Nomura Securities International, Inc.

Nomura Securities International, Inc.

U.S. Quantitative Research

Investment in the era of

unintended bets

16 June 2009
Joseph Mezrich Please read the analyst
certifications and important
Nomura Securities International, Inc. disclosures on pp. 21–22. gl
U.S. Quantitative Research

All together now

The legacy of financial engineering
Systemic risk will likely change in magnitude but won’t go away
0.50

After -> 0.064

SPX 1 Year Implied Volatility
0.45

0.056
0.40

Baa and 10 Yr Tbond Spread

0.35 0.048
SPX 1 Year Implied Vol

0.30 0.040

0.25
0.032

0.20
0.024

0.15

0.016
0.10

Baa & 10 Year Tbond Spread 0.008

0.05
<- Before
0.00 0.000
Oct-92

Oct-93

Oct-94

Oct-95

Oct-96

Oct-97

Oct-98

Oct-99

Oct-00

Oct-01

Oct-02

Oct-03

Oct-04

Oct-05

Oct-06

Oct-07

Oct-08
Note: Shows the 15-year relationship between the volatility implied in 1-year S&P500 index options and the spread between Moody’s Seasoned
Baa corporate bonds and 10-year US treasuries. The vertical line in the chart separates what seem to be two regimes: “after” when these risk
measures tracked each other and “before” when they did not track each other. Last data as of 6/4/09.
Source: Nomura Securities International, Inc., Opitionmetrics, Federal Reserve and Moody’s.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 2

U.S. Quantitative Research

All together now

The legacy of financial engineering
Systemic risk will likely change in magnitude but won’t go away
-9
8 Default risk return (LHS)
-8
Synthetic CDX (LHS)
SPX 1 year implied volatility (LHS) -7
6 B/P return (RHS) -6
-5
Z Score

Z Score
4 -4
-3
2 -2
-1
0 0
1
<- Before After ->
-2 2
Mar-93

Mar-94

Mar-95

Mar-96

Mar-97

Mar-98

Mar-99

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08
Note: Shows z scores of cumulative monthly long-short factor returns of B/P and default risk (long low B/P and long low default risk). Also shows z scores of SPX
1-year implied volatility and synthetic CDX (post 2004 Markit’s index of Credit Default Swap market risk, before 2004 implied CDX values imputed by spread
between Baa corporates and 10-year T-bonds). The “before” and “after” line in the exhibit is placed at November 2001, the end of the 2001 recession. B/P factor
returns based on decile spreads in Russell 1000 and default probability factor returns based on quintile spreads in S&P500. Decile or quintile baskets are
rebalanced at the beginning of month. Last data as of 12/31/08. Factor returns do not include transaction costs.
Source: Nomura Securities International, Inc., Russell, S&P, Compustat, Worldscope, IDC, Ex-Share.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 3

U.S. Quantitative Research

B/P-default probability correlation and major risk measures

B/P Default Correlation Synthetic CDX

4.0

3.0

2.0

z-score
1.0

0.0

-1.0

-2.0

-3.0
Jan-96

Jul-96

Jan-97

Jul-97

Jan-98

Jul-98

Jan-99

Jul-99

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09
B/P Default Correlation SPX 1Y Volatility
6.0

5.0

4.0

3.0
z-score

2.0

1.0

0.0

-1.0

-2.0

-3.0
Jan-96

Jul-96

Jan-97

Jul-97

Jan-98

Jul-98

Jan-99

Jul-99

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09
Note: The B/P-default probability correlation is based on the B/P score and the logarithm of default probability in S&P500 universe with 0
default probability stocks excluded. B/P spread is based on differences of the median B/P between top and bottom quintile baskets based on
default probability. Synthetic CDX is CDX since the end of 2004, but extended before that by using the linear relationship with bond spreads,
where the coefficients are estimated by the time series regression from 31 Dec 2004 to 4 Feb 2008. Last data as of 5/29/09.
Source: Nomura Securities International, Inc., Markit Group Ltd., Optionmetrics, Federal Reserve, Moody’s, Merrill Lynch/Bloomberg, S&P,
Compustat, Worldscope, IDC, Ex-Share.
Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 4
U.S. Quantitative Research

The stock market shifted focus from equity volatility to credit risk
US
3.5 2.0
Lehman VIX (left axis)
CDS index (left axis)
bankruptcy 1.5
2.5
1.0
1.5
0.5

Z Score

Z Score
S&P500 (right axis)
0.5 0.0

-0.5
-0.5
-1.0
-1.5
-1.5

-2.5 -2.0
May-08

Jun-08

Jul-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09
Sep-08

Apr-09
Aug-08
Japan
4 2.0
Lehman Nikkei 225 implied volatility (left axis)
bankruptcy 1.5
3 CDS index (left axis)

1.0
2

Nikkei 225 (right axis)

Z Score

0.5

Z Score
1
0.0

0
-0.5

-1
-1.0

-2 -1.5
May-08

Aug-08

Nov-08

Mar-09

Apr-09
Jun-08

Jul-08

Sep-08

Oct-08

Dec-08

Jan-09

Feb-09

Notes: The charts show the path of credit risk (CDS), equity volatility (VIX for US, Nikkei 225 implied volatility for Japan), and the equity
market for US (S&P500, top panel) and Japan (Nikkei 225, bottom panel). Data are from 1 May 2008 through 30 April 2009.
Source: Nomura Securities International Inc., Bloomberg and Markit.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 5

 U.S. Quantitative Research

S&P500 implied volatility –

equity risk jumped, then exploded, then reverted

80% 80%
75%
Credit Crisis
70% 70%
2002, Accounting
LTCM 9/11 Scandals 65%
60%
Asian 60%

50%
Crisis 55% One Year vol LTCM peak 1-yr vol
Iraq War Begins - vol 50%
slide begins 45%
40%
40%
30% 35%
30%
20% 25%
20%
One Month vol One Year vol
10% 15%
10% One Month vol (VIX)
0%
5%
Nov-95

Nov-97

Nov-99

Nov-01

Nov-03

Nov-05

Nov-07
Jul-96

Mar-97

Jul-98

Mar-99

Jul-00

Mar-01

Jul-02

Mar-03

Jul-04

Mar-05

Jul-06

Mar-07

Jul-08

Mar-09

Nov-07

Nov-08
May-08

May-09
Mar-08
Jul-07

Sep-07

Jan-08

Jul-08

Sep-08

Jan-09

Mar-09
Note: Shows implied volatilities of 1-month and 1-year S&P500 index options. Last data as of 6/4/2009.
Source: Nomura Securities International Inc. and Optionmetrics.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 6

U.S. Quantitative Research

Valuation and default probability –

How fear and relief affect value stocks
Lehman bankruptcy

Cheap
US 2.0
Subprime crisis

1.5 High default probability stocks Corporate scandals

B/P Low default probability stocks

1.0

0.5
Expensive

0.0
1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008
1.8
Yamaichi bankruptcy Lehman bankruptcy
Japan
Cheap

1.6
Financial crisis high default risk stocks
1.4
Subprime crisis
1.2
B/P

1.0

0.8

0.6
Expensive

0.4
low default risk stocks
0.2
1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008
Note: Green line in the exhibit shows the average B/P for the 100 stocks in the S&P500 (US) and Nomura 400 (Japan) with the highest default probability, blue line
shows the average B/P for the 100 stocks with the lowest default probability. Returns do not include transaction costs. Last data as of 5/29/2009.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC.
Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 7
 U.S. Quantitative Research

Valuation and default probability –

How fear and relief affect value stocks
1.8

1.6 B/P default correlation

B/P spread ( high default risk - low default risk )
1.4

1.2

1.0

Z-SCORE
0.8

0.6

0.4

0.2

0.0

-0.2

Jan-96

Jul-96

Jan-97

Jul-97

Jan-98

Jul-98

Jan-99

Jul-99

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09
B/P Default Correlation Synthetic CDX

4.0

3.0

2.0
z-score

1.0

0.0

-1.0

-2.0

-3.0
Jan-96

Jul-96

Jan-97

Jul-97

Jan-98

Jul-98

Jan-99

Jul-99

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09
B/P Default Correlation SPX 1Y Volatility
6.0

5.0

4.0

3.0
z-score

2.0

1.0

0.0

-1.0

-2.0

-3.0
Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09
Jul-96

Jul-97

Jul-98

Jul-99

Jul-00

Jul-01

Jul-02

Jul-03

Jul-04

Jul-05

Jul-06

Jul-07

Jul-08
Note: The B/P-default probability correlation is based on the B/P score and the logarithm of default probability in S&P500 universe with 0 default probability stocks excluded. B/P spread
(high default risk – low default risk) is based on the gap between median B/P for top and bottom quintile in S&P500 universe due to the default probability. Synthetic CDX is CDX since the
end of 2004, but extended before that by using the linear relationship with bond spreads, where the coefficients are estimated by the time series regression from 31 Dec 2004 to 4 Feb 2008.
Transaction costs not included in factor returns. Last data as of 5/30/09.
Source: Nomura Securities International, Inc., Markit Group Ltd., Optionmetrics, Federal Reserve, Moody’s, Merrill Lynch/Bloomberg, S&P, Compustat, Worldscope, IDC, Ex-Share.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 8

U.S. Quantitative Research

Revenge of the cheap losers

20%

10% Book/Price

Cumulative Excess Returns

0%

-10%

-20%
Q1 (Highest B/P)
-30% Q2
Q3
Q4
-40% Q5 (Lowest B/P)
Spread (Highest - Lowest) Spread: Q5 - Q1
-50%

Nov-07

May-08

Nov-08

May-09
Aug-07

Aug-08
Jul-07

Sep-07
Oct-07

Dec-07
Jan-08
Feb-08
Mar-08
Apr-08

Jun-08
Jul-08

Sep-08
Oct-08

Dec-08
Jan-09
Feb-09
Mar-09
Apr-09
80%
1 year Price Momentum
60% Spread: Q5 - Q1
Cumulative Excess Returns

40%

20%

0%

-20%
Q5 (Highest 1yr PM)
Q4
Q3
-40% Q2
Q1 (Lowest 1yr PM)
Spread (Highest - Lowest)
-60%
Aug-07

Nov-07

May-08

Aug-08

Nov-08

May-09
Jul-07

Sep-07
Oct-07

Dec-07
Jan-08

Mar-08
Feb-08

Apr-08

Jun-08
Jul-08

Sep-08
Oct-08

Dec-08
Jan-09

Mar-09
Feb-09

Apr-09
Note: Shows cumulative excess returns over Russell 1000 of each quintile of B/P and one-year price momentum from July 2007 to May 2009
in Russell 1000. Transaction costs not included. Last data as of 5/29/2009.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 9

 U.S. Quantitative Research

Market turbulence and unintended factor bets

4 2.5

3 Deafult risk (safe - risky) 2.0

Z score of cumulative returns

Up to down revision
Z Sco re o f cu m u lative retu rn s

1.5
2
1.0
1 0.5
0 0.0
-0.5
-1
-1.0
-2
-1.5
-3 Default risk ( safe - risky )
-2.0
Up-to-down revision
-4 -2.5

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009
J un-07
J ul-07

O c t-07
Nov -07
Nov -07
Dec -07
J an-08
F eb-08
F eb-08
Mar-08

May -08
May -08
J un-08
J ul-08
J ul-08

O c t-08
O c t-08
Nov -08
Dec -08
Dec -08
J an-09
F eb-09
Mar-09
Mar-09

May -09
Sep-07
Sep-07

Sep-08
Aug-07

Apr-08

Aug-08

Apr-09

Note: Each factor return is normalized for the period through 5/30/08. Based on quintile spreads in S&P500. Transaction costs not included.
Source: Nomura Securities International Inc., I/B/E/S

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 10

U.S. Quantitative Research

Seeking safety around the globe:

Impact of estimate dispersion & default risk on stocks
US Europe
120 60 60 50
Default probability(low -high, LHS) Default probability(low -high, LHS)
Cumulative daily factor return (%)

Cumulative daily factor return (%)

100 50
Estimate dispersion (low -high, RHS) 50 Estimate dispersion (low -high, RHS)
80 M ar 9 40
40
No v 21
60 40 Citigro up
30 30
40 bailo ut
20 30
20 20
10 20
0
0 10
-20 10
-40 No v 21 -10
Jan 8 Jan 8 M ar 9 0
Citigro up US jo bs -20 0 US jo bs
-60 bailo ut
-80 -30 -10 -10
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08

May-08
Jun-08
Jul-08

Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Sep-08

Nov-07
Dec-07
Jan-08
Feb-08
Mar-08

May-08
Jun-08
Jul-08

Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-08

Aug-08

Apr-09

Sep-08
Apr-08

Aug-08

Apr-09
Japan Asia
40 30 60 45
Default probability(low -high, LHS) Default probability(low -high, LHS)
Cumulative daily factor return (%)

Cumulative daily factor return (%)

30 Estimate dispersion (low -high, RHS) 20 40
50 Estimate dispersion (low -high, RHS)
Dec 5
35
20 10
China 40 Dec 5 30
10 0 China
30 25
0 -10 20
20 15
-10 -20
10 10
-20 -30
No v 21 Jan 8 No v 21 5
Jan 8 M ar 9
-30 Citigro up US jo bs -40 0 Citigro up US jo bs
bailo ut bailo ut
0
-40 -50 -10 -5
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08

May-08
Jun-08
Jul-08

Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09

Nov-07
Dec-07
Jan-08
Feb-08
Mar-08

May-08
Jun-08
Jul-08

Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Sep-08
Apr-08

Aug-08

Apr-09

Sep-08
Apr-08

Aug-08

Apr-09
Note: US = Russell 1000; Europe = MSCI Europe, Japan = NOMURA 400, Asia ex Japan = MSCI Asia Pacific ex Japan (Australia, Hong Kong, New Zealand and
Singapore). Shows cumulative return of a factor portfolio that is long lowest default risk stocks while short the highest default risk stocks, and the cumulative return
of a factor portfolio that is long the lowest estimate dispersion stocks and short the highest estimate dispersion. US is based on decile baskets, while other regions
are based on quintile baskets. Long and short baskets are rebalanced monthly with equal weighting. Last data as of 5/29/2009. Factor returns do not include
transaction costs.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, IDC, Worldscope, ExShare and MSCI.
Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 11
U.S. Quantitative Research

Value fails when risk aversion rises and vice versa:

Estimate dispersion vs. B/P
US Europe
80 50
Estimate dispersion (low -high) Estimate dispersion (low -high)
Cumulative daily factor return (%)

Cumulative daily factor return (%)

40
60 B/P B/P
30
40
20
M ar 9
20 10 M ar 9

0
0
-10
-20 -20
No v 21 -30
-40 Citigro up Jan 8
bailo ut US jo bs -40
-60 -50
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08

May-08

Jun-08
Jul-08

Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Sep-08
Apr-08

Aug-08

Apr-09

Nov-07
Dec-07
Jan-08
Feb-08
Mar-08

May-08
Jun-08
Jul-08

Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Sep-08
Apr-08

Aug-08

Apr-09
Japan Asia
80 50
Estimate dispersion (low -high) Dec 5
Cumulative daily factor return (%)

Estimate dispersion (low -high)

Cumulative daily factor return (%)

60 China
B/P Dec 5
40 Jan 8
B/P
China US jo bs
40 30
M ar 9
20 20

No v 21 M ar 9
0 10
Citigro up
bailo ut
-20 0

No v 21 Jan 8
-40 US jo bs -10
Citigro up
bailo ut
-60 -20
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08

May-08

Jun-08
Jul-08

Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Sep-08

Nov-07
Dec-07
Jan-08
Feb-08
Mar-08

May-08
Jun-08
Jul-08

Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-08

Aug-08

Apr-09

Sep-08
Apr-08

Aug-08

Apr-09
Note: US = Russell 1000; Europe = MSCI Europe, Japan = NOMURA 400, Asia ex Japan = MSCI Asia Pacific ex Japan (Australia, Hong Kong, New Zealand
and Singapore). Shows cumulative return of a factor portfolio that is long the lowest estimate dispersion stocks and short the highest estimate dispersion, and
the cumulative return of a factor portfolio that is long the highest book-to-price (B/P) stocks while short the lowest B/P stocks. US is based on decile baskets,
while other regions are based on quintile baskets. Long and short baskets are rebalanced monthly with equal weighting. Last data as of 5/29/2009 for Japan,
4/6/2009 for US, and 4/3/2009 for Europe and Asia. Factor returns do not include transaction costs.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, IDC, Worldscope, ExShare and MSCI.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 12

U.S. Quantitative Research

Estimate dispersion and the economy

US Europe
Recession
10 20
Dispersion of analyst estim ates (% )

Dispersion of analyst estim ates (% )

Value

8 Value
15 Market

6 Market

10
4

5
2
Earnings down
Growth Growth trend period
0 0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Japan Asia
30 18

16

Dispersion of analyst estim ates (% )

Dispersion of analyst estim ates (% )

Value Value
25 Recession Earnings down
14
trend period
20 12 Market
Market
10
15
8

10 6

4
5 Growth
Growth 2

0 0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

Notes: The median dispersion of analyst estimate is plotted for value, growth stocks and the universe (smoothed FY1 estimate dispersion using 12-
month moving average). The top half of the universe based on B/P is labeled value, the bottom labeled growth. Period of analysis is from May 1988
through February 2009. US = S&P500; Europe = MSCI Europe, Japan = NOMURA 400, Asia ex Japan = MSCI Asia Pacific ex Japan.
Source: Nomura Securities International Inc., I/B/E/S, Worldscope, ExShare, S&P, MSCI, NBER and ESRI.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 13

U.S. Quantitative Research

Earnings uncertainty for value stocks –

value’s risk premium
120 1
110 Gap of estimate dispersion
100 ( Value - Growth, right axis )
0.8
90

Gap of estimate dispersion

80
Cumulative return (%)

(log, Value - Growth)

70 0.6
60
50
0.4
40
30
20 0.2
10
0
0
-10 Cumulative return to B/P
-20 ( High - Low, left axis )
-30 -0.2
1988
1989

1990
1991

1992

1993
1994

1995
1996

1997
1998

1999
2000

2001
2002

2003
2004

2005
2006

2007
2008
Note: The S&P500 stocks are divided into two groups, with the top half of the S&P500 based on B/P labeled value, and the bottom labeled growth. The gap of
median dispersion of analyst estimate between value and growth stocks is plotted (smoothed FY1 estimate dispersion using 12-month moving average).
Returns to B/P are based on decile spreads in Russell 1000 universe (rebalanced monthly and equally weighed) and the cumulative return is smoothed using
12-month moving average. The data are from Nov 1988 through Jan 2009. Factor returns do not include transaction costs.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, S&P, IDC, Russell.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 14

U.S. Quantitative Research

Estimate dispersion and the effectiveness of stock strategies

B/P return vs Estimate Dispersion
140
120 High dispersion
100 Low dispersion

Cumulative Return (%)

80
60
40
20
0
-20

Why value & -40

momentum are
-60
-80

opposites Dec-87
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Momentum return vs Estimate Dispersion
300
High dispersion
250
Cumulative Return (%)

Low dispersion
200

150

100

50

-50
Dec-87
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Notes: Universe is S&P500. Top panel shows cumulative returns to B/P (quintile spread base) for highest and lowest one-third based on estimate
dispersion. Bottom panel shows cumulative returns to one-year price momentum (quintile spread base) for highest and lowest one third based on
estimate dispersion. Returns do not include transaction costs. Last data as of 4/30/2009.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, IDC, S&P.
Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 15
U.S. Quantitative Research

Principle components of fundamental factors

… is it a single factor world?

1 Mon. Price Momentum (Low - High)

Momentum
1 Year Price Momentum
14 62%
1 Year Dividend Growth
Since Jun 2007
5 Year EPS Growth
Growth
12 Since Sep 1984 Predicted LT Growth
Up to Down Revisions
B/P
10
Dividend Yield
Variances (%)

E/P
8 36% Value
EBITDA/EV
PEG (Low - High)
63%
6 Predicted E/P
Quality Accruals (Low - High)
Leverage Debt/Equity (Low - High)
4 77%
Beta
73%
86% Risk Default Risk (Safe - Risky)
2
90% 78% Estimate Dispersion (Low - High)
Profitability ROE
0 Market Cap (Small - Large)
Comp.1

Comp.2

Comp.3

Comp.4

Comp.5

Comp.6

Comp.7

Comp.8

Comp.9

Comp.10
CapEx/Sales (Low - High)
Other
Analyst Coverage (Low - High)
Share Buybacks

Note: The bar chart displays the variance of the principal components derived from the factor set shown at right, and the number above the bars
corresponds to the cumulative percentage of variances. Universe is Russell 1000. The analysis is as of 4/30/2009.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 16

U.S. Quantitative Research

Principle components of fundamental factors

… is it a single-factor world?
1st component since June 2007
-0.3 -0.2 -0.1 0 0.1 0.2 0.3

1 Yr. Price Momentum

Default Risk (Safe-Risky)
Estimate Dispersion(Low-High)
1 Year Dividend Growth
Up to Down Revisions
Debt/Equity(Low-High)
5 Year EPS Growth
ROE
Predicted LT Growth
Share Buybacks
Predicted E/P
CapEx/Sales(Low-High)
Analyst Coverage(Low-High)
1 Mon. Price Momentum (Low - High)
Accruals(Low-High)
PEG(Low-High)
Dividend Yield
Beta
E/P
EBITDA/EV
Market Cap (Small - Large)
B/P

Note: The bars show the loadings of the factors that produce the primary, first principal component for the period since the crisis began. The
principal components analysis is based on monthly time series of 22 representative factor returns shown on page 16 from Jun 2007 through
Apr 2009. Universe is Russell 1000.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC.
Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 17
 U.S. Quantitative Research

Factor momentum – best/worst 3 out of 22 factors on trailing 5 years

Long term history During the crisis

300 60

Winner Winner
250

Cumulative monthly returns (%)

40
Cumulative monthly returns (%)

Loser Loser
200
20

150
0
100
-20
50

-40
0

-60
-50

May-07

May-08

May-09
Mar-07
Apr-07

Aug-07

Nov-07

Mar-08
Apr-08

Aug-08

Nov-08

Mar-09
Apr-09
Dec-06
Jan-07
Feb-07

Jun-07
Jul-07

Sep-07
Oct-07

Dec-07
Jan-08
Feb-08

Jun-08
Jul-08

Sep-08
Oct-08

Dec-08
Jan-09
Feb-09
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

Note: Universe is Russell 1000. The exhibit shows the cumulative return to owning the best and the worst three factors in 22 representative factors, based on
the past five years’ performances. The analysis ranges from Dec 1977 through May 2009. Factor returns do not include transaction costs.
Source: Nomura Securities International Inc., Compustat, I/B/E/S, Russell, and IDC.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 18

U.S. Quantitative Research

Principle components of fundamental factors

… is it a single-factor world?
1st component since June 2007
-0.3 -0.2 -0.1 0 0.1 0.2 0.3

1 Yr. Price Momentum

Default Risk (Safe-Risky)
April factors
Estimate Dispersion(Low -High)
1 Year Dividend Grow th
Up to Dow n Revisions
Debt/Equity(Low -High)
5 Year EPS Grow th
ROE
Predicted LT Grow th
Share Buybacks
Predicted E/P
CapEx/Sales(Low -High)
Analyst Coverage(Low -High)
1 Mon. Price Momentum (Low - High)
Accruals(Low -High)
PEG(Low -High)
Dividend Yield
Beta June factors
E/P
EBITDA/EV
Market Cap (Small - Large)
B/P

Note: The bars show the loadings of the factors that produce the primary, first principal component since the crisis began. Universe is Russell
1000. The principal components analysis is based on monthly time series of 22 representative factor returns shown on page 16 from Jun
2007 through Apr 2009. Source: Nomura Securities International Inc., Compustat, I/B/E/S, IDC, S&P.

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 19

U.S. Quantitative Research

Investment in the era of unintended bets

• Cash and derivatives, stocks and bonds have been woven together. High
volatility only tightens the bond that is a persistent feature of modern markets.

• Is presumed alpha often just the reward for bearing risk ?

• Of course you need to diversify – this can’t always be done easily within a region

• But macro forces could make ‘Think Global, Act Local’ a key to diversification

Joseph Mezrich, 212.667.9316, jmezrich@us.nomura.com 20

 U.S. Quantitative Research

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 U.S. Quantitative Research

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U.S. Quantitative Research

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