Smart Beta Investing In Europe

Nicolai Tøttrup Clausen

Student thesis: Master thesis

Abstract

A lot of factor premiums have been found, but a lot of them have disappeared and reappeared again. There is no clear academic explanation for the cause of this. Most of the research is made on the US market, because it is the most developed market and only limited research is made on the European market.
The purpose of this thesis is to test whether recent empirical data supports the existence of factor premiums on the European market. The six tested factors are Value, Size, Momentum, Investment, Profitability and Market beta, which are the factors which have the most solid empirical and theoretical foundation. The factors are tested by using the stocks included in the STOXX Europe 600 Index. These stocks are sorted every month into deciles with respect to the individual factors. The factors are then constructed by going long in the most favourable decile and short in the least favourable decile for each factor. Then the stocks within the decile are equally weighted. This sorting is done for the 180 months from January 2002 to December 2016.
All factors returned on average a positive monthly premium. The factor premiums vary between 0.13% to 1.81% for the quality factors “High Profitability” and “Size” respectively. The factor premiums are found to be very dependent on the different phases of the economic cycle. Only the Size factor has positive premiums all around the economic cycle. For protection against recession, the High Profitability factor has proved to be the best hedge, despite the low overall premium. Some of the factors are proven to make industry bets by overweighting some industries. These bets are estimated and found to be too small to affect the overall findings of the premiums. Overall the factors don’t seem to be robust, but some factors more than others. Finally, the trading costs due to the turnover within the deciles are calculated. The highest monthly costs are within the Momentum and the Market beta factor, which reduce the premium by 0.20%. Therefore these costs are crucial for the factor premiums when the strategies are carried out in practice.

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2017
Number of pages97