University of the Western Cape

Faculty of Economic and Management Sciences School of Business and Finance

Finance Research Proposal

Topic 10: Style Investing

Student Number 3077722 3060299 3008952 2901871 3116853

Name MBE BERLIN HERVE MAHLANGU THUBELIHLE P. MATEMBA STELLAH LUGOLOOBI DENNIS NKONGHO MITTERAND ENOW

ABSTRACT Graham and Dodd laid out a plan for how investors in any environment might sort through hundreds or even thousands of common stocks, preferred shares, and bonds to identify those worthy of investment and remarkably, their approach is essentially the same one that value, growth and contrarian investors employ today. The objective of this essay is to outline empirical evidence on the achievement by investors using contrarian strategies, value and growth styleinvesting. A performance analysis of well ranked international funds investing on developed and emerging markets assets is used to point to the success of the above mentioned investment strategies. A returns comparison of the Columbia Contrarian Core fund, the Vanguard Capital Value Fund, Thornburg Developing World Fund, Virtus Emerging Markets Opportunities Fund and the Oppenheimer International Growth Fund with their benchmark the S&P 500 TR index and MSCI EAFE NR USD index is illustrated. The results showed that those funds have outperformed the above indexes from December 2002 to February 2013.

Table of Contents
Page Abstract 1. Introduction 2. Contrarian Strategies and Momentum Style 2.1 Overview 2.2 Empirical Evidence 3. Growth Investing 3.1 Overview 3.2 Empirical Evidence 4. Value Investing 3.1 Overview 3.2 Empirical Evidence 5. Performance analysis 5.1 Developed Markets Fund 5.1.1 Columbia Contrarian Core Fund 5.1.2 Vanguard Capital Value Fund 5.2 Developed and Emerging Markets Fund 5.2.1 Oppenheimer International Growth Fund 5.3 EMERGING MARKETS FUNDS 5.3.1 Thornburg Developing World Fund 5.3.2 Virtus Emerging Markets Opportunities Fund
3

2 5 5 5 6 7 7 8 9 9 10 11 11 11 12 13 13 15 15 16

6. Conclusion and Recommendation 7. Bibliography

18 19

1. INTRODUCTION
Over the past decades many discussions have arisen about the ability of assets managers to select stock that can earn abnormal returns. Jensen (1968) rejects the possibility of earning extra return but Grinblatt and Titman (1989) and (1992) and Hendricks, Patel, and Zeckhause (1993) contradict that point. Recent studies from Boudreaux, Rao, and Ward, (2007), and Gallea and Patalon (2000) show evidence that by using momentum, contrarian, growth and value strategies, assets managers have outperformed the markets on a risk-adjusted basis. The performance track records of guru investors such as Warren Buffet (value investor), Peter Lynch (growth investor), George Soros and John Templeton (contrarian investors) illustrated the superiority of these investing strategies, (Reese and Forehand 2009). The first part of this essay provides evidence on the successes of the contrarian, value and growth investment styles over the past years. The second part of the essay provides a comparative performance analysis of international funds with their respective benchmark. The Columbia Contrarian Core fund and the Vanguard Capital Value Fund returns are analysed for developed markets stocks. On the other hand, Thornburg Developing World Fund and Virtus Emerging Markets Opportunities Fund returns are analysed for emerging markets stocks. To incorporate the two markets, the Oppenheimer International Growth Fund returns are also analysed. The benchmark used here are the S&P 500 TR index and MSCI EAFE NR USD index

2. CONTRARIAN STATEGIES AND MOMENTUM STYLE

2.1 OVERVIEW A contrarian style consists of purchasing stocks that have been losers and selling those that have been winners, Chan (1988). Winner stocks are those stocks that have been performing well in the past while loser stocks are those that have performed poorly in the past, (Dreman 1982). Chan (1988), suggests that the contrarian style strategy is based on the assertion that stock markets overreact to news such that winners tend to be overvalued and losers undervalued. De Bondt and Thaler (1985) support this notion, and propose that investors overreact to both bad news and good news. The contrarian investor can therefore take
5

advantage of this investor mentality to capitalise on the inefficiency of the market to reap financial gains when stock prices revert to their normal prices, (Addae-Dapaah and Peiying 2009). Gallea and Patalon, (2000) suggest that contrarian investing is going against the market, by buying and selling stocks when the rest of the investors are not doing that, or are doing the opposite. This means that contrarians are able to buy and or sell a stock first and other investors will later follow that path. According to Dreman (1982), a momentum investor buys stocks that are outperforming the market, and sells the stocks when their value starts declining.

2.2 EMPIRICAL EVIDENCE

In 1985, De Bondt and Thaler carried out an empirical study on stock market overreaction. The results showed that investor overreaction occurs in the markets. The study was conducted by forming winner and loser portfolios made up of the 30 worst-performing and 30 bestperforming stocks and calculated the portfolio returns subsequently over a certain period. Over time, a comparison showed that the loser portfolio had outperformed the winner portfolio. De Bondt and Thaler (1985), also suggest that this investment approach earns excess returns of about 8 percent per year. The results therefore depict the profitability of the contrarian strategies. This is also supported by Graham and Dodd (1934), who conclude that investors over-price favourable companies and under-price those which seem to have comparatively poor prospects. However, available evidence overwhelmingly demonstrates that the original contrarian strategy based on price-to-earning (P/E) ratio sorting criterion worked flawlessly for decades, (Dreman, 1998). Similar results were replicated by using the following accounting measures of performance: earnings to-price ratios (E/P), cash flow-to-price ratio (C/P) and book value-to-price ratio (B/M) as well strategies based on low/high measures of earning per share (EPS) growth (Capual, 1993), and the results point to the same conclusion that the contrarian style is profitable. Further studies by Gallea and Patalon (2000) found that, in early the 1990s Xerox Corporations share price was declining, and most investors did not want to hold it, but contrarian investors took the opportunity and by mid 1997, Xerox share price increased and investors earned higher returns. In another instance cited by Gallea and Patalon (2000), Citicorp in the year 1991 was trading at $9 because of bad loans made on real estate and a
6

low capital base, and only a few people bought its shares, but contrarian investors had capitalized on them. Conrad and Kaul (1998), Lewellen (2002), and others argue that rational cross-sectional and time-series variation in risk is a plausible explanation of price momentum. On the other hand, Lee and Swaminathan (2000) observe that the profitability of momentum strategies is related to the speed with which information diffuses into prices. De Bondt and Thaler (1985) and Jegadeesh and Titman (2001), report that medium-horizon price momentum is typically followed by price reversals high stock prices taking a downward trend and lower stock prices taking an upward trend. These findings indicate that the profits of momentum investing arise from a delayed overreaction to news.

Berger, Israel and Moskowitz (2009) suggest that the momentums strategys higher returns are compensation for some unique risk associated with investments that have recently outperformed the market. Berger et.al (2009), further suggest that this style investing strategy is associated with some inefficiency in markets and suggest that this could be due to investor behavior. Investors may be slow to react to new information. Efficient market theory suggests that once new information is released, it is instantly available to all investors and that prices adjust to reflect the news. In practice, however, different investors receive news from different sources and react to news over different time horizons and in different ways, (Berger et.al, 2009).

3. GROWTH INVESTING
3.1OVERVIEW Growth stocks are those companies that have high growth potential in their sales and earnings and are generally highly priced by market investors, (Hsieh and Hodnett, 2012). According to Capaul et al (1993), securities of companies with substantial growth prospects will provide returns to investors over the long run. Reese and Forehand (2009) exposed the growth strategy of Peter Lynch as the strategy for investors willing to take moderate amount of risk, pick stock with earnings per share (EPS) growth greater than 20 percent anywhere from three to ten years. The investor must also select stock with EPS growth less than 20 percent but

greater than 10 percent which can produce gains of 30 percent to 50 percent in one to two years and be willing to put moderate amount of effort.

3.2 EMPIRICAL EVIDENCE Jensen (1968) proposes that average fund performance and individual performance was not able to predict security prices well enough to outperform a buy and hold policy. Grinblatt and Titman (1989) suggest that mutual fund managers have the ability to choose stocks that outperform their benchmark before any expenses are deducted. The evidence is especially strong among growth oriented funds which hold stocks that outperform their benchmark by an average of 2 to 3 percent per year before expenses. This conflicts with Malkiel (1995) who argues that there might be some evidence of performance persistence during the 1970s however, the phenomenon does not continue through the 1980s. He concludes that the persistence phenomenon is likely to be influenced by survivorship bias.

Grinblatt and Titman(1992), examined a sample of 279 funds (not contaminated by survival requirements) that existed from December, 31 1974 to December, 31 1984 using the eight portfolios or P8 benchmark. This benchmark consisted of a composite of passive portfolios which were constructed to take into account size, dividend yields and past returns. They used the least squares method to estimate the intercept in a time series regression of excess return for each fund. They found evidence that a difference in performance between funds persists over time and that this persistence is consistent with the ability of the fund manager to earn abnormal returns. In support of the above, Hendricks et al.(1993) found strong evidence that funds that did well in the past did well in the short-term future. In their study of load growth-oriented mutual funds from 1974-1988 based on quarterly returns that are net of management fees for a total sample of 165 fund, they concluded that funds in the top octile (one eighth) of past performers over the previous year outperformed the lowest octile of past performers in the following year. They also reported theoretical profits from a strategy of buying past winners as well as selling past losers.

A recent study by Boudreaux et al (2007) examined the annual risk-adjusted returns using Sharpes Index for ten portfolios of international mutual funds for the period September 2000 through September 2006.The conclusion was that, nine out of ten of the international mutual fund portfolios including Foreign Small Growth Portfolio outperformed the benchmark (U.S. mutual fund performance reported by Morningstar).

4. VALUE INVESTING
4.1 OVERVIEW Value investing is the purchasing of securities at a price below the intrinsic value. Intrinsic value is the ability of a company to generate future earnings. Value investing started since the work of John Maynard Keynes (1928) with the chest fund.This work on value investing was later improved by Benjamin Graham, a professor at the University of Columbia and the father of value investing. According to Graham (1952) value investing is basically a typical analysis of the intrinsic value of a company. The core task for the investor is to accurately calculate this value and then maintain the discipline to buy stock only when the price is below the calculated amount. The reputation of the notion value investing was made by Warren E Buffett (1952), who gained inspiration from Benjamin Graham. Buffet considers tents when selecting stocks which include business tents, financial tents, management tents and market tents. BUSINESS TENTS provides answers to questions such as; is the business simple and understandable?, Does the business have a consistent operating history?,Does the business have favorable long-term prospects? MANAGEMENT TENTS provides answers to the question such as; Is management rational?,Is management candid with shareholders?,Does the management resist the institutional imperative? FINANCIAL TENTS, it focuses on return on equity, not on earnings per share, owners earnings and high profit margin. MARKET TENTS; looks at the value of business and purchasing a business at a significant discount to its value.

4.2 EMPIRICAL EVIDENCE In 1934 Keynes wrote to a business associate It is a mistake to think one limits ones risk by spreading too much between enterprises about which one knows a little and has no reason for special confidence. He purposely limited his stock to a few in order to keep portfolio turnover at a very low rate. He did this during the eighteen-year period with the chest fund were he achieved an average annual return of 13.2% compared with the UK market return of -0.5 which remained flat between the years 1928-1945. Hagstrom (1999), analyzed Buffett Partnership in 1957 to 1969 and the results showed that the returns were remarkable.Buffet creamed the Dow Jones Industrial average annual return by 22% points over the period with less volatility. More so, Sequoia Fund the first mutual fund run on the principle of focus investment, from 1971 to 1977 earned an average annual return of19.6% compared to the 14.5% of the S&P 500..(reference) Chan, Hamao and Lakonishok (1991) found strong support for the superior performance of value investing strategies. Book value to market (BV/MV) has become an important indicator of a portfolio orientation towards value investment. Fama and French (1992) sorted stock on the NYSE, Amex and the Nasdaq markets into 10 portfolio based on the stock (BV/MV), the value portfolio generated an average monthly return of 1.83 percent compared with the average monthly return of glamour portfolio of 0.30 percent. Ibbotson (1988) suggests that stocks with a low price-to-book value ratio (value stocks) had significantly better investment returns over the 18-year period than stock with a high price to book value. To further show that value investing is recommendable and successful, a test of high price to book value against low price to book value was conducted in theUnited Kingdom, France, Germany, and Japan..by who?

5. PERFORMANCE ANALYSIS
10

5.1 DEVELOPED MARKETS FUNDS 5.1.1 Columbia Contrarian Core Fund As reported by the U.S. News and world report, Columbia Contrarian Core fund (US) have assets totaling $2.65 billion invested in 79 different holdings, as of March 05, 2013. The fund portfolio consists primarily of shares of large companies such as such as Apple, ExxonMobil, IBM, Microsoft etc. The investment Strategy of this fund is to combine fundamental and quantitative analysis with risk management in identifying investment opportunities and constructing the Fund's portfolio. The fund has returned 15.05 percent over the past year, 14.07 percent over the past three years, 6.86 percent over the past five years, and 9.52 percent over the past decade. This is shown in the performance table below and the graph that follows shows how the investments grow from December 2002 to February 2013, compared to S&P 500. Performance Table 1 Trailing Returns Year to date 1 Year 3 Years (Annualized) 5 Years (Annualized) 10 Years (Annualized) Updated 02.28.2013 7.6% 15.1% 14.1% 6.9% 9.5%

Source:http://money.usnews.com/funds/mutual-funds/large-blend/columbia-contrariancore-fund/lccax

11

Graph 1: Columbia Contrarian Core Fundvs S&P 500 TR - initial investment of $10000

Source:http://money.usnews.com/funds/mutual-funds/large-blend/columbia-contrariancore-fund/lccax 5.1.2 Vanguard Capital Value Fund As reported by the U.S. News and world report, The Vanguard Capital Value Fund (US) seeks long-term capital appreciation by investing in a portfolio of stocks across the capitalisation spectrum that is considered by the advisor to be undervalued. The fund has returned 13.37 percent over the past year, 10.90 percent over the past three years, 6.82 percent over the past five years, and 9.57 percent over the past decade. This is shown in the performance table below and the graph that follows shows how the investments grow from December 2002 to February 2013, compared to S&P 500. This was accessed on 17 March 2013. Table 2 : Trailing Returns ofVanguard Capital Value Fund Trailing Returns Updated 02.28.2013 Year to date 1 Year 3 Years (Annualized) 5 Years (Annualized) 10 Years (Annualized) 7.9% 13.4% 10.9% 6.8% 9.6%
12

Source:http://money.usnews.com/funds/mutual-funds/large-blend/vanguard-capital-valuefund/vcvlx Graph 2: Vanguard Capital Value Fund vs S&P 500 TR - initial investment of $10000

Source:http://money.usnews.com/funds/mutual-funds/large-blend/vanguard-capital-valuefund/vcvlx 5.2 DEVELOPED AND EMERGING MARKETS FUND 5.2.1 Oppenheimer International Growth Fund As reported by the U.S. News and world report, The Oppenheimer International Growth Fundseeks long-term capital appreciation by investing in the common stock of growth companies that are domiciled or have their primary operations outside of the United States. It may invest 100% of its assets in securities of foreign companies. The fund may invest in emerging markets as well as in developed markets throughout the world. It normally will invest at least 65% of its total assets in common and preferred stocks of issuers in at least three different countries outside of the United States, and emphasize investments in common stocks of issuers that the portfolio managers consider to be "growth" companies.The fund has returned 13.44 percent over the past year, 11.69 percent over the past three years, 3.25 percent over the past five years, and 13.71 percent over the past decade.The graph below

13

shows how the investments grow from December 2002 to February 2013, compared to MSCI EAFE Index Performance. Table 3: trailing returns of Oppenheimer International growth fund Trailing Returns Year to date 1 Year 3 Years (Annualized) 5 Years (Annualized) 10 Years (Annualized) Updated 02.28.2013 4.5% 13.4% 11.7% 3.3% 13.7%

Source:http://money.usnews.com/funds/mutual-funds/foreign-large-growth/oppenheimerinternational-growth-fund/oigax

Graph 3: Oppenheimer International Growth fund vs MSCI EAFE NR USD - initial investment of $10 000

Source:http://money.usnews.com/funds/mutual-funds/foreign-large-growth/oppenheimerinternational-growth-fund/oigax

14

5.3 EMERGING MARKETS FUNDS

5.3.1 Thornburg Developing World Fund As reported by the U.S. News and world report, Thornburg Developing World Fundseeks long-term capital appreciation by investing at least 80% of assets in equity securities and debt obligations of developing country issuers. It expects that investments in the fund's portfolio normally will be weighted in favor of equity securities. The investment in debt obligations may include, but is not limited to, those of sovereign and corporate issuers. It may purchase debt obligations of any maturity and quality. The fund may invest in debt obligations which have a combination of equity and debt characteristics. It may invest in issuers of any size of capitalization, including small companies.The fund has returned 14.29 percent over the past year, and 14.30 percent over the past three years.This is shown in the performance table below and the graph that follows shows how the investments grow from December 2002 to February 2013, compared to MSCI EAFE Index Performance.

Table 4: Trailing Return of Thornburg Developing World Fund Trailing Returns Year to date 1 Year 3 Years (Annualized) Updated 02.28.2013 7.6% 14.3% 14.3%

Source:http://money.usnews.com/funds/mutual-funds/diversified-emerging-mkts/thornburgdeveloping-world-fund/thdax

15

Graph 4: Thornburg Developing World Fundvs MSCI EAFE NR USD initial investment of $10 000

Source

http://money.usnews.com/funds/mutual-funds/diversified-emerging-

mkts/thornburg-developing-world-fund/thdax

5.3.2 Virtus Emerging Markets Opportunities Fund As reported by the U.S. News and world report, the Virtus Emerging Markets Opportunities Fundseeks capital appreciation byoffering investors exposure to emerging economies through well-established companies. Under normal circumstances, it invests at least 80% of its assets in equity securities or equity-linked instruments of issuers located in emerging markets countries; such issuers may be of any capitalization. Emerging markets countries generally include every nation in the world except the U.S., Canada, Japan, Australia, New Zealand and most nations located in Western Europe.The fund has returned 6.87 percent over the past year, 14.97 percent over the past three years, 4.90 percent over the past five years, and 17.57 percent over the past decade.This is shown in the performance table below and the graph that follows shows how the investments grow from December 2002 to February 2013, compared to MSCI EAFE Index Performance.

16

Table 5: Trailing Returns ofVirtus Emerging Markets Opportunities Fund Trailing Returns Year to date 1 Year 3 Years (Annualized) 5 Years (Annualized) 10 Years (Annualized) UUpdated 02.28.2013pdated 02.28.2013 -0.5% 6.9% 15.0% 4.9% 17.6%

Source:

http://money.usnews.com/funds/mutual-funds/diversified-emerging-mkts/virtus-

emerging-markets-opportunities-fund/hemzx

Graph 5:Virtus Emerging Markets Opportunities Fund vs MSCI EAFE NR USD initial investment of $10 000

Source:

http://money.usnews.com/funds/mutual-funds/diversified-emerging-mkts/virtus-

emerging-markets-opportunities-fund/hemzx Both in the developed and emerging markets, theColumbia Contrarian Core Fund,Vanguard Capital Value Fund, Oppenheimer International Growth Fund, Thornburg Developing World

17

Fund and Virtus Emerging Markets Opportunities Fund beat the market. The graphs above shows how the investments grew from December 2002 to February 2013.

6 CONCLUSION AND RECOMMENDATIONS

The basis of the essay was to provide an analysis of evidence pointing to the success of various styles of investing and present supporting empirical evidence of some of the styles thereof. The performance analysis was based on developed market fund and emerging market fund and the results show that value stocks, growth stock and contrarian where outperforming the benchmark. Further the analysis has shown that styles perform differently over time. What was effective a year ago may becounterproductive today. In 1998 and 1999, growth stocks did spectacularly well butvalue stocks performed poorly despite good earnings news. During the first part of 2002,small capitalization firms kept the Standard and Poors-500 index from falling as steeplyas the Nasdaq Composite Talley, (2002). No single style or mix of styles is optimal for allperiods and circumstances.Barberis andShleifer (2003) believe that many investors trade baskets of stocks and move fundsbetween styles depending on their performancealways chasing past winner styles anddumping losers. In theory, several consequences follow. One of them is that past stylereturns help to explain the cross-section of expected returns for individual stocks. At thestyle level, we may find intermediate-term momentum and long-term reversals in prices. The empirical discussion has highlighted the fact that excess returns are offset by management fees. We therefore recommend that asset managers should develop new tools of picking stocks to reduce management expenses. Fund managers should also keep abreast of market changes because the different styles work best in different time periods. In addition, fund managers should not specialize on one style but rotate styles or combine them to suit the prevailing market conditions.

18

BIBLIOGRAPHY Addae-Dapaah, K., &Peiying, L. (2009).Investing in REITS: Contrarian versus Momentum. Barberis, N., &Shleifer, A. (2003).Style investing.Journal of Financial Economics, 68(2), 161-199. Boudreaux, D. O., Rao, S. P., Ward, D., & Ward, S. (2007). Empirical analysis of international mutual fund performance. International Business & Economics Research Journal (IBER), 6(5).

Best funds [online] available at http://money.usnews.com [accessed the 17 March 2013]

Capaul, C., Rowley, I., & Sharpe, W. F. (1993). International value and growth stock returns. Financial Analysts Journal, 27-36.

Carlo Cahaul, Ian Rowley and William F. Sharpe: international value and growth stock returns, Financial analysts journal, January-February 1993

Chan, K. C. (1988). On the contrarian investment strategy. Journal of Business, 147-163.

Conrad, J., &Kaul, G. (1998).An anatomy of trading strategies. Review of Financial Studies, 11(3), 489-519.

De BONDT, W. F. M. and THALER, R. (1985), Does the Stock Market Overreact?. The Journal of Finance, 40: 793805. doi: 10.1111/j.1540-6261.1985.tb05004.x

Dreman, D. N. (1982). The new contrarian investment strategy. New York: Random House.

Gallea, A., &Patalon, W. (1998). Contrarian Investing.New York Institute of Finance.

Graham, B. (1934). Security analysis (Doctoral dissertation, School of Business, Columbia University).
19

Graham, B. O. (1952). U.S Patent No. 2,595,937. Washington, DC: U.S. Patent and Trademark Office. Grinblatt, M., & Titman, S. (1989). Mutual fund performance: An analysis of quarterly portfolio holdings. Journal of Business, 393-416 Grinblatt, M., & Titman, S. (1992).Performance persistence in mutual funds.Journal of Finance, 47(5), 1977-1984.

.Grinblatt, M., & Titman, S. (1993). Performance measurement without benchmarks: An examination of mutual fund returns. Journal of Business, 47-68. Hagstrom, R. G. (1999). The Warren Buffett Portfolio.John Wiley & Sons.

Hendricks et al 1993 Hot hands in mutual funds : short run persistence of relative performance 1974-1988, journal of Finance , volume 48, issue 1 Pp 93-130

http://money.usnews.com/funds/mutual-funds/large-blend/columbia-contrarian-corefund/lccax

http://money.usnews.com/funds/mutual-funds/large-blend/vanguard-capital-value-fund/vcvlx

http://money.usnews.com/funds/mutual-funds/diversified-emerging-mkts/thornburgdeveloping-world-fund/thdax

http://money.usnews.com/funds/mutual-funds/diversified-emerging-mkts/virtus-emergingmarkets-opportunities-fund/hemzx http://money.usnews.com/funds/mutual-funds/foreign-large-growth/oppenheimerinternational-growth-fund/oigax Israel, and Tobias Moskowitz. 2009. The Case for Momentum Investing (summer). AQR Capital Management. http://www.aqrcapital.com/ ResearchDetails

20

Jegadeesh, N., & Titman, S. (2002). CrossSectional and TimeSeries Determinants of Momentum Returns. Review of Financial Studies, 15(1), 143-157.

Jensen, M., & Scholes, M. (1972). The capital asset pricing model: Some empirical tests Keynes, M. (Ed.).(1934). Essays on John Maynard Keynes.Cambridge University Press. KockJr, N. F., McQueen, R. J., & Scott, J. L. (1997). Can action research be made more rigorous in a positivist sense? The contribution of an iterative approach. Journal of Systems and Information Technology, 1(1), 1-23. Lee, C., &Swaminathan, B. (2000).Price momentum and trading volume. The Journal of Finance, 55(5), 2017-2069. Lewellen, J. (2002). Momentum and autocorrelation in stock returns. Review of Financial Studies, 15(2), 533-564.

Malkiel, B. G. (1995). The structure of closed-end fund discounts revisited. The Journal of Portfolio Management, 21(4), 32-38.

Reese, J. P & Forehand, J.M ( 2009) the guru Investor: how to beat the market using historys best investment strategies, ed John Wiley & sons

Talley, K, Wall Street Journal (2002 (April 15))Small caps within the S&P-500 help buoy the index

21