Global Investment Strategies:

Implications for market practitioners

Presentation by
Sanjay Sehgal
Professor of Finance
Department of Financial Studies
University of Delhi, South Campus
Email: sanjay@mfc.edu
 The Biggest Challenge

¾ To beat the market consistently on risk-adjusted

basis

¾ Global fund managers try to develop trading

strategies that provide extra normal profits.

¾ They scan global capital markets on their

investment radar using the risk and returns
parameters.
 The framework for generating super profits
¾ If markets are informationally efficient, securities provide
only fair returns consistent with the risk level
¾ Market efficiency anomalies will cause prices to move
away from equilibrium values providing opportunities for
extra normal returns
¾ Market inefficiency implies that noise traders co-exist
with value traders
¾ Higher noise trader activity will create larger departure
from equilibrium levels
¾ Noise traders under react/overreact to information
creating extra normal profit opportunities for the market
players.
 Three major efficient market anomalies
¾ Size effect [Benz (1981)]
¾ Value effect
- PB ratio [ Stattman (1980)]
- PE ration [Basu (1978,1983)]
¾ Prior return effects
- Contrarian effect [De Bondt and Thaler (1985)]
- Momentum effect [Jegadeesh and Titman
(1993)
 The Size anomaly

¾ Small firm stocks outperform big firm stocks on risk-

adjusted basis

¾ Small companies are riskier than big companies owing to

differences in (1). business risk (2). financial risk (3).
liquidity risk

¾ Size effect is stronger for emerging markets than for

mature markets [Fama and French (1998)]
 The value anomaly

¾ Low PB/PE stocks outperform high PB/PE stocks on risk

adjusted basis

¾ Low PB stocks represent fundamentally distressed firms

which have a weak track record of sales and earnings
growth rates [Fama and French (1995)]

¾ These low PB firms destroy economic profits, hence the

market punishes them with lower prices

¾ Value effect is stronger for mature markets compared to

emerging markets [Fama and French (1998)].
 Prior return anomalies

¾ Contrarian effect
- Long term past losers become future winners, while,
long-term past winners become future losers
- Loser portfolio exhibits reversals and outperforms
winners portfolio on risk adjusted basis.
¾ Momentum effects
- Short term past winners continue to be future winners
- winners portfolio exhibits continuation and
outperforms losers portfolio on risk-adjusted basis.
 Risk argument in case of momentum effect

¾ Winner portfolios may comprise of

- small firms stocks
- low PB stocks
- Stocks belonging to winning sectors as a large part of
momentum is contributed by sector momentum
[Sehgal and Jain (2011)
¾ Wining sectors exhibit higher growth potential and have
higher risk exposures.
 Combining the three dimensions
¾ Single sorted portfolios based on size/value/momentum

¾ Double sorted portfolios based on size-momentum and

value-momentum

¾ Triple sorted portfolio based on size-value-momentum

 Segregating normal returns from abnormal
returns: the three benchmarks
1. CAPM: the model offers risk premium only for the
market factor

2. Fama French model: The model offers risk premium for

market size and value factors

3. Carhart model: The model offers risk premium for

market size, value and momentum factors.
 Empirical results for India: single sorted
portfolios [Sehgal and Subramaniam (2011)]

1. Size based portfolios (monthly results)

Mean returns Risk-adjusted (CAPM)
P1 5.4% 4.8%
P5 0.7% 0.1%
P1-P5 4.7% 4.7%

2. Value Sorted portfolios (monthly results)

Mean returns Risk-adjusted (CAPM)
P1 2.9% 2.2%
P5 1.2% 0.6%
P1-P5 1.7 % 1.6%

3. Momentum sorted portfolios (monthly results)

Mean returns Risk-adjusted (CAPM)
P1 2.5 % 1.5%
P5 3.4 % 2.3%
P5-P1 0.9 % 0.8%
 Empirical results for India: double and triple
sorted portfolios [Sehgal and Jain (2011)]
4. Size/momentum portfolios

Mean returns Risk adjusted (CAPM)

S1 1.9 % 1.42%
S3 3.0 % 2.53%
S3-S1 1.1 % 1.08%

B1 0.8% 0.36%
B3 2.0% 1.52%
B3-B1 1.1% 1.16%

5. Value momentum portfolios

Mean returns Risk adjusted (CAPM)

L1                                   1.7%                        1.15% 
L3                                   3.6 %                   2.7%
L3‐L1                              1.9%                             1.45%

H1                                   0.8%                    0.30%
H3                                   2.3%                    1.84%
H3‐H1                            1.5%                               1.81%
 Continued……..
6. Size/value/momentum portfolios
Mean returns Risk adjusted (CAPM)
Small-Low

SL1 2.3% 1.62%

SL3 3.8% 3.15%
SL3-SL1 1.5% 1.53%

Small-High

SH1 2.09% 1.26%

SH3 3.03% 2.32%
SH3-SH1 0.94% 1.06%

Big -Low

BL1 1.26% 0.70%

BL3 2.44% 1.89%
BL3-BL1 1.18% 1.19%

Big-High

BH1 0.58% 0.12%

BH3 2.37% 1.85%
BH3-BH1 1.79% 1.73%
 How can global fund mangers develop
investment strategies
Step1
¾ Develop the first screen
a. pick 100 smallest stocks out of BSE-500 based on
market cap
b. Perform a 3/3 value-momentum sorting
c. Select 10-11 stocks belonging to low PB and high
momentum category.
¾ Develop the second screen
a. select the stocks which are in the 101-200 ranking
from BSE-500 list based on market cap
b. repeat steps b & c.
Note: Hold the 2 screen portfolios of about 20 securities and rebalance it at regular intervals semi-annual/annual.
 A Global portfolio management strategy

¾ Rank the global markets (market indices) on the basis of

aggregate market cap and PB ratio
¾ Form momentum portfolios within the small size and low
PB category
¾ Buy winners and sell losers
¾ The long short strategy involves zero investment and risk
but provides positive returns
¾ Country selection accounts for more than 90 percent of
portfolio returns. Hence there is an overemphasis on
security analysis in equity research framework.