Research in Investments

C. Mitchell Conover, Ph.D., CFA

Research Question• Do Value Stocks outperform Growth Stocks in

International Markets?

• Do Small Stocks outperform Large Stocks in International Markets

• Data are for 20 countries of the EAFE, plus Canada.

• Quartiles formed of:o Value Stocks = low P/E, or low P/B, or low P/CF (Quartile 1)o Growth Stocks = high P/E, or high P/B, or high P/CF (Quartile 4)

“Growth versus Value and Large-Cap versus Small-Cap Stocks in International Markets”, with W.Scott Bauman and Robert E. Miller, Financial Analysts Journal, March/April 1998, 54:2

Returns for Value and Growth Stocks Internationally

(in U.S. $)

Return and Risk for Value and Growth Stocks For Entire Sample of International Stocks

Return and Risk for Small and Large Stocks for International Firms

Returns for International Value and Growth Quartiles Subdivided by Company Size

Value 2 3 Growth

Smallest 27.5% 17.8% 18.5% 22.1%

2 16.6% 14.5% 10.5% 11.7%

3 13.9% 12.3% 10.4% 8.9%

Largest 14.5% 13.0% 10.8% 7.1%

Research Question

• Why do value stocks outperform growth stocks in international markets?

“Investor Overreaction in International Stock Markets” with W. Scott Bauman and Robert E. Miller, Journal of Portfolio Management, Summer 1999, 24:4

Growth Rates of EPS for International Value and Growth Quartiles

Value 2 3 Growth

Prior 3 Year EPS Growth

-22.9% -1.5% 12.5% 35.6%

EPS Growth in Year t

11.3% 2.3% 0.7% 0.2%

Summary

• Value stocks outperform growth stocks on a risk adjusted basis in most years and in most countries

• Small company stocks have larger returns than large company stocks

• The higher returns for value stocks appear to be due to a reversion in EPS that investors ignore when they price these stocks

Research Question

• The relationship between monetary environment and international stock returns:• An expansive environment = Series of discount

rate decreases• A restrictive environment = Series of discount

rate increases

• Data are for 16 developed countries from 1956 to 1995

“Monetary Environments and International Stock Returns” with Gerald R. Jensen and Robert R. Johnson, Journal of Banking and Finance, 1999, 23:9“Monetary Conditions and the International Diversification Decision”, with Gerald R. Jensen and Robert R. Johnson, Financial Analysts Journal, July/August 1999, 55:4

Monthly Stock Returns By Local Monetary Environment (in U.S. $)

Monthly Stock Returns by U.S. Monetary Environment (in U.S. $)

Monthly Stock Returns by Combined Local and U.S. Monetary Environment

(in U.S. $)

Summary

• Stock returns for most developed countries are higher when monetary conditions are expansive and lower when conditions are restrictive.

• These patterns exist with respect to both local and U.S. monetary environments.

• The higher returns in expansive environments are not accompanied by increased risk, in most countries.

Research Question• Do these same patterns exist in emerging

markets during expansive and restrictive U.S. monetary environments?

• What are the returns and risk in emerging market?

• Data is from IFC from 1976 to 1999 for 20 countries.

“Emerging Markets: Are They Worth It?” with Gerald R. Jensen and Robert R. Johnson, Financial Analysts Journal, March/April 2002

Monthly Risk and Return During Entire Time Period (in U.S. $)

Monthly Stock Returns for Emerging Countries During Expansive and Restrictive U.S. Monetary

Environments (in U.S. $)

Correlations Between Emerging and Developed Country Markets

Emerging Market and EAFEC

World

U.S.

Expansive U.S. Environment

0.36

0.42

0.39

Restrictive U.S. Environment

0.26

0.27

0.21

Risk and Return For Efficient Portfolios

Risk and Return for Efficient Portfolios during Expansive and Restrictive Monetary Periods

Summary• For entire time period, the addition of emerging

markets to an international portfolio adds 1.5 – 2.0% annually to return for a given amount of risk.

• Emerging market returns are not as strongly related to U.S. monetary environments as developed country markets.

• Most of the diversification benefits from emerging markets occurs during restrictive U.S. monetary environments. o U.S. investors could have added 4.5% a year to their

returns by investing in emerging markets during restrictive U.S. monetary environments.

Research Questions• Recent research indicates that diversifying

internationally fails at the very time when investors need it the most.

• During periods of increased volatility (i.e. crash of October 1987), global stock markets tend to move together.

• Does foreign real estate provide greater diversification benefit in times of increased volatility?

• Data from 1986 to 1995 for publicly traded real estate firms in Canada, France, Great Britain, Hong Kong, Japan and Singapore.

“Diversification Benefits form Foreign Real Estate Investments” with H. Swint Friday andG. Stacy Sirmans, Journal of Real Estate Portfolio Management, 2002

Correlation of Assets with U.S. Stocks

Risk and Return for Efficient Portfolios of International Assets

Summary

• Foreign real estate has a lower correlation with U.S. stocks than do foreign stocks in 98 of the 102 months examined.

• Foreign real estate returns are less integrated with U.S. stocks during periods of increased volatility.

• The addition of foreign real estate improves the mean-variance efficiency of U.S. stock portfolio.

Research Question• In the U.S., firms that file their accounting statements

late have weaker performance and experience lower stock returns in the post filing period.

• What is the frequency of late filing in foreign countries?

• Does late filing abroad signal bad news?

• Do the patterns differ for common and code law countries?

• Data for 1987 to 1995 for 13 foreign countries.

From “The Timeliness of International Accounting Disclosures,” with Robert E. Miller and Andrew Szakmary, forthcoming in the International Review of Financial Analysis 2008

Median Number of Days to File

Frequency of Late Filing

Summary

• Code law firms take longer to file their statements.

• The frequency of late filing is also higher in code law countries.

• Late filers demonstrate weaker performance in common law countries than in code law countries.

• The less timely filing in code law countries may be associated with the role that banks play in those countries.

Research Question

• Which industries have historically been value or growth over time? What is the performance of industries over time?

• Do value stocks outperform growth stocks within individual industries?

• Do value industries outperform growth industries?

• Data from 1968 to 1999 for 21 industries.From “Industry Relationships and Value/Growth Stock Performance” with Gerald R. Jensen, working paper

Price to Book Ratios for Industries

Risk and Return for Industries

Risk and Return for Value/Growth Quartiles Formed Within Industries

Risk and Return for Value/Growth Industries

Annual Percent Returns for Value/Growth Quartiles Within Value/Growth Industries

Value Industry

2 3 Growth Industry

Value Quartile

20.36 19.04 18.77 19.54

2 17.09 14.29 14.59 14.12

3 14.22 13.36 12.25 12.95

Growth Quartile

12.47 7.54 7.52 6.11

Summary

• Value stocks have higher returns and lower risk than growth stocks when quartiles are formed within industries.

• Value industries have higher returns and lower risk than growth industries over time.

• Value quartiles within value industries have the highest returns while growth quartiles within growth industries have the lowest returns and highest risk.

Research Question

• Does the relationship between monetary conditions and stock returns still exist in U.S. and global markets?

• Does it vary by the size of the firm?

• Does it vary depending if the firm is a defensive or cyclical stock?

“Is Fed Policy Still Relevant for Investors?” with Gerald R. Jensen, Robert R. Johnson, and Jeffrey M. Mercer. Financial Analysts Journal, January/February 2005

U.S. Investment Strategy Performance: Annualized Mean Return

1963-2001

U.S. Sector Performance: Annualized Mean Return

1973-2001

U.S. Monetary Conditions and International Stock Returns:

Annualized Mean Return 1973-2001

Summary

• U.S. Monetary Policy continues to have a significant relationship with both U.S. and Global stock returns

• Small stocks are more sensitive to changes in monetary conditions than large stocks

• Cyclical stocks are more sensitive to changes in monetary conditions than defensive stocks

Research Question

• Is the relationship between monetary conditions and sector stock returns valuable in a rotation strategy?

• Rotation between cyclical and noncyclical stocks

• Data for 33 years from 1973 to 2005

“Sector Rotation and Monetary Conditions” with Gerald R. Jensen, Robert R. Johnson, and Jeffrey M. Mercer. Journal of Investing, forthcoming 2008• Cited on CNBC, in the Wall Street Journal and the Financial

Times

Cyclical and Non-cyclical Stocks

• Cyclical Stocks: Cyclical consumer goods, Cyclical services, General industrials, Information technology, Financials, and Basic industries

• Non-cyclical Stocks: Resources, Noncyclical consumer goods, Noncyclical services and Utilities

Results

Expansive Period Returns

(Standard Deviations)

Restrictive Period Returns

(Standard Deviations)

Non-cyclical Stocks 14.65%(15.95%)

10.24%(17.01%)

Cyclical Stocks 20.27%(18.82%)

2.25%(19.81%)

Benchmark (sectors equally weighted)

17.98%(14.32%)

5.32%(15.39%)

Results

Summary

• The sector rotation strategy would have beat the benchmark by 3.5% a year

• Rebalancing occurs only 14 times

• Defensive stocks perform best during restrictive periods

• Cyclical stocks perform best during expansive periods

Research Question

• How does an investment in precious metal commodities compare to that of precious metal equities?

• Are their performances related to monetary policy given the Fed’s role in fighting inflation?

• Is this relationship to Fed policy valuable in a trading strategy?

“Can Precious Metals Make your Portfolio Shine?” with Gerald R. Jensen, Robert R. Johnson, and Jeffrey M. Mercer. Working paper

Data

• Data for global precious metal equities and commodities (gold, silver & platinum)

• Data for 34 years from 1973 to 2006

• 14 turning points in monetary policy

Risk, Return & Correlations

US Equities

Precious Metal

Equities

Precious Metals

Commodities

Annualized Return 10.83% 14.11% 8.33%

Standard Deviation 15.37% 24.81% 23.11%

Correlation with U.S. Equities 1.00 0.08 -0.01

Returns by Monetary Environment

Asset ClassRestrictive Period

ReturnExpansive Period

Return

U.S. Equities 3.87% 16.25%

Precious Metals Equities

11.60% 16.41%

Precious Metal Commodities

13.29% 4.56%

Investment Strategies

• Benchmark is U.S. Equities

• Strategic allocation:75% to US Equities and 25% to Precious Metals Equities for entire period.

• Tactical allocation:Expansive periods: 75% to US Equities and 25% to Precious Metals EquitiesRestrictive periods: 75% to US Equities and 25% to Gold

Strategy Performance

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Jan-73Jan-74Jan-75Jan-76Jan-77Jan-78Jan-79Jan-80Jan-81Jan-82Jan-83Jan-84Jan-85Jan-86Jan-87Jan-88Jan-89Jan-90Jan-91Jan-92Jan-93Jan-94Jan-95Jan-96Jan-97Jan-98Jan-99Jan-00Jan-01Jan-02Jan-03Jan-04Jan-05Jan-06

Benchmark Strategic Allocation Tactical Allocation

Summary

• Allocating 25% precious metals equities to a U.S. equity portfolio increases annual returns by 1.65% and reduces the standard deviation by 1.86%

• Portfolio performance is superior when using PM equities, rather than PM commodities, over the entire time period

• During Fed tightening, the returns to PM commodities are significantly higher than during expansive periods (in contrast to the returns for U.S. and PM equities)

Summary

• The benefits of adding PMs to a portfolio are small when Fed policy is expansive

• However the benefits are substantial when monetary policy is restrictive

• Gold provides the best hedge against restrictive Fed policy

• Using monetary policy shifts to guide a tactical strategy had slightly higher return and lower risk than that with a strategic allocation