Equity Investment Styles: Recent evidence on the existence and cyclicality of investment styles

Christian Jensen-Gaard

Student thesis: Master thesis


Over the past two decades, financial academics and investment professionals have documented several anomalies on the global financial markets. A subset of these anomalies, known as equity style strategies, has been shown to yield substantial excess returns, which cannot be explained by traditional finance theory. However, in the light of the financial turmoil during the 2000s, several studies have shown considerable changes in the magnitude of the style-based strategy premiums. The purpose of this thesis is to investigate whether recent data support the continued existence of these premiums and evaluate how these premiums fluctuate in relation to the economic cycle. Furthermore, this thesis provides practical advice on how investors can apply the findings. Through reiterative monthly sorting processes on data from the combined Standard and Poor’s (S&P) US Broad Market Index (BMI), S&P Europe BMI and S&P Japan BMI indices during the period 1990 to 2013, this thesis measures the performance of eighteen fundamental factors within the Value, Growth, Momentum, Market Beta, Quality and Size style strategies. A thorough analysis of the individual factors confirms the existence of statistically significant value, momentum and quality premiums during the sample period. The data on the remaining factors is found to be largely inconclusive. Traditional risk-based measures are shown to be unable to explain these anomalies. In response, behavioral arguments, such as the extrapolation- and overreaction hypotheses and institutional biases, are discussed and found to support the results. By applying purchasing managers’ index (PMI) data, the premiums of each factor are measured during each phase of the economic cycle. The results show pronounced cyclicality in the returns of the six strategies as both the level and change in the PMI data is found to affect the premiums. Two methodologies for applying the findings, based on traditional asset allocation and multidimensional factor screenings, are reviewed. Adjusting for transaction costs eliminates the momentum premium but does not affect the significance of the value and quality spreads. However, the compounded effects of increased transaction costs related to both portfolio maintenance and reallocation between factors are found to reduce the observed premiums substantially in the long run. Transition matrixes also indicate that several fundamental factors remain stable over time. In conclusion, this thesis supports the continued existence of several style-based investment strategies, thereby proposing considerable benefits to investors by exploiting the systematic mispricing in the market. It is argued that the existence of such premiums is not a question of if but rather why and when the premiums appear.

EducationsMSc in Finance and Accounting, (Graduate Programme) Final Thesis
Publication date2013
Number of pages118