 80s, $450 p.a. thereafter.) - Tax deferred investment account. - Delisting and Acquisitions

7


Scope:






vi.Conclusion

8


Portfolio Selection Mechanism:

• General Procedure

- Recreate O’Shaugnessey’s ranking (by previous returns) for each of the three segments in his portfolio.

- Calculate the Ps – Pu for each of the three segments.

- Apply it to generate the portfolios for the fund’s strategy.

9


Sample Portfolios (1975):

10



11



12



13



14


Sector Weights:

15


Scope:






vi.Conclusion

16


Creating Benchmarks

Compared against:

- O’Shaugnessey’s Reduced Portfolio Returns

- NYSE/S&P Returns

- Against the other Sector-based Strategies

17


Scope:






vi.Conclusion

18


Returns and Results (Seed Capital = $10k)

19


Returns and Results (Seed Capital = $10k)

20


Returns: Summary Statistics

21


Annual Returns:

22


5 Year Rolling Returns:

23


10 Year Rolling Returns:

24


Returns: “Beating Ratios”

25


Scope:




iv.Creating Benchmarks

v.Back-testing the Fund’s Strategy

vi.Conclusion

26


Conclusion:

i.Advantages of the MFSS Investment Strategies

ii.Downside Risks

iii.Schumpeterian Theory of Growth

iv.Back-testing as Optimization of Hindsight

v.Leverage as a matter of Preference

27


Questions?

28

Documents

Multi-Factor Sector Based Investment Strategy (MFSS) Team Ichiban: Wei Fu, Dingyi Li, Fei Ni, Taliya Perera, Benjamin Tang 28 th November 2011 STAT 682