Value Partners Center for Investing Newsletter - Performance of Various Investing Strategies in Japan’s Stock Market

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Performance of

Various Investing

Strategies in Japan’s

Stock Market

May 16, 2013

Value Partners Center for

Investing

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3 | 9 P a g e s

Performance of Various Investing Strategies

in Japan’s Stock Market

Introduction

This report examines the performance of several investing strategies based on stock level information in the Japanese stock market and how they compare with the aggregate stock market. We find that the strategy based on the past one-month returns provided investors with good returns in the period from January 1975 to December 2011. The portfolio consisting of stocks with the lowest past one-month returns outperformed the aggregate Japanese stock market in the past 37 years.

Data Sample and Measures

Our source of data on the daily total return index of each stock and the Japanese equity market and the monthly prices, total return index and market value of each stock is Datastream. Exchange-traded funds (ETFs) and warrants are excluded from our study. We also ignore the bottom one-third of stocks based on their market value in order to eliminate any penny stocks that filed for bankruptcy each month. Our portfolio formation focuses on the 37-year period between January 1975 and December 2011, which contains the two-decade-long bear stock market in Japan. The measures we consider here are the market capitalization (size), total volatility and idiosyncratic volatility, past one-month returns and past six-month cumulative returns (momentum).

The performance of various investing strategies

At the end of each month, we sort stocks into five portfolios based on five measures in that month. These measures are market capitalization (size), total volatility, idiosyncratic volatility, past one-month returns and past six-month returns (momentum). We calculate both equal- and value-weighted forward-looking one-month returns of a portfolio. The former is calculated by taking the simple average of the returns of all stocks in the portfolio whereas the latter is calculated by weighting each stock’s returns based on its market capitalization. In this way, the five portfolios are rebalanced monthly according to the five measures of the stocks in the portfolios in the 37 years. We then subtract the equal- and value-weighted returns of each portfolio from the total market returns to obtain the outperformance of each portfolio against the Japanese market, namely the excess returns. We therefore report the performance of portfolios sorted by market capitalization, total volatility, idiosyncratic volatility, one-month returns and momentum (six-month returns) in Table 1.

We find that the equal-weighted portfolios with low past one-month returns significantly outperformed stocks with high past one-month returns while the other strategies did not. The portfolio with the lowest past one-month returns also generated market-adjusted excess returns

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4 | 9 P a g e s (alpha) in CAPM. The zero-cost portfolios that long the portfolios with the lowest past one-month returns and short the portfolios with the highest past one-month returns generated returns of 0.76% and 0.83% and market-adjusted excess returns (alpha) of 0.65% and 0.87% in CAPM per month over the 1975–2011 period and 1990–2011 period, respectively. We find similar results for value-weighted portfolios sorted by the same past return measures only in the 1990–2011 period. However, we do not find any significant results for market capitalization, total volatility, and idiosyncratic volatility, nor do we find similar results for three-, six-, nine-, and twelve-month holding periods.

Table 1: Returns of Various Investing Strategies for the Period from January 1975 to December 2011

Panel A: Portfolio Returns in the 1975–2011 Period

Portfolio Market Value Short-term Reversal Momentum Total Vol. Idiosyncratic Vol.

ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret 1 0.71 0.71 0.93 0.82 0.75 0.74 0.45 0.53 0.47 0.56 (2.67) (2.65) (2.96) (2.60) (2.21) (2.24) (3.00) (3.05) (3.05) (2.97) 2 0.64 0.64 0.65 0.52 0.72 0.58 0.75 0.60 0.75 0.62 (2.40) (2.40) (2.60) (2.07) (2.79) (2.21) (3.35) (2.65) (3.22) (2.65) 3 0.53 0.52 0.59 0.48 0.50 0.36 0.76 0.46 0.80 0.53 (2.04) (2.01) (2.54) (2.13) (2.15) (1.52) (2.94) (1.82) (3.06) (2.05) 4 0.53 0.52 0.58 0.50 0.50 0.37 0.68 0.50 0.69 0.41 (2.17) (2.17) (2.52) (2.18) (2.20) (1.61) (2.34) (1.69) (2.36) (1.42) 5 0.54 0.45 0.17 0.33 0.47 0.47 0.30 0.49 0.25 0.39 (2.33) (1.88) (0.63) (1.09) (1.73) (1.61) (0.87) (1.29) (0.74) (1.06) 1-5 0.17 0.25 0.76 0.49 0.28 0.27 0.15 0.04 0.22 0.17 (0.94) (1.16) (3.57) (1.60) (0.98) (0.81) (0.55) (0.13) (0.87) (0.55) Alpha 0.09 0.19 0.65 0.38 0.30 0.28 0.28 0.21 0.34 0.30 (0.49) (0.79) (2.83) (1.15) (1.00) (0.76) (1.20) (0.69) (1.47) (0.96)

Panel B: Portfolio Returns in the 1990–2011 Period

ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret 1 -0.10 -0.11 0.29 0.29 0.04 0.15 -0.33 -0.12 -0.29 -0.07 (-0.26) (-0.27) (0.60) (0.63) (0.07) (0.31) (-1.73) (-0.58) (-1.47) (-0.30) 2 -0.06 -0.05 -0.15 -0.13 0.03 -0.05 0.00 -0.09 -0.01 -0.06 (-0.14) (-0.13) (-0.41) (-0.37) (0.08) (-0.12) (0.01) (-0.28) (-0.02) (-0.18) 3 -0.22 -0.23 -0.15 -0.23 -0.21 -0.31 0.03 -0.30 0.07 -0.19 (-0.57) (-0.59) (-0.44) (-0.71) (-0.59) (-0.89) (0.07) (-0.85) (0.18) (-0.52) 4 -0.16 -0.16 -0.15 -0.27 -0.28 -0.38 -0.02 -0.23 -0.02 -0.33 (-0.43) (-0.44) (-0.45) (-0.86) (-0.88) (-1.23) (-0.04) (-0.54) (-0.05) (-0.79) 5 -0.14 -0.23 -0.54 -0.50 -0.28 -0.33 -0.35 -0.05 -0.42 -0.23 (-0.43) (-0.71) (-1.36) (-1.18) (-0.70) (-0.86) (-0.65) (-0.08) (-0.80) (-0.41) 1-5 0.04 0.12 0.83 0.79 0.31 0.48 0.02 -0.08 0.12 0.16 (0.18) (0.45) (2.83) (1.93) (0.81) (1.10) (0.04) (-0.15) (0.31) (0.34) Alpha 0.03 0.11 0.87 0.82 0.39 0.55 0.25 -0.35 -0.11 -0.07 (0.13) (0.40) (3.04) (1.99) (1.05) (1.27) (0.86) (-0.95) (-0.39) (-0.18) Note: Adjusted t-statistics are in parentheses

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5 | 9 P a g e s Performance against the Japanese stock market

We also investigate the performance of these investing strategies against the aggregate Japanese stock market. We subtract the portfolio returns from the Japanese stock market aggregate returns and call this difference in returns the excess returns. As shown in Table 2, we find that the zero-cost portfolio based on the past one-month returns significantly outperformed the aggregate stock market by 1.0% per month in the 1990–2011 period while other investing strategies did not. Note that during this period the Japanese stock market plunged 62.21% while the Nikkei 225 index dropped from 38916 to 8455.

Table 2: Excess Returns of Various Investing Strategies for the Period from January 1975 to December 2011

Panel A: Excess Returns in 1975–2011 Period

ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret

1 0.20 0.19 0.42 0.30 0.24 0.23 -0.06 0.02 -0.04 0.05 (1.02) (0.99) (2.14) (1.67) (1.03) (1.10) (-0.34) (0.10) (-0.25) (0.31) 2 0.13 0.13 0.14 0.00 0.21 0.07 0.24 0.09 0.24 0.11 (0.72) (0.72) (0.90) (0.04) (1.30) (0.49) (1.80) (0.94) (1.84) (1.34) 3 0.02 0.01 0.08 -0.03 -0.01 -0.15 0.25 -0.05 0.28 0.02 (0.13) (0.07) (0.570 (-0.29) (-0.09) (-1.47) (1.83) (-0.73) (2.07) (0.21) 4 0.02 0.01 0.07 -0.01 -0.02 -0.15 0.17 -0.01 0.17 -0.10 (0.14) (0.09) (0.49) (-0.06) (-0.11) (-1.35) (1.13) (-0.14) (1.12) (-0.99) 5 0.03 -0.06 -0.34 -0.18 -0.04 -0.05 -0.21 -0.03 -0.26 -0.13 (0.50) (-1.17) (-2.18) (-1.05) (-0.25) (-0.28) (-0.97) (-0.11) (-1.23) (-0.55) 1-5 -0.34 -0.26 0.25 -0.03 -0.23 -0.24 -0.36 -0.47 -0.29 -0.34 (-1.02) (-0.71) (0.84) (-0.07) (-0.67) (-0.60) (-0.78) (-0.93) (-0.66) (-0.72)

Panel B: Excess Returns in 1990–2011 Period

ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret ew_ret vw_ret

1 0.10 0.10 0.49 0.49 0.24 0.36 -0.13 0.08 -0.09 0.13 (0.40) (0.38) (1.76) (1.94) (0.76) (1.29) (-0.50) (0.34) (-0.37) (0.60) 2 0.15 0.15 0.05 0.07 0.23 0.16 0.21 0.12 0.20 0.15 (0.62) (0.64) (0.24) (0.44) (1.03) (0.80) (1.12) (0.83) (1.09) (1.27) 3 -0.02 -0.03 0.05 -0.03 0.00 -0.10 0.23 -0.10 0.27 0.02 (-0.09) (-0.13) (0.26) (-0.23) (-0.01) (-0.69) (1.23) (-1.16) (1.42) (0.17) 4 0.05 0.05 0.05 -0.07 -0.08 -0.18 0.18 -0.02 0.18 -0.12 (0.29) (0.28) (0.25) (-0.46) (-0.40) (-1.18) (0.84) (-0.20) (0.81) (-0.94) 5 0.06 -0.02 -0.33 -0.30 -0.07 -0.13 -0.15 0.16 -0.21 -0.03 (0.74) (-0.39) (-1.53) (-1.23) (-0.30) (-0.60) (-0.46) (0.45) (-0.69) (-0.08) 1-5 0.24 0.32 1.03 1.00 0.51 0.69 0.22 0.13 0.33 0.37 (0.57) (0.72) (2.52) (1.91) (1.15) (1.35) (0.31) (0.17) (0.47) (0.50)

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6 | 9 P a g e s The $1 investment cumulative payoff of various investing strategies

In Figure 1, we examine the cumulative payoff in dollar terms of investing $1 in the portfolios having the lowest values of our value and other measures with monthly portfolio rebalancing. We also compare this payoff with the cumulative payoff from a $1 investment in the aggregate stock market. We find that the investing strategies based on a stock’s past one-month returns, past six-month returns, market capitalization, total volatility, and idiosyncratic volatility grew a $1 dollar investment into $24.04, $9.14, $11.65, $5.92, and $6.35 respectively in the 1975–2011 period, while the aggregate stock market turned $1 into $5.35 in the same period. This demonstrates that the investing strategy based on the past one-month returns easily outperformed the Japanese stock market while other investing strategies marginally did so. The effective monthly compound returns of the various investing strategies are 0.72%, 0.50%, 0.55%, 0.40% and 0.42% while the aggregate stock market managed 0.38%.

Figure 1. Cumulative Payoff of $1 Invested in Japan’s Total Market Index and in Portfolios with the Lowest Values of

Past One-month returns, Past Six-month returns (Momentum), Market capitalization, Total volatility, and Idiosyncratic volatility with Monthly Portfolio Rebalancing in the Japanese Stock Market.

0 10 20 30 40 50 60 70 Ja n-197 5 Ju l-19 76 Ja n-197 8 Ju l-19 79 Ja n-198 1 Ju l-19 82 Ja n-198 4 Ju l-19 85 Ja n-198 7 Ju l-19 88 Ja n-199 0 Ju l-19 91 Ja n-199 3 Ju l-19 94 Ja n-199 6 Ju l-19 97 Ja n-199 9 Ju l-20 00 Ja n-200 2 Ju l-20 03 Ja n-200 5 Ju l-20 06 Ja n-200 8 Ju l-20 09 Ja n-201 1 Do lla r

CUMULATIVE PAYOFF OF MARKET VALUE, SHORT-TERM REVERSAL, MOMENTUM, TOTAL VOLATILITY, AND IDIOSYNCRATIC VOLATILITY INVESTING STRATEGIES AND OF

JAPAN’S MARKET RETURN INDEX, 1975–2011

MOMENTUM RESERVAL PAST SIZE

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7 | 9 P a g e s It is interesting to see that none of these investing strategies rewarded investors with positive returns in the bear market that spanned two decades from 1990 to 2011 when the stock market plunged 62.21%. In fact, these investing strategies turned a $1 investment into $0.96, $0.45, $0.44, $0.36 and $0.40 in this period, implying losses of 3.76%, 55.27%, 56.33%, 63.52%, and 60.15%. In addition, the investing strategy based on the past one-month returns gave a peak return of $62.30 in February 2005 while the aggregate stock market peaked much earlier in January 1990. But this strategy shed $43.73 to finally close at $18.57 (a 70% loss from the peak) in March 2009 which is also when the stock market hit bottom during the global financial crisis. In this period, this strategy largely underperformed the other investing strategies and the aggregate market. On the other hand, it dramatically outperformed the other strategies and the market from January 2003 to February 2005.

Conclusion

We find that the investing strategy based on the past one-month returns generated good returns for investors in Japan’s stock market in the 1975–2011 period. But even this strategy suffered a 3.76% loss of capital during the country’s two-decade-long bear market between 1990 and 2011, during which time the Nikkei index dropped 62.21%. In the next newsletter, we will investigate whether value investing strategies can outperform the aggregate stock market and reward investors with positive returns.

About Value Partners Center for Investing (http://vpcenter.ust.hk/)

The Value Partners Center for Investing of the Hong Kong University of Science and Technology Business School is an academic and intellectual center supporting research and training on investing with an

emphasis on China and Hong Kong financial markets. It aims to promote Hong Kong's role as the regional asset management center. The center is sponsored by Value Partners Group Limited.

About Value Partners Group Limited (http://www.valuepartners.com.hk/en/home.html)

Value Partners is one of Asia’s largest asset management firms. Since its establishment in 1993, Value Partners has been a dedicated value investor with a focus on the Greater China region. The Group manages absolute return long-biased funds, long-short hedge funds, exchange-traded funds, quantitative funds, and private equity funds for institutional and individual clients in Asia Pacific, Europe and the United States.

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Author Contact Information

Dr. Samuel Xin Liang Associate Director

Value Partners Center for Investing Tel: +852 2358 8204

Mobile: +852 9175 8951 Fax: +852 2358 1749 Email: [email protected]

Supporting Researchers: Ms. Cheuk, Man Yin Ms. Fang, Lei