Running head: EVALUATION OF PASSIVE INVESTMENT STRATEGIES IN OSLO STOCK EXCHANGE EVALUATION OF PASSIVE INVESTMENT STRATEGIES IN OSLO STOCK EXCHANGE A Thesis Presented to the Faculty of Economics programme at ISM University of Management and Economics in Partial Fulfillment of the Requirements for the Degree of Bachelor of Economics by Gytis Štarolis Advised by Lect. Tomas Krakauskas May 2015 Vilnius EVALUATION OF PASSIVE INVESTMENT STRATEGIES IN OSLO STOCK EXCHANGE 2 Abstract Štarolis, G., Evaluation of Passive Investment Strategies in Oslo Stock Exchange [Manuscript]: bachelor thesis: Economics. Vilnius, ISM University of Management and Economics, 2015. The aim of this thesis was to evaluate and compare results of traditional passive investment strategy (market capitalization weighted portfolio) and alternative passive investment strategies (Smart Beta portfolios) in Oslo Stock Exchange in 2005-2014 period. The situation analysis showed that Oslo Stock Exchange is a safe and attractive market for investors because of Norway‘s political and economic stability and strong performance of Oslo Stock Exchange in the recent decade. Also, alternative passive investment strategies were found to outperform traditional passive investment strategy in the US market in the analyzed period. Analysis revealed supporting evidence for the hypothesis that alternative Smart Beta portfolios outperform traditional market capitalization weighted portfolios. All 7 portfolios that were formed according to various Smart Beta portfolio formation rules outperformed market capitalization weighted portfolio and Oslo Stock Exchange Benchmark Index. Smart Beta strategies showed significantly higher rates of annual returns that were from 2.2pp to 22.7pp higher than the ones of market capitalization weighted portfolio. Sharpe ratios of all Smart Beta portfolios were also found to be higher than the ones of market capitalization weighted portfolio and Oslo Stock Exchange Benchmark Index. Value portfolio, which consisted of shares with lowest price-to-book value ratios, was found to perform best in the analyzed period, as it showed the highest annual growth rate (34.3%) and highest Sharpe ratio (1.09) of all portfolios. Keywords: passive investment, Smart Beta strategies, Oslo Stock Exchange, value investing. EVALUATION OF PASSIVE INVESTMENT STRATEGIES IN OSLO STOCK EXCHANGE 3 Table of contents List of Figures ............................................................................................................................ 6 List of Tables ............................................................................................................................. 7 Situation analysis ....................................................................................................................... 9 Overview of political situation in Norway ........................................................................... 10 Geopolitical risk. .............................................................................................................. 10 Corruption ......................................................................................................................... 11 Conclusion on political environment in Norway. ............................................................. 11 Overview of economic situation in Norway ........................................................................ 11 Nominal GDP ................................................................................................................... 11 Population and GDP per capita (PPP) .............................................................................. 12 Nominal GDP growth (%). ............................................................................................... 13 Inflation and unemployment. ............................................................................................ 13 Interest rates. ..................................................................................................................... 14 Overview of Oslo Stock Exchange ...................................................................................... 15 Oslo Axess. ....................................................................................................................... 15 Oslo Bors. ......................................................................................................................... 15 Comparison to other stock exchanges. ............................................................................. 16 Oslo Bors by liquidity....................................................................................................... 18 Oslo Stock Exchange indices. .......................................................................................... 18 Brokers.............................................................................................................................. 20 Performance of passive investment strategies ...................................................................... 22 Literature Review and Methodology ....................................................................................... 24 Literature review .................................................................................................................. 24 Passive investment versus active investment. .................................................................. 24 Asset pricing models. ....................................................................................................... 25 Smart Beta strategies ........................................................................................................ 26 EVALUATION OF PASSIVE INVESTMENT STRATEGIES IN OSLO STOCK EXCHANGE 4 Equally-weighted portfolio. .............................................................................................. 28 Low volatility investing .................................................................................................... 30 Value investing and fundamental weighting. ................................................................... 31 Growth investing. ............................................................................................................. 34 Momentum investing. ....................................................................................................... 35 Methodology ........................................................................................................................ 36 Return. .............................................................................................................................. 37 Volatility. .......................................................................................................................... 38 Sharpe ratio. ...................................................................................................................... 38 Analysis.................................................................................................................................... 39 Data selection ....................................................................................................................... 39 Methodology for formation and evaluation of portfolios..................................................... 40 OSEBX and Market Capitalization portfolio ....................................................................... 41 Formation of Market Capitalization portfolio. ................................................................. 41 Performance of Market Capitalization portfolio. ............................................................. 41 Equally-weighted portfolio .................................................................................................. 43 Formation of Equally-weighted portfolio. ........................................................................ 43 Performance Equally-weighted portfolio. ........................................................................ 43 Low Volatility and High Volatility portfolios...................................................................... 44 Formation of Low Volatility and High Volatility portfolios. ........................................... 44 Performance of Low Volatility and High Volatility portfolios. ....................................... 45 Momentum and Contrarian portfolios .................................................................................. 47 Formation of Momentum and Contrarian portfolios. ....................................................... 47 Performance of Momentum and Contrarian portfolios .................................................... 47 Growth portfolio ................................................................................................................... 48 Formation of Growth portfolio. ........................................................................................ 48 Performance of Growth portfolio. .................................................................................... 49 EVALUATION OF PASSIVE INVESTMENT STRATEGIES IN OSLO STOCK EXCHANGE 5 Value portfolio ..................................................................................................................... 50 Formation of Value portfolio. ........................................................................................... 50 Performance of Value portfolio. ....................................................................................... 51 Comparison of performances