2014 EQUITY THEMES

ASSESSMENT

ERIC J. WEIGEL

January 2015

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Motivation & Methodology

• In a year where only a tiny fraction of active equity managers

outperformed their benchmarks we wanted to assess the

effectiveness of some common buy and hold strategies

• We also wanted to seen if there was any consistency in

strategy performance across major equity markets

• At the end of 2013 we allocate stocks into three buy and hold

buckets (Top, Middle, Bottom) depending on the value of the

factor or strategy in question

• Our conclusions are based on median returns measured in

local currency

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Methodology

Dec 31, 2013

Create Top, Middle Bottom Portfolios

(by country & characteristic)

2014

Local Currency Performance

(equally weighted)

Dec 31, 2014

Calculate stock median

returns for Portfolios

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Universe

Stocks with market cap

> $200M

Popular Equity Strategies

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•Price to Earnings

•Price to Book ValueValuation

•Sales Growth (last year)

•Earnings Growth (last year)Growth

•ROE

•Net MarginsProfitability

•12 Month Total Return (local currency)Momentum

•Mean RatingAnalyst Recommendation

•Stock Volatility (last year, measured in local currency)

•Beta to MSCI World Index (last two years, measured in USD)Stock Behavior

•Market Capitalization (in USD)Size

•Dividend Yield

•Dividend Growth (last year)Income

•Assets to EquityLeverage

PORTFOLIO

RESULTS

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• Lower P/E stocks did best in the US, Germany and Hong Kong but the effect was not globally uniform

• In Japan, France and Switzerland we observe a monotonic relationship between higher P/E’s and higher median stock returns

• Verdict: The relationship between P/E’s and stock returns worked as expected in about 1/3 of our sample. For globally oriented strategies, a low P/E tilt did not prove of much value

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• Lower P/B strategies worked in the top three markets by capitalization (US, UK, Japan) as well as in Germany and Hong Kong

• In Canada and Switzerland we observe that more expensive stocks (higher P/B) outperformed the middle and bottom end of the distribution

• Verdict: The relationship between P/B’s and stock returns worked as expected in the larger markets. For globally oriented, large cap strategies, a low P/B tilt would have helped active managers

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• Bottom-line growth worked well as a strategy in the US, UK, Germany,

Canada and Hong Kong

• For Japanese stocks we observe a negative relationship between past EPS

growth and subsequent annual median stock returns

• Verdict: Not a bad strategy to have used in 2014. In markets where a tilt

toward higher past growth was not rewarded, the penalty wasn’t too

harsh with the exception of Japan

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• Top line growth worked well as a strategy in the US, UK, Germany, Australia and Hong Kong

• In other markets, we did not observe a monotonic relationship between past sales growth and 2014 median stock returns

• Similar directional results as with eps growth

• Verdict: Not a bad strategy to have used in 2014. In markets where a tilt toward higher past growth was not rewarded, the penalty wasn’t too harsh

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• The top 1/3 of companies in terms of net margins (higher) outperformed in Japan, Germany, Switzerland, Australia and Hong Kong, but the degree of outperformance was marginal

• In the US as well as Canada, the highest median returns were seen in the middle third of the distribution

• Verdict: Net margins worked reasonably well across most equity markets, but the degree of return differentiation would not have added much value to active management

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• Using ROE as a stock selection factor proved uniformingly beneficial in the US, Germany, Australia and Canada

• In Japan, France and Hong King stocks with the lowest ROE’s actually outperformed the top 2/3

• Verdict: High ROE worked reasonably well across most equity markets. ROE was more effective than Net Margins in differentiating median stock performance

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• US stocks with lagging performance in 2013 reversed fortunes in 2014. Median returns to “losers” (bottom 1/3) vastly outperformed those of “winners”

• Japanese stocks showed the same pattern as in the US with prior “losers” leading in 2014

• In France, Germany, Australia and Canada the more usual pattern of “winners” remaining “winners” prevailed

• Verdict: Momentum strategies worked generally well outside of the two largest cap markets of the US and Japan

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• Poorly rated stocks (those in bottom 1/3) outperformed in the US, France and Australia

• In Germany, Canada and Hong Kong stocks in the middle of the rating distribution actually outperformed

• Only in Japan did highly rated stocks show an edge over lower rated stocks

• Verdict: Following analyst recommendations did not help in 2014

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• The low volatility effect was alive and well in 2014

• There was a strong and monotonic relationship between low volatility and subsequent median returns in the US, UK, Japan and Canada

• Only in France, Germany and Hong Kong do we fail to see a big difference in terms of median returns between the least and most volatile stocks

• Verdict: Pretty strong relationship especially in the larger capitalization markets. Tilts toward low volatility stocks were one of the approaches that active managers could have used effectively last year

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• Lower beta stocks tended to have higher median returns during 2014

• There was a strong and monotonic relationship between low beta and

subsequent median returns in all markets with the exception of Switzerland

(where the middle 1/3 in terms of beta outperformed)

• Verdict: Strongest relationship for 2014. Tilts toward low beta stocks

were handsomely rewarded. As with low volatility approaches, going for

less actually meant higher median stock returns

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• For the US 2014 clearly turned out to be a large cap market, but in most other markets the median return to small caps exceeded that of large caps

• While overall the Japanese market had a robust 2014, small caps were the standout performers

• In Hong Kong and the UK, median returns to small caps (bottom 1/3) were positive while the top 2/3 of the stocks in terms of capitalization exhibited negative median returns

• Verdict: Having a small cap tilt would have worked well in most markets except the US

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• Higher dividend yield stocks performed best in the Us as well as in the UK, Japan, Germany, Australia and Hong Kong

• Higher dividend yield strategies is not a very common strategy among equity managers as the higher yields are usually associated with distress

• In an environment of once again global interest rate drops, this strategy can be seen as a refuge for investors starved for yield

• Verdict: 2014 proved to be a good year in which to invest in stocks with high dividend yields

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• Counter to intuition and detrimental to a lot of income seeking strategies, stocks showing the highest rate of dividend growth (prior 12 months) underperformed in the US and Switzerland

• The strategy of tilting toward higher dividend growth did, however, work well in Germany but did not offer much discrimination elsewhere

• Verdict: Mixed picture, not a lot of discrimination between top and bottom performers based on trailing dividend growth

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• Higher leverage companies in the US and Canada underperformed, but the effect in other markets was mixed

• In Japan and France we actually observe that higher leverage stocks outperformed the middle 1/3 as well as the least levered stocks

• The global macro environment for most of 2014 was fairly benign with no major credit panics

• Verdict: This factor was mixed in 2014. This factor works best during periods of a credit squeeze. Last year there was more noise than signal from this factor

2014 Equity Themes Summary

• While the macro picture proved fairly benign for most of the year,

portfolio managers around the globe struggled to find winning

strategies in 2014

• After the strong 2013 global equity performance (MSCI ACWI up

22.8%), managers seemed to have shortened their holding periods in

anticipation of greater market volatility and higher interest rates which

never fully materialized last year

• Some of the buy & hold strategies that could have been of real value

to equity managers included low beta and low volatility. These factors

are normally associated with portfolio construction approaches

• Active managers could have also benefited from growth-oriented tilts

as well as a focus on higher yield securities

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2014 Equity Themes Summary

• Two usually strong investment strategies – momentum and small size –failed to work in the US

• Median returns to small caps in the rest of the world did, however, outperform

• The outperformance of mega caps in the US greatly affected active management results given the consistent small size bias prevalent in such approaches

• In Japan, we observed a strong reversal market with previous performance “losers”, small caps and more levered names out-performing in 2014

• Given that none of the popular equity strategies examined proved universally perverse some of the underperformance of active management must be related to idiosyncratic issues (such as AAPL vastly outperforming) as well as portfolio construction failings

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FOR FURTHER INFORMATION ON OUR

RESEARCH PRODUCTS AND/OR ASSET

MANAGEMENT STRATEGIES PLEASE

CONTACT:

Eric J. Weigel at eweigel@gf-cap.com

617-529-2913

www.gf-cap.com

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