[slides - downloadable]
- Building on Mang (2012, 2014) and the extant tradition of investments that claim to improve upon the market index, I replicate, analyze, and attempt to understand a general menu of investment options in global financial markets.
- I do this first by replicating key value investments found in Carhart et. al (2010) and then evaluating their relative performance in relation to market-capitalization based investments. I find that they are generally superior investment strategies with persistent abnormal returns. For various metrics used to evaluate relative performance, global value investments are almost unanimously better.
- To make sense of the persistent abnormal returns, I construct an index that tracks time-variation in global value risk, what I call the market sentiment index. This variable captures the tendency for financial market relative returns to spike simultaneously across asset classes. I find statistically significant evidence that the excess returns of an asset class diversified portfolio of securities is predictable using the market sentiment index.
- Using the market sentiment index, I build a simple asset pricing model of global value risk using a modified CAPM framework. I then use the model to assess the performance of various global investments. I find that they perform well for value-based investments but are not well-suited for market-cap based ones.
- In the paper, I also analyze the performance of a large menu of investment options, from a U.S.-centric equity index, a global equity index, an asset class diversified market-cap based index, a comparable value-based index, to hedge funds. I find empirical support that exposure to global value risk rewards investors with an additional source of risk compensation, one that is often superior to traditional market risk.
- The mere existence of global value risk-related compensation has far reaching implications, particularly its ability to stabilize financial market fluctuations. This is an important issue that merits further research.
Abstract
- I construct an investment portfolio by aggregating value strategies across asset classes. An asset class diversified portfolio of value investments achieves a desirable risk-return profile. The large risk-adjusted returns result from aggregating imperfectly correlated value strategies whose risk-premium survives asset class diversification. To understand the global nature of excess returns to these value investments, I employ a uni-variate statistic that aggregates signals from individual global value strategies. I find statistical evidence of cross-sectional and time-series predictability only for value-based strategies and not market-capitalization based ones.
JEL Classification: C52, D84, E17, E03, G10, G11, G23
Keywords: institutional investing; portfolio analysis; strategic substitutability; value risk-premium