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The Effectiveness of Value Style Investing in South Africa Senzo Langa

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The Effectiveness of Value Style Investing in South Africa Senzo Langa The Effectiveness of Value Style Investing in South Africa Senzo Langa 1 Abstract Style investing is a well-documented global phenomenon that refers to the manner in which investors formulate their capital allocation decisions. The two broad styles of investing to be discussed in this report are the ‘value style’ and the ‘growth style’ investing. Recent empirical research suggests that value style of investing outperforms growth style investing over the long term. Rational theories suggest that a value premium exist because value counters have higher unsystematic risk. However, theories such as behavioural finance attribute the value premium to more psychological social factors such as emotional and heuristic biases. The aim of this study was to determine whether value style investing outperforms growth style investing in South Africa. For the purposes of this study, we evaluated the performance of various portfolios for the period of December 2000 to December 2015. In addition, the study determined the relative risk of the two styles, by testing whether value outperforms growth during periods of financial crisis, and during a period of slow economic growth. In defining the parameters of our study, we divided the constituents of Financial Times and London Stock Exchange/Johannesburg Stock Exchange (FTSE /JSE) index into growth and value based on their relative Price to book (P/B) going back to December 2000. This created four portfolios; namely, Deep value, Relative value, Relative growth and Super growth. Portfolio Analytics were employed to determine which style outperforms over the period. Regression analyses was used to ascertain which portfolio generated abnormal risk adjusted returns over the period. Relative risk is also analysed. The results of this research indicate that there is limited evidence of value premium in South Africa over the period of the study, albeit there are some periods where one style is dominant over the other. Regressions suggest that none of the portfolios constructed using market capital weighted generate abnormal returns. However, deep value, relative value and relative growth portfolios generate abnormal returns when constructed on equal- weighted basis. On a relative risk basis, deep value outperforms during the financial crisis, whereas relative value outperforms during economic slowdowns. 2 Declaration I declare this research project is my own work.It is submitted in partial fulfilment of the requirement for degree in Masters of Management in Finance and Investment.It has not been submitted before for any degree or examination in any other University Senzo Langa 3 Thesis Acknowledgment I would like to express my sincere gratitude to investment solutions (division of Alexandra Forbes) for funding my studies and also allowing me to take time off the busy schedule at work. I would also like to thank my supervision Dr T Mthanti for his continuous support, motivation and patience over the past year. Last but not the least, I would like to thank my family for their infinite understanding and unwavering support through this time. 4 Table of Contents 1 Introduction .................................................................................................................. 11 1.1 Background and Context .................................................................................................. 12 1.2 Problem statement............................................................................................................ 13 1.3 Research objective and hypothesis .................................................................................. 14 1.3.1 Hypothesis I .............................................................................................................. 15 1.3.2 Hypothesis II ............................................................................................................. 15 1.3.3 Hypothesis III ............................................................................................................ 15 1.4 Planned structure ............................................................................................................. 15 2 Literature Review ......................................................................................................... 17 2.1 Introduction ....................................................................................................................... 17 2.2 Defining style investing ..................................................................................................... 18 2.3 Efficient Market Hypothesis .............................................................................................. 19 2.4 Capital asset pricing model (CAPM) ................................................................................. 23 2.5 Behavioural Finance ......................................................................................................... 26 2.6 Size Effect ........................................................................................................................ 29 2.7 Understanding Lakonishok, Shleifer and Vishny (1994) .................................................... 31 2.8 Hypothesis I (Value versus Growth stocks) ....................................................................... 32 2.9 Hypothesis II and III (Relative riskiness of Value and growth strategy) ............................. 35 2.10 Conclusion ........................................................................................................................ 36 3 Methodology ................................................................................................................ 37 3.1 Introduction ....................................................................................................................... 37 3.2 Research Method ............................................................................................................. 37 3.2.1 Returns process ....................................................................................................... 38 3.2.2 Sharpe ratio Formula ................................................................................................ 39 3.2.3 Calculating the value Premium ................................................................................. 40 5 3.2.4 Statistical inference .................................................................................................. 40 3.2.5 Abnormal risk adjusted returns ................................................................................. 40 3.3 Secondary Research ........................................................................................................ 42 3.4 Population, Sample and Unit of Analysis .......................................................................... 43 3.4.1 Population ................................................................................................................ 43 3.4.2 Sample ..................................................................................................................... 43 3.4.3 Unit of Analysis ......................................................................................................... 44 3.5 Data Collection ................................................................................................................. 45 3.6 Portfolio Analysis .............................................................................................................. 45 3.6.1 Portfolio creation ....................................................................................................... 45 3.6.2 Portfolio Construction ............................................................................................... 46 3.6.3 Portfolio Maintenance ............................................................................................... 46 3.7 Data Management ............................................................................................................ 47 3.7.1 Survivorship bias ...................................................................................................... 47 3.8 Data validity and reliability ................................................................................................ 47 3.9 Limitation of the study ....................................................................................................... 48 4 Findings ....................................................................................................................... 49 4.1 Summary of the data ........................................................................................................ 49 4.1.1 Portfolios by Sector .................................................................................................. 52 4.1.2 Returns calculation results ........................................................................................ 55 4.2 Abnormal risk adjusted returns ......................................................................................... 60 4.3 Mean excess returns of value versus growth .................................................................... 64 4.4 Perfomance of value versus growth strategies in different financial market and economic conditions .................................................................................................................................... 67 4.5 Conclusion .......................................................................................................................
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