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Long/Short Sector-based Trading Strategy Emergent Asset Management, LLC. Konstantin Savov Scott Smith Pin-Yew Wong Vaswar Mitra Vinaya Jain. February 27, 2006. Agenda. Establishing the Long/Short Trading Strategy Description of Factors Scoring Methodology Sectors Chosen for Analysis - PowerPoint PPT Presentation
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Long/Short Sector-based Trading Strategy
Emergent Asset Management, LLC
Konstantin Savov Scott Smith
Pin-Yew WongVaswar Mitra
Vinaya Jain
February 27, 2006
2
Agenda Establishing the Long/Short Trading Strategy Description of Factors Scoring Methodology Sectors Chosen for Analysis Sector Analysis
Average Top and Bottom Quintile Returns for all Considered Factors
Factors Chosen and Calculated Scores In Sample Analysis 1996-2003 Out of Sample Analysis 2004-2005
Imperfections in the Analysis
3
Establishing Long/Short Trading Strategy Overview
Limit universe of stocks to firms with market capitalization > $500M Stocks selected from the S&P 1500 Index (US large, mid and small cap
stocks). Sectors were defined using S&P’s GICS classification system We feel these stocks will have sufficient liquidity and historical data
Establish long / short sector based portfolios using quantitative stock selection. Equal weight strategy Rebalance portfolios monthly In Sample: 1996-2003, Out of Sample: 2004-2005
Quantitative stock screen Thirteen factors considered initially Find predictive powers on positive and negative returns
Select factors with strong predictive power for sector returns Go long stocks in top quintile Go short stocks in bottom quintile
4
Description of factorsFundamentalFundamental1. Book to Price: book value per share / price per share2. Dividend Yield: dividends per share / price per share3. CFO Yield: cash flow from operations / price per share4. Earnings Yield: LTM earnings / price per share5. Return on Assets: annual net earnings / total assets6. % Change in ROA: % change in ROA over previous month7. Return on Equity: annual net earnings / total shareholder equity8. % Change in ROE: % change in ROE over previous month
ExpectationalExpectational1. Revision Ratio: (Upward revisions – downward revisions) / total revisions2. SUE Score: standard unexpected earnings (Earnings surprise / std deviation)3. Mean FY1 to Actual % Change: (FY1 Estimate – Current Actual) Current Actual4. LT Projected Growth – Historical Growth: Next 5 year annualized estimate – previous
5 year annualized actual
MomentumMomentum1. 12-Month Lagged Monthly Price Growth: Eg: (Jan’06 Price – Jan’05 Price) / Jan’05 P
5
Scoring methodology
Each month the quintiles are ranked based on returns
Assign points from highest to lowest rank (+2,+1,0, -1, -2)
Sum points for quintiles 1 and 5
Scale points across factors from +10 to -10
We tried using an objective scoring methodologyParameter 1
Date F1 F2 F3 F4 F5 F1 F55/1/2003 7.83 2.89 5.23 4.92 3.90 2 -1
5/30/2003 3.55 1.10 1.34 1.23 3.89 1 27/1/2003 7.82 7.98 6.42 5.87 6.92 1 08/1/2003 7.33 4.52 4.78 5.76 4.79 2 0
8/29/2003 -4.57 -2.76 -5.58 -4.42 -5.88 0 -210/1/2003 8.29 9.07 7.08 8.35 6.59 0 -2
10/31/2003 5.11 4.13 3.46 2.69 3.88 2 012/1/2003 6.25 4.03 5.12 5.17 5.75 2 1
10 -2
Points Summary for all selected ParametersF1 F5 F1 F5
Parameter 1 10 -2 2.86 -5.71Parameter 2 12 -8 4.29 -10.00Parameter 3 20 -1 10.00 -5.00Parameter 4 10 -4 2.86 -7.14Parameter 5 8 -2 1.43 -5.71
Max 20Min -8Range 28
Points
Assigned Scores
6
Sector choice
Considerations in choosing sectors: Sufficient number of companies in the defined
universe Maturity of sector
Final Choice Financials Industrials Healthcare
7
Financials
8
Average Annual Factor Returns for top and bottom quintiles
Financials
0.00
0.50
1.00
1.50
2.00
2.50
Change inROE
Change inROA
Book toPrice
DividendYield
EarningsYield
Momentum ROE ROA CFO Yield RevisionRatio
Sue Score EPS FY1to Actual
Rate ofChange of
Growth
Long TermGrowth -HistoricalGrowth
Ret
urn
1st Fractile 5th Fractile
9
Factors chosen & calculated scores
Financials
Factors 1 5Earnings Yield 10.00 CFO Yield 1.33 ROE Change 1.86 (10.00) Book to PriceEPS FY1-to-Actual (5.58) ROE 2.92 (8.58)
Quintile Scores
10
In sample analysis 1996-2003
Financials
Cumulative annual returns - (index = 100 each year)
Year F1 F2 F3 F4 F5
1996 152.5 122.7 133.9 118.4 124.4
1997 168.8 142.3 159.0 156.2 133.8
1998 110.4 118.6 106.1 101.3 96.1
1999 90.4 101.6 96.6 93.8 88.1
2000 166.9 148.4 138.7 135.2 125.3
2001 126.4 107.8 102.5 100.2 102.8
2002 105.6 100.8 95.9 104.9 80.6
2003 148.8 136.3 133.5 138.6 135.7
Average relative performance
1.5 2.5 3.1 3.5 4.4
11
Out of sample analysis 2004-2005
Financials
Cumulative annual returns - (index = 100 each year)
Year F1 F2 F3 F4 F5
2004 133.6 123.8 117.2 122.8 118.8
2005 118.1 114.9 103.3 107.0 103.0Average relative performance
1.0 2.0 4.5 3.0 4.5
12
Healthcare
13
Average Annual Factor Returns for top and bottom quintiles
Healthcare
0.00
0.50
1.00
1.50
2.00
2.50
Change inROE
Change inROA
Book toPrice
DividendYield
EarningsYield
Momentum ROE ROA CFO Yield RevisionRatio
Sue Score EPS FY1to Actual
Rate ofChange of
Growth
Long TermGrowth -HistoricalGrowth
Ret
urn
1st Fractile 5th Fractile
14
Factors chosen & calculated scores
Healthcare
Factors 1 5Earnings Yield 10.00 (10.00) Book to Price 7.74 ROE change (5.16) Revision Ratio 2.26 SUE Score 9.35
Quintile Scores
15
In sample analysis 1996-2003
Healthcare
Cumulative annual returns - (index = 100 each year)
Year F1 F2 F3 F4 F5
1996 112.2 110.1 105.1 106.1 84.4
1997 153.8 115.9 125.5 124.8 112.4
1998 112.3 140.6 149.0 134.3 100.1
1999 109.4 92.8 101.1 91.2 164.8
2000 236.1 176.4 144.7 172.7 142.0
2001 117.6 115.2 104.1 94.3 85.7
2002 97.1 87.0 84.4 80.8 63.4
2003 160.4 138.2 124.7 138.5 138.2
Average relative performance
1.5 2.6 3.1 3.4 4.4
16
Out of sample analysis 2004-2005
Healthcare
Cumulative annual returns - (index = 100 each year)
Year F1 F2 F3 F4 F5
2004 121.6 106.4 116.3 108.4 119.1
2005 128.5 104.3 112.9 111.8 110.3
Average relative performance
1.0 5.0 2.5 3.5 3.0
17
Industrials
18
Average Annual Factor Returns for top and bottom quintiles
Industrials
-1.50
-1.00
-0.50
0.00
0.50
1.00
1.50
2.00
Change inROE
Change inROA
Book toPrice
DividendYield
EarningsYield
Momentum ROE ROA CFO Yield RevisionRatio
Sue Score EPS FY1to Actual
Rate ofChange of
Growth
Long TermGrowth -HistoricalGrowth
Ret
urn
1st Fractile 5th Fractile
19
Factors chosen & calculated scores
Factors 1 5Earnings Yield 10.00 CFO Yield 4.70 (10.00) ROE 2.77 Revision Ratio (3.25) ROA Change 3.49
Quintiles
Industrials
20
In sample analysis 1996-2003
Industrials
Year F1 F2 F3 F4 F5
1996 134.8 117.3 121.2 113.3 115.2
1997 142.0 135.7 132.2 123.4 119.3
1998 93.2 108.8 100.3 98.1 106.1
1999 113.4 90.6 111.2 88.4 110.1
2000 116.7 110.1 126.4 104.6 118.7
2001 135.4 107.9 108.1 108.5 83.6
2002 96.1 99.4 107.3 88.5 76.0
2003 152.1 141.4 131.1 124.9 136.6
Average relative performance
2.0 2.8 2.4 4.3 3.6
21
Out of sample analysis 2004-2005
Industrials
Cumulative annual returns - (index = 100 each year)
Year F1 F2 F3 F4 F5
2004 136.2 125.1 125.3 119.5 125.9
2005 106.0 117.9 111.2 110.7 110.6
Average relative performance
1.5 1.4 1.4 1.8 1.5
22
Imperfections in analysis
Monthly rebalancing – trading costs not taken into consideration
Migration tracking could potentially reduce turnover and trading costs
Need a more exact estimation of the impact of turnover and short sale restrictions
Use of static scores