...CFA Institute Fundamental Indexation Author(s): Robert D. Arnott, Jason Hsu and Philip Moore Source: Financial Analysts Journal, Vol. 61, No. 2 (Mar. - Apr., 2005), pp. 83-99 Published by: CFA Institute Stable URL: http://www.jstor.org/stable/4480658 . Accessed: 24/02/2014 01:32 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. . CFA Institute is collaborating with JSTOR to digitize, preserve and extend access to Financial Analysts Journal. http://www.jstor.org This content downloaded from 134.117.10.200 on Mon, 24 Feb 2014 01:32:09 AM All use subject to JSTOR Terms and Conditions FinancialAnalysts Journal Volume 61 . Number 2 ?2005, CFAInstitute X Fundamental Indexation Robert D. Arnott,Jason Hsu, and PhilipMoore to A trillion-dollar industryis basedon investingin or benchmarking capitalization-weighted the This literature indexes, eventhough thefinance rejects mean-variance efficiency suchindexes. of measures whether stockmarket indexesbasedon an arrayof cap-indifferent study investigates of than...
Words: 12714 - Pages: 51
...bases its strategy mainly on academic research and related theories. They work together with proponents of the efficient market hypothesis, indicating a relatively strong belief in this theory and thus in efficient markets. However DFA also feels that skilled traders have the ability to contribute to a fund’s profits even when the investment is inherently passive and DFA does adjusts its strategy to new findings in the field. In this report we will evaluate the relevance and accuracy of the theories used by DFA, especially the value premium and the size premium where almost all of their funds are based upon. This will lead to comments on the usefulness of these theories to increase the return of DFA’s funds and to recommendations about changes in strategy that will enhance the performance of DFA overall. Performance and strategy so far DFA has performed relatively well over the years, aside from some relatively rough patches in the late 1990s. Growth of the company had been stable and profits high. There was no need to sell shares for liquidity reasons and shares were only sold if they did not fit into a fund anymore. This didn’t happen very often though as DFA had several funds that were “connected”, when a stock in the Micro Cap portfolio grew too big it could be placed into a fund with bigger companies (Small Cap portfolio). An important part of DFA’s strategy, that contributed to the performance of DFA so far, is aimed at achieving discounts in trades through buying in...
Words: 2932 - Pages: 12
...AN ANALYTICAL STUDY ON EFFICACY OF ALGORITHM FOR BOTH TRADING AND INVESTING AN ANALYTICAL STUDY ON EFFICACY OF ALGORITHM FOR BOTH TRADING AND INVESTING ABSTRACT INDEX AIM OF STUDY PURPOSE * The main agenda of this study is to test the basic oscillators like RSI and OBV is to identify the behavior of these early indicators in various types of market. The agenda of using moving average lag indicators like Bollinger band is to check how well these bands work in giving out trade signals. * The study aims to find out using Bloomberg terminal that whether combination of studies and Risk management help to enhance the performance of the indicators and do they really help to make a more profitable decision. * This study also intends to use some basic fundamental indicators to identify whether they can be used as tool to invest in securities and how well they are able to perform as compared to a benchmark index. The aim is to use a matrix of indicators, so that it can be also assessed whether combination of basic indicators are good enough to make portfolio creation judgment that can lead to market beating portfolio or not. * All the testing has been done using the Bloomberg terminal. LIMITATIONS * There are many lead, hybrid and lag indicators available in the market however not every single one can be tested. * The testing only targets the NSE that is typically Indian market, hence the results may be non-inferential for international markets...
Words: 15371 - Pages: 62
...volatility is needed to some degree because if prices do not move sufficiently, it will be difficult to make money from trading them. Thus, the recent fluctuations in the share market have highlighted the fact that there are risks involved with investing money and that finding the right investment strategy is a crucial step in investing. Investors today have more investment options than were available to the average investor just a few decades ago. While having multiple options is usually a good thing, too many options can cause confusion and system overload and lead many people to avoid making decisions about their investment strategies. Most strategies used to invest in the share market fall into three general categories including technical analysis, fundamental analysis, or a buy-and-hold strategy. The fundamental analysis approach is primarily concerned with value; it examines factors that determine a company's expected future earnings and dividends as well as the continued dependability of those earnings and dividends (McDonald 2007, 100). The investor who uses technical analysis attempts to predict the future price of a stock or the future direction of the market based on past price and trading volume changes (Subramaniam 2010, 46). The buy-and-hold approach is the benchmark against which any other approaches to market investing should be measured. This strategy provides the...
Words: 21981 - Pages: 88
...------------------------------------------------- Portfolio Composition The Money Team designed this portfolio September 27th, 2013 with the plan to invest mainly in large cap and high growth U.S equities. All equities were purchased on that date with the intention to hold them until December 6th, 2013. The primary goal of this portfolio was to maximize growth and value of the portfolio through an active investment strategy. This portfolio was concentrated in large cap U.S equities and domestic mutual funds. There was a blend of small cap growth stocks, which were selected based on potential for large growth. This decision was in line with our primary goal of maximizing growth. The portfolio is highly focused in the technology sector in order to capitalize on advance in the short-term. The portfolio is tailored to an investor with high-risk tolerance. The Money Team held on to its U.S equities throughout the course of the time horizon. The only changes The Money Team made to its portfolio during the time horizon was selling underperforming bonds. Below is the holding period return data for each of The Money Team’s assets: Company Name | QTY | Currency | Price Paid | Last Price | Profit/Loss (local curr) | P/L % | 3-D Systems Corp (Delaware) | 100 | USD | $55.96 | $75.38 | $1,942.00 | 34.70 | Rite Aid Corp | 1000 | USD | $4.59 | $5.75 | $1,160.00 | 25.27 | Virtus Investment Partners Inc | 100 | USD | $168.00 | $202.04 | $3,404.00 | 20.26 | Nokia Shs...
Words: 3822 - Pages: 16
...interest between management and stockholders. ASSET ALLOCATION – allocation of an investment across broad asset classes. SECURITY SELECTION – choice of specific securities within each asset class. SECURITY ANALYSES – analyses of the value of securities. RISK-RETURN TRADE-OFF – assets with higher expected returns entail greater risk. PASSIVE MANAGEMENT – buying and holding a diversified portfolio without attempt to identify mispriced securities. ACTIVE MANAGEMENT – attempting to identify misplaces securities or to forecast broad future trends. FINANCIAL INTERMEDIARIES – institutions that connect borrowers and lenders by accepting funds from lenders and loaning funds to borrowers. INVESTMENT COMPANIES – company that manages funds for investors. An investment company can manage several mutual funds. INVESTMENT BANKERS – firms specializing in the sale of new securities to the public, typically by underwriting the issue. PRIMARY MARKET – a market in which new securities are offered to the public. SECONDARY MARKET – a market in which previously issued securities are traded among investors. GLOBALIZATION – tendency toward a worldwide investment environment, and the integration of international capital markets. PASS-THROUGH SECURITIES – pool of loans sold in one package. Owners of pass-troughs receive all of the principal and interest payments made by the borrowers....
Words: 3207 - Pages: 13
...many times a company’s inventory is sold and replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or “Inventory turnover days” Sales may be substituted with COGS because sales are recorded at market value while inventories are usually recorded at cost. Average inventory may be used instead of the ending inventory level to minimize seasonal factors. The ratio should be compared against industry averages. A low turnover implies poor sales and therefore excess inventory. A high ratio implies either strong sales or ineffective buying. 4) Debt-Equity Ratio-This ratio compares external liabilities with internal liabilities. The interpretation of this ratio depends upon the financial and business policies of the organization. 5) Debt-Asset Ratio-It indicates what proportion of the company’s assets are being financed through debt. It is similar to the debt-equity ratio. A ratio...
Words: 562 - Pages: 3
...(EMH). The authors provide a systematic review of the correlation between several financial factors namely: Adaptive Markets Hypothesis (AMH), Efficient Markets Hypothesis (EMH), Evolving Return Predictability, Stock markets and Weak-form EMH. The authors pay keen attention on how return predictability from past price changes is affected by key players and determinants on the stock markets. From the survey they conduct, the posit that the bulk of the empirical studies examine whether the stock market under study is or is not weak-form efficient in the absolute sense, assuming that the level of market efficiency remains unchanged throughout the estimation period. The authors acknowledge that one field that has drawn extensive investigation by scholars and other players alike is the predictability of stock returns on the basis of past price changes. This is partly due to its direct implication on weak-form market efficiency. They find that a vast majority of the literature implicitly assumes the level of market efficiency remains unchanged throughout the estimation period. However, the possibility of temporal instability in the underlying economic relations has received increasing attention from economists (see, for example, Stock and Watson, 2003). Kian-Ping Lim and Robert Brooks through their present survey show that there is an expanding literature which challenges the assumed static characteristic of market efficiency by means of non-overlapping sub-period analysis,...
Words: 1925 - Pages: 8
...“When the price of a stock can be influenced by a “herd” on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical.” ------------------------------------------------- This report will analysis the statement by Warren Buffett, and it considers the contrasting evidence on the validity of the observation on the Efficient Markets Hypothesis. The report briefly outlines the forms of the Efficient Market Hypothesis, the report also analysis’s the evidence both seminal and recent on the theory relating to the three forms of the hypothesis. It also examines the theoretical role and motivation of analysts in creating market efficiency; lastly it looks at alternative perspectives on the pricing of securities. Introduction In 1984 Warren Buffett penned an article titled “The Superinvestors of Graham-and-Doddsville”, based on a speech he had given on the occasion of the 50th anniversary of his mentor Ben Graham’s legendary textbook, Security Analysis. In it, Buffett rejected the then growing (and now entrenched) view in academia that markets are ''efficient'' because ''stock prices reflect everything that is known about a company’s prospects and about the state of the economy.'' Warren Buffett argued against EMH, saying the preponderance of value investors among the world's best money managers rebuts...
Words: 2524 - Pages: 11
...Suggested Solution to Homework 4, part 1 and part 2 Chapter 11 7.(20 points) The following effects seem to suggest predictability within equity markets and thus disprove the Efficient Market Hypothesis. However, consider the following: a. Multiple studies suggest that “value” stocks (measured often by low P/E multiples) earn higher returns over time than “growth” stocks (high P/E multiples). This could suggest a strategy for earning higher returns over time. However, another rational argument may be that traditional forms of CAPM (such as Sharpe’s model) do not fully account for all risk factors which affect a firm’s price level. A firm viewed as riskier may have a lower price and thus P/E multiple. b. The book-to-market effect suggests that an investor can earn excess returns by investing in companies with high book value (the value of a firm’s assets minus its liabilities divided by the number of shares outstanding) to market value. A study by Fama and French 1 suggests that book-to-market value reflects a risk factor that is not accounted for by traditional one variable CAPM. For example, companies experiencing financial distress see the ratio of book to market value increase. Thus a more complex CAPM which includes book-to-market value as an explanatory variable should be used to test market anomalies. c. Stock price momentum can be positively correlated with past performance (short to intermediate horizon) or negatively correlated (long horizon). Historical data seem to...
Words: 981 - Pages: 4
...economies in the United States and Europe. The crisis has also shaken the foundations of modern-day financial theory, which rested on the proposition that our financial markets were basically efficient. Critics have even suggested that the efficient--market–hypotheses (EMH) was in large part, responsible for the crises. This paper argues that the critics of EMH are using a far too restrictive interpretation of what EMH means. EMH does not imply that asset prices are always “correct.” Prices are always wrong, but no one knows for sure if they are too high or too low. EMH does not imply that bubbles in asset prices are impossible nor does it deny that environmental and behavioral factors cannot have profound influences on required rates of return and risk premiums. At its core, EMH implies that arbitrage opportunities for riskless gains do not exist in an *Princeton University. I am indebted to Alan Blinder and to the participants in the Russell Sage Conference on Economic Lessons From the Financial Crisis for extremely helpful comments. 2 efficiently functioning market and if they do appear from time to time that they do not persist. The evidence is clear that this version of EMH is strongly supported by the data. EMH can comfortably coexist with behavior finance, and the insights of Hyman Minsky are particularly relevant in eliminating the recent financial crisis. Bubbles, when they do exist are particularly dangerous when they are financed with debt. And the housing...
Words: 11209 - Pages: 45
...markets. The empirical results provide direct evidence of the gradual information diffusion model in Hong and Stein (1999). Consistent with their theory, we show that a successful identification of stocks’ information diffusion stage helps explain momentum profits. We are able to enhance momentum profits by longing winner stocks with higher growth (and shorting loser stocks with larger drop) in call options implied volatility. Our empirical strategy generates a risk-adjusted alpha of 1.8% per month for a hedged winner-minus-loser portfolio over the 1996–2011 period, during which the simple momentum strategy fails to perform. The results are stronger and clearer if we use call options compared with put options, which are consistent with managers’ tendency to reveal good news and hide bad news. Our results are robust to transaction costs, choice of options’ moneyness, elimination of implied volatility persistence, and choice of options’ time-to-maturity. Finally, our results are not driven by existing stock-level characteristics, such as size, trading volume, and analyst coverage. JEL Classification: G10, G11, G12, G13 Keywords: Momentum, Implied Volatility PBC School of Finance, Tsinghua University. Email: chenzh@pbcsf.tsinghua.edu.cn. Tel: +86-1062781370. † Department of Finance, University of Melbourne. Email: andrea.lu@unimelb.edu.au. Tel: +61-449566225. For helpful comments and discussions, the authors thank Torben Andersen, Snehal Banerjee, Zhi Da, Stephen Figlewski, Kathleen...
Words: 22536 - Pages: 91
...about the type of stock they will invest in. However it provides an academic understanding as to which stock the company should select based on the formulations. The company’s growth and profit continued to grow with their academic approaches. The company’s management never set the goal to maximize assets. DFA based their approach on academic research and skilled traders. This create a essential formula for the company to create a list of possible investments that fit within the company’s ideal portfolio. DFA used a strategy to decrease the costs between the client and DFA as well as create value. DFA additionally used a value proposition of DFA by using the academic research to create specialized portfolios focusing on the small cap companies (small cap = 300 mil- 2 bill range). This investment approach focused on the Fama and French model. Their research demonstrated the small cap companies tended to outperform the large cap companies. DFA also added trading capabilities to increase variety among the competitive market while decreasing transaction costs. Passive Approach - Pros the company created low operating expenses, no initial decision making from managers or the investors. Relied on the fundamentals of the Fama and French Model. Cons the company managers do not actively participate with decisions, performance measures are set by the model and therefore does not include trending or forecasting of the stock variety types. Ex. Technology boom 2. What...
Words: 3480 - Pages: 14
...Tweedy, Browne Company LLC Investment Advisers Established in 1920 ______________________________________________________________________________________ Managing Directors Christopher H. Browne William H. Browne John D. Spears Thomas H. Shrager Robert Q. Wyckoff, Jr. WHAT HAS WORKED IN INVESTING: Studies of Investment Approaches and Characteristics Associated with Exceptional Returns What Has Worked In Investing is an attempt to share with you our knowledge of historically successful investment characteristics and approaches. Included in this booklet are descriptions of 44 studies, one-half of which relate to non-U.S. stocks. Our choice of studies has not been selective; we merely included most of the major studies we have seen through the years. Interestingly, geography had no influence on the basic conclusion that stocks possessing the characteristics described in this booklet provided the best returns over long periods of time. While this conclusion comes as no surprise to us, it does provide empirical evidence that Benjamin Graham’s principles of investing, first described in 1934 in his book, Security Analysis, continue to serve investors well. A knowledge of the recurring and often interrelated patterns of investment success over long periods has not only enhanced our investment process, but has also provided long-term perspective and, occasionally, patience and perseverance. We hope this knowledge will also serve you well. The investment selection criteria...
Words: 3414 - Pages: 14
...I. JUDGMENT and DECISION BIASES In the first section of the survey, psychological effects which are relevant for securities markets are defined. These effects mostly derive from common roots. Since it is almost impossible to analyze all the given data, rules of thumbs are preferred such as algorithmic, heuristics and mental modules. Heuristics must be applied to appropriate problems and cases so that they can be effective. There have been debates between both economists and psychologists on how heuristics do. Most of the economists believe in the fact that errors are independent across individual investors. The idea ends up with the equilibrium point and correction. However people mostly share similar heuristics gained from experience. Human mind is not designed solely to make good decisions but also to experience pleasantness. Individuals believe that they are better than they actually are. Also decisions are affected by feelings and mood of decision maker individuals. People can learn from past experiences and failures. However learning is hard and self-deception makes people realize their success more than failures and losses. Many (though not all) of the cognitive biases are stronger for individuals with low cognitive ability or skills than for those with high ability or skills, consistent with biases being genuine errors. A. Heuristic Simplification A.1 Attention/Memory/Ease-of-processing effects Lack of full attention, limitations on memory...
Words: 4287 - Pages: 18
