fama & freedom 3½ factor model scott gavlick todd hoskin edward kim
TRANSCRIPT
Fama & Freedom 3½ Factor Model
Scott Gavlick
Todd Hoskin
Edward Kim
Page 2
Small-Value Portfolio Strategy Screening
US Securities Common Stock Excluding American Depository Receipts (ADR’s)
Questionable Returns
Small Capitalization Less Coverage/Public Information Less Market Efficiency Higher Growth Potential
Page 3
Approach
Equally-Weighted Investments Monthly Rebalancing Assumes NO Transaction Costs Benchmark is the S&P500
Page 4
Factors
Value Factors Operating Income / Enterprise Value Operating Income / Net Assets
Technical Factors Momentum – 1-year return, lagged 1 month Volume Moving Average – difference between the
daily average over the last 5 days and the daily average over the past year, scaled by the latter
Page 5
Factor AssessmentOperating Income / Enterprise Value (Fractile Report)
0.00
0.50
1.00
1.50
2.00
1 2 3 4 5
Fractile
Mon
thly
Ret
urn
% (a
vg)
Operating Income / Net Assets (Fractile Report)
0.00
0.50
1.00
1.50
2.00
1 2 3 4 5
Factile
Mon
thly
Ret
urn
% (a
vg)
Momentum (Fractile Report)
0.00
0.50
1.00
1.50
2.00
1 2 3 4 5
Fractile
Mon
thly
Ret
urn
% (a
vg)
Volume Moving Average (Fractile Report)
0.00
0.50
1.00
1.50
2.00
1 2 3 4 5
Fractile
Mo
nth
ly R
etu
rn %
(av
g)
Page 6
Factor Assessment
Quintile Heat Map (Operating Income / Enterprise Value)
Overall 104.9 173.7 208.4 236.1 289.2
1986 106.5 115.9 113.4 122.0 120.3
1987 80.3 89.6 84.8 89.3 96.5
1988 110.0 114.5 123.6 130.3 138.6
1989 100.7 97.6 104.8 107.2 104.7
1990 90.1 102.1 107.2 108.4 107.6
1991 174.3 154.9 148.0 144.4 151.6
1992 86.8 115.4 124.2 116.7 131.2
1993 106.7 129.6 126.5 119.7 117.3
1994 71.9 96.0 98.1 101.0 103.5
1995 158.0 141.4 128.0 123.6 130.2
1996 101.7 127.8 135.0 129.6 136.3
1997 88.1 109.4 124.5 134.2 148.4
1998 95.5 94.5 94.0 97.5 105.9
1999 210.1 151.6 103.3 102.0 105.3
2000 67.4 80.8 116.4 126.3 128.7
2001 73.1 87.8 116.5 124.7 141.9
2002 50.8 68.5 91.3 106.4 121.4
2003 261.1 196.7 163.5 166.0 191.1
2004 85.5 92.9 105.8 118.7 134.3
2005 90.9 102.2 106.4 111.1 120.8
Quintile Heat Map (Operating Income / Net Assets)
Overall 101.6 177.6 214.9 245.2 268.2
1986 108.1 117.8 121.4 112.5 118.6
1987 85.2 91.0 89.0 88.8 85.7
1988 114.1 116.4 133.4 124.3 128.3
1989 99.8 96.4 105.5 107.0 107.0
1990 89.9 99.7 102.0 117.5 105.1
1991 168.1 140.8 144.6 149.8 171.1
1992 90.4 117.2 114.3 124.8 127.2
1993 110.1 122.9 115.4 128.5 120.1
1994 75.0 100.1 97.8 100.2 96.0
1995 147.1 133.7 127.0 128.5 138.3
1996 102.5 122.4 131.4 135.1 138.7
1997 88.6 114.7 125.0 136.2 139.0
1998 95.8 90.7 96.8 100.3 101.8
1999 218.6 132.5 103.7 102.8 110.5
2000 60.0 90.7 115.7 123.9 126.6
2001 65.2 97.2 123.5 125.3 117.3
2002 51.7 70.9 94.4 105.4 106.8
2003 259.2 200.5 172.1 161.5 231.1
2004 83.0 99.3 109.3 119.8 123.5
2005 91.9 104.8 108.2 111.6 115.0
Page 7
Factor Assessment
Quintile Heat Map (Volume Moving Average)
Overall 100.8 212.8 233.4 254.4 240.1
1986 112.1 118.9 115.3 114.8 117.0
1987 78.8 87.9 90.0 91.1 92.0
1988 118.8 128.3 125.9 123.2 116.1
1989 100.2 107.8 103.2 103.1 104.7
1990 99.5 111.4 108.8 106.5 89.9
1991 152.4 158.2 161.5 148.2 147.5
1992 110.9 118.8 118.0 116.7 114.0
1993 112.2 117.4 121.3 124.0 127.4
1994 90.0 95.1 96.8 99.3 87.1
1995 120.1 133.7 137.5 143.8 147.2
1996 111.5 131.1 128.0 130.1 128.5
1997 111.2 118.7 125.5 126.7 114.2
1998 82.6 104.2 102.0 103.8 99.1
1999 121.7 136.1 132.0 127.6 131.3
2000 59.4 104.3 126.0 132.3 115.7
2001 81.9 108.2 113.7 120.6 113.9
2002 72.9 81.9 89.4 92.3 88.3
2003 161.7 181.6 188.5 208.9 232.5
2004 83.2 100.8 105.8 118.7 124.6
2005 91.0 94.0 99.8 112.5 135.4
Quintile Heat Map (Momentum)
Overall 121.3 186.9 219.3 230.4 259.7
1986 113.7 115.9 114.4 114.9 115.8
1987 85.9 97.7 92.0 81.1 87.0
1988 114.4 120.1 120.3 121.5 137.5
1989 87.5 101.7 103.4 112.3 112.4
1990 87.9 95.7 106.7 100.9 113.2
1991 136.2 136.7 145.1 153.0 190.6
1992 114.4 112.7 117.6 117.8 114.3
1993 99.5 116.8 119.5 126.7 136.7
1994 85.2 93.0 97.1 97.2 94.3
1995 114.3 129.4 128.7 136.9 161.6
1996 118.7 124.6 128.4 128.4 124.2
1997 95.1 119.5 124.4 130.1 129.7
1998 88.8 96.9 96.0 98.1 102.9
1999 117.2 102.0 113.0 123.9 190.6
2000 97.5 113.5 117.5 111.7 84.6
2001 70.4 110.3 125.5 117.6 116.6
2002 59.0 73.0 95.2 101.5 94.3
2003 301.8 186.1 170.2 176.7 193.1
2004 100.8 110.2 111.8 110.6 95.9
2005 97.7 102.4 105.3 109.6 112.2
Page 8
Scoring
Based upon subjective review of Heat Map output.
Scoring Matrix
Highest Quintile Lowest Quintile
Operating Income / Enterprise Value +4 -4
Operating Income / Net Assets +2 -3
Momentum +3 -2
Volume Moving Average 0 -5
Page 9
3 ½ Factor Portfolio Heat Map Results1986 111.9 85.4 115.7 144.8 118.3
1987 77.7 89.6 89.6 93.3 91.2
1988 108.4 122.2 118.3 127.6 141.9
1989 98.2 93.9 105.5 102.5 110.7
1990 86.7 98.2 102.9 108.3 109.7
1991 171.1 143.7 139.2 163.3 163.9
1992 87.6 115.5 116.6 122.7 134.9
1993 107.0 109.7 124.2 123.8 124.7
1994 71.7 92.4 97.6 101.3 100.7
1995 150.8 121.9 126.8 138.0 137.3
1996 100.5 121.2 127.9 141.8 134.7
1997 87.4 102.2 120.7 133.0 147.7
1998 95.7 90.6 91.3 103.5 104.8
1999 204.5 127.0 108.5 128.9 107.1
2000 65.0 94.3 104.6 113.2 126.3
2001 67.6 82.2 109.7 110.6 140.2
2002 50.8 73.3 85.2 95.2 117.7
2003 264.8 212.4 190.7 182.4 181.4
2004 85.8 100.5 104.9 110.3 129.8
2005 91.9 96.6 104.1 113.7 120.2
Page 10
Investment Strategy – 1986 to 2005
SCORED - Comparative Returns ($100 Base)
99
790
2,209
3,673
7,599
2,748
803
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Jan-
87
Jan-
88
Jan-
89
Jan-
90
Jan-
91
Jan-
92
Jan-
93
Jan-
94
Jan-
95
Jan-
96
Jan-
97
Jan-
98
Jan-
99
Jan-
00
Jan-
01
Jan-
02
Jan-
03
Jan-
04
Jan-
05
Dates
$'s
Tier 1
Tier 2
Tier 3
Tier 4
Tier 5
Long-Short
S&P500
Page 11
Investment Strategy – Shorter Timeframes
SCORED 2001-2005
462
050
100150200250300350400450500
Feb-0
1
Aug-0
1
Feb-0
2
Aug-0
2
Feb-0
3
Aug-0
3
Feb-0
4
Aug-0
4
Feb-0
5
Aug-0
5
Date
$'s
Tier 1
Tier 2
Tier 3
Tier 4
Tier 5
Long-Short
S&P 500
SCORED 1998-2000
152
0
50
100
150
200
250
Jan-9
8
Apr-9
8
Jul-9
8
Oct-98
Jan-9
9
Apr-9
9
Jul-9
9
Oct-99
Jan-0
0
Apr-0
0
Jul-0
0
Oct-00
Jan-0
1
Date
$'s
Tier 1
Tier 2
Tier 3
Tier 4
Tier 5
Long-Short
S&P 500
SCORED 1990-1995
374
050
100150200250300350400
Feb-90
Aug-9
0
Feb-91
Aug-9
1
Feb-92
Aug-9
2
Feb-93
Aug-9
3
Feb-94
Aug-9
4
Feb-95
Aug-9
5
Date
$'s
Tier 1
Tier 2
Tier 3
Tier 4
Tier 5
Long-Short
S&P 500
SCORED 1987-1990
163
0
50
100
150
200
250Ja
n-8
7
Ma
y-8
7
Se
p-8
7
Jan
-88
Ma
y-8
8
Se
p-8
8
Jan
-89
Ma
y-8
9
Se
p-8
9
Jan
-90
Ma
y-9
0
Se
p-9
0
Jan
-91
Date
$'s
Tier 1
Tier 2
Tier 3
Tier 4
Tier 5
Long-Short
S&P 500
Page 12
One-Factor Tier 5 Portfolio Returns
Tier 5 Portfolio Returns
8,257
4,956
4,075
2,594
7,599
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000Ja
n-87
Jan-
88
Jan-
89
Jan-
90
Jan-
91
Jan-
92
Jan-
93
Jan-
94
Jan-
95
Jan-
96
Jan-
97
Jan-
98
Jan-
99
Jan-
00
Jan-
01
Jan-
02
Jan-
03
Jan-
04
Jan-
05
Date
Cu
mu
lati
ve
Re
turn
Opt-to-Ent
Opt-to-NA
Momentum
Volume
3.5 Factor
Page 13
One-Factor Tier 5 Portfolio Returns
Annualized 25.60% 19.05% 11.58%Std Dev 0.048 0.058 0.044
Sharpe Ratio 0.401 0.253 0.210
Annualized 26.15% 14.13%Std Dev 0.048 0.073
Sharpe Ratio 0.405 0.151
Annualized 22.80% 14.99%Std Dev 0.060 0.066
Sharpe Ratio 0.289 0.178
Annualized 21.55% 13.90%Std Dev 0.078 0.070
Sharpe Ratio 0.210 0.156
Annualized 18.69% 16.65%Std Dev 0.057 0.033
Sharpe Ratio 0.251 0.388
VolumeMomentum
Operating Income to Net AssetsOperating Income to Enterprise Value
FAF 3½ Factor Model
Page 14
Conclusions
Go Long Long Strategy Produces the Best Results Even When Not the Best Returning Tier, Still Returns Positive
Results
Model Weaknesses Fails to Forecast Periods of Large Gains in the Short Tier
(especially 1999 & 2003) Given Monthly Rebalancing Transaction Costs will be Significant
Further Study Benchmark Against Small Stock Returns vs. S&P500