Why US Investing Differs A Lot From Europe Investing…
Université Paris Dauphine; Uncia Asset Management
May 30, 2015
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We compare European Indices (DJ Stoxx 600, Eurostoxx 50, FTSE 100) to US Indices (Russell 2000, S&P 500, Nasdaq Composite, Nasdaq 100) and Japanese Indices (Topix, Nikkei225).
First, from 2014, December 31st to 2015, November 11th. Using a longer period could lead to wrong conclusions given the important turnover of the components within each index (roughly 5% per year), and the death-survivorship bias.
Therefore, in a second attempt, we compare the behavior of the large indices such as Topix, Nasdaq Composite and Russell 2000, year after year, from 1999 to 2015. We do the same analysis for DJ Stoxx 600, even if the sample seems tight. Why year after year and not the 16 years in a row? Because turnover is huge on US indices, and the Russell 2000 or Nasdaq Composite composition as of 2015 is very different from the one as of 1999…
Conclusions vary a lot, and explain this article’s title.
Once again, we do not want to look at fundamental (and useless because static) data such as PER, but only on easy to watch data: capitalization, historical volatility, sectors. We decided to investigate patterns through the median rather than through the mean because the median is less sensitive to outliers (and there are many) than the mean.
It is worth to mention that the main part of that sample is composed by capitalization-weighted indices, whereas Nikkei225 is the only index to be price-weighted.
In the following development, performances are always total-return.
Why US Investing Differs A Lot From Europe Investing… – Introduction
As of 2014, December 31st, there are 2011 stocks. After cleaning the data, only 1908 stocks remain.
Statistics for actuarial returns (%):
The performance of the whole Index over the period is -1.13 (%). This can be compared to the average performance of the Russell components: -4.33 (%). The explanation is simple: the biggest weights were the most successful. As the Russell is a capitalization-weighted index, the rule is as follows: The bigger, the better…
Using actuarial returns does not help to have a proper view as the downside performance is capped to -100%, whereas the upside performance has no boundary.
Using logreturns () helps to get some symmetry in our returns study. For example, the return will be opposite for a stock whose price is divided by 2 and for a stock whose price doubles as ln(0.5) = ?ln?(2)
Statistics for logarithmic returns (%):
Average is at -14.30% (vs -4.33% with actuarial returns). Skewness coefficient switches from +0.95 to -1.94. This means that the Russell2000 Index contains huge underperformers whose actuarial return is awful (minimum actuarial return is -97.84%)
We decided to test two hypotheses, by sorting the stocks in deciles.
First, with respect to capitalization (LHS). The largest capitalization as of 2014, December 31st is around 7 293Mln$, the smallest 30Mln$.
Second, with respect to the stock’s sector. In order to avoid any information bias, please note that this two measures are calculated as of the last day of year N-1: in this example as of 2014/12/31.
As it can be noticed in the charts below, in 2015, the larger the better, with small caps posting an awful performance. How to read the charts? Each bar stands for a decile with the upper bound standing for the 3rd quartile of the decile in terms of performance, and the lower bound standing for the 1st quartile of the decile. The spot stands for the median performance of the decile.
NB: Telecommunication Services sector performance is not relevant as it does not take enough stocks into account (23 < 30).
Third, we test the performance of each stock with respect to its 1year historical volatility (RHS). Once again, in order to avoid any information bias, please note that this measure is calculated as of the last day of year N-1: in this example as of 2014/12/31, and stands for the realized volatility between 2013/12/31 and 2014/12/31.
Lastly, we simply check the distribution of the YtD performance of each stock belonging to the Russell 2000 Index.
This table enables to sort the factors between volatilities and capitalizations. We can notice that volatilities impact exceeds capitalizations one by far. Low volatility stocks exhibit positive returns, whereas the impact of capitalization, given a previous sort with respect to volatilities is difficult to analyze. Therefore, the first criteria to take into account for stock picking in the Russell 2000 is extracting a low-volatility universe and picking stocks within it, whatever be the capitalization. This goes against the philosophy of the upsides, as the higher the volatility, the larger the upside. Once again, the Russell 2000 and the US small caps universe is definitely not a stock-picking friendly one…at least for 2015. We will see over a whole investment period, from 1999 to 2015.
See full PDF below.