Style Investing: Benchmarks and Strategies
31 Pages Posted: 27 Feb 2011
Date Written: February 26, 2011
Capitalizing on the results in Shapovalova et al. (2011a} and Shapovalova et al. (2011b} on the properties of the stock returns premia, this paper focuses on the practical issues of equity style investment. Company fundamentals are often used to define the so-called style scores, from which the compositions of the style indices are defined. Style indices are used as benchmarks for dynamic style investment strategies. The value and growth indices, published by the leading providers, are based on the scores computed from multiple characteristics. Using a panel data model, we assess the quality of the multi-factor score definitions and find that aggregation of the company fundamentals often leads to significant losses of information, compared to the situation when style characteristics are analyzed separately. Generally, such aggregation is not justified by the empirical properties of the data, since characteristics' impacts on returns are highly heterogeneous in magnitude and direction. We propose a synthetic multi-factor style score, based on our model, and evaluate a corresponding long-short dynamic investment strategy. We then improve it by integrating the information about the size of the style premia contained in the past shocks to macroeconomic indicators.
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