This case discusses the unique value proposition of Dimensional Fund Advisors (DFA), which used academic research to create specialized portfolios focused on Small Capitalization companies. Their investment philosophy particularly focused on research by Fama and French and Banz. They researched how small cap companies tend to outperform large cap companies over time. In addition, FDA created an additional competitive advantage by created trading efficiencies to reduce transaction cost.
1. Fama and French findings shocked the modern portfolio theory and their study was nick named "Beta is Dead". With respect to CAPM they found that stocks with high betas did not have consistently higher returns than low-beta stocks. Furthermore, Fama and French concluded that a high book value to market value was the most important variable related to predicting high stock returns on small cap stocks. These findings were published in a 1992 paper titled "The Cross-Section of Expected Stock Returns".
2. DFA's business strategy centers on the core concept that markets are "efficient" that is that no one has the ability to consistently pick stocks that would beat the market. In addition, the founders of DFA believed that combining solid academic research with the abilities of skilled traders would complement each other to produce superior returns. DFA's Small Cap objective is to deliver the size effect (research has indicated that small companies provide higher expected returns than larger companies in the long term) and provide the diversification benefits of investing in small companies worldwide. Dimensional defines small companies as those whose market capitalization comprises the smallest 12.5% of the total market universe. On a quarterly basis, the market capitalization ranking of eligible stocks is examined to determine which issues are eligible for purchase and which are sale candidates. The US Micro Cap Portfolio invests in securities of US companies whose size falls within the smallest 4% of the total market universe. The US Small Cap Portfolio invests in securities of US companies whose size falls within the smallest 8% of the total market universe.
Dimensional's value strategies are based on the Fama/French research in multifactor portfolios designed to capture the return premiums associated with high book-to-market (BtM) ratios.
The company, General Mills, for which I was assigned, proved to be a worthwhile investment researching since it contains a large portion of the market share of its “niche,” that being breakfast cereals and the like. In conducting the research necessary to find out if a potential investor might strike interest upon General Mills, we find out a myriad of things. By drawing our attention towards the spreadsheet, which contains the bits of information we need to infer conclusions, we can see the patterns that develop over a 5 or 10 year period involving such things as: stock price, EPS, ROI, and many others. The following will give some insight into the history of General Mills among other things.
Investing in stocks involves owning part of a company’s equity which effectively enables the shareholder to receive a portion of the company’s earnings and assets in form of dividends. Stocks are generally categorized as either common stocks or preferred stocks whereby common stock allow investors to vote on key issues but do not guarantee of dividends (Markowitz 78). Preferred stocks on the other hand do not provide voting rights but assure stockholders of dividend payments. Investing in stocks offers investors comparatively high returns relative to treasury securities but the investments also have high inherent risk. Stocks are purchased through licensed stockbrokers who range from the discounted order-taking online brokers, to the pricey full-service brokers and money managers (Sourd 112). Despite the type of broker an investor opts for, the stock market has the potential to generate high returns through an investment strategy. One of the main strategies employed is diversification which involves the purchasing of different stocks with varied performance and rates of returns in order to spread out the risk of the individuals stocks across a portfolio. Investing in stocks is therefore one of the most profitable alternatives of personal financial planning, and should be considered as one of the investment vehicles that generates an additional income stream.
Bodie, Zvi, Alex Kane, and Alan J. Marcus. Essentials of Investments. Ninth ed. N.p.: McGraw, 2013.
For instance, CAPM assumes all investors have access to the same level of information which allows them to invest in assets wisely. Also, the model assumes the variation of an asset is a tolerable tool used to ration the risk of the asset. With this assumption, CAPM assumes all investment in assets have the same percentage of risk which is relatively not real. Furthermore, the Fama-French three factor model is a model by the famous award winning Eugene Fama and also by Kenneth French to relatively explain and describe returns on stocks. The assumptions shows that observed assessments in market glitches like the scope and worth result of the assets cannot be explained by the CAPM. The CAPM is used to evaluate cost of common
Growth and value investing are two distinct styles of investing that have spurred interest from investors and academics alike. Scholars have come to agree that value investment strategies, on average, outperform growth investment strategies (Chan et al., 2004, p.71). However, the underlying cause of this discrepancy in performance is still highly debated. In Chan and Lakonishoks’ (2004) research they dismantle the argument that the performance differential is a result of a difference of risk and look towards behavioral theories that can explain the superior value investing strategy. The researchers hypothesize that individual investors have a tendency to use simple heuristics in picking a security, resulting in a selection of securities with recent high earnings yet a lack of consistent earnings (p.76-77). This behavioral analysis parallels Statman’s (2004) use of behavioral analysis of the tendency for individual investors to utilize simple heuristics in their decision to not diversify their portfolios (p. 44). Chan and Lakonishoks’ (2004) use of the behavioral theory to call to attention an excellent explanation for the improved performance with value stocks indirectly bolsters Statman’s conjectural use of the behavioral theory to justify the lack of diversification amongst individual
On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint Group, a mutual-fund management firm, pored over analysts' write-ups of Nike, Inc., the athletic-shoe manufacturer. Nike's share price had declined significantly from the beginning of the year. Ford was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors, McDonald's, 3M, and other large-cap, generally old-economy stocks. While the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of
Over the previous five years, the return of the ProIndex fund have outperformed the S&P 500 index, as the 5-year-return is nearly 3 times than the benchmark and the annualised return is nearly 2 times than the benchmark. It means ProIndex fund has a significant increase in value within that period. However, the ProIndex Fund has a higher standard deviation which means it is more risk than the S&P 500 index. Especially for the annualised standard deviation, it is approximately 10% higher than the benchmark. The correlation coefficient between the ProIndex and benchmark is about 0.65 which means both two variables are positive changing consistently, but there are still some other factors which have impacts on the relationship between two variables as the correlation is less than 1. Furthermore, the higher beta, 1.0132, which is more than 1 and it may be one of the reasons for high risk as well since it is more sensitive to the market change. It means that the ProIndex fund would increase by 1.0132% if the market increased by 1%.
By Morningstar, Inc. concentrating more on mutual funds, rather than stocks and bonds would be a positive move for the business because they will be assisting more individual investors who are having a problem making a decision regarding how to invest (Ferrell, et al., 2016). Furthermore, mutual fund investments are the best investment for clients who are too busy to do their own investing in the market (Ferrell, et al., 2016).
Efficient market hypothesis was developed by professor Eugene Fama at the University of Chicago Booth School Of Business as an academic concept of study through his published Ph.D. thesis in the early 1960s . Fama proposed two crucial concepts that have defined the conversation on efficient markets in his thesis. The efficient market hypothesis was the prominent theory in the 1960s, Fama published dissertation arguing for the random walk hypothesis to support his efficient market theory. “Fama demonstrated that the notion of market efficiency ...
This structure was beneficial for the decision-making and profit generation for the clients and gave incentive to the fund manager to get a good investment performance. If clients were solely focused on investment performance and the entire peer group also kept to adopt the traditional model, this approach proved effective to business growth.
...el, 2003. The Efficient Market Hypothesis and Its Critics, Journal of Economic Perspectives, Vol. 17, No. 1, Winter 2003, pp. 59-82.
Capital Asset Pricing Model (CAPM) is an ex ante concept, which is built on the portfolio theory established by Markowitz (Bhatnagar and Ramlogan 2012). It enhances the understanding of elements of asset prices, specifically the linear relationship between risk and expected return (Perold 2004). The direct correlation between risk and return is well defined by the security market line (SML), where market risk of an asset is associated with the return and risk of the market along with the risk free rate to estimate expected return on an asset (Watson and Head 1998 cited in Laubscher 2002).
According to Investopedia (Asset Allocation Definition, 2013), asset allocation is an investment strategy that aims to balance risk and reward by distributing a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. There are three main asset classes: equities, fixed-income, cash and cash equivalents; but they all have different levels of risk and return. A prudent investor should be careful in allocating each asset class to his portfolio. Proper asset allocation is a highly debatable subject and is not designed equally for everybody, but is rather based on the desires and needs of the individual investor. This paper discusses the importance of asset allocation, the differences and the proper diversification within the portfolio.
This assignment is concerned with your understanding of the key issues relative to portfolio analysis and investment. In completing this assignment you are to limit your scope to the US stock markets only. Use the Cybrary, the Internet, and course resources to write a 2-page essay which you will use with new clients of your financial planning business which addresses the following issues and/or practices:
The Modern portfolio theory {MPT}, "proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. The basic concepts of the theory are the efficient frontier, Capital Asset Pricing Model and beta coefficient, the Capital Market Line and the Securities Market Line. MPT models the return of an asset as a random variable and a portfolio as a weighted combination of assets; the return of a portfolio is thus also a random variable and consequently has an expected value and a variance.