FTSE 100 INDEX

FTSE 100 Index Returns and Porfolios based on low price-toearning ration and low price to book ratio

Abstract

This paper examines whether short-term variation m the portfolio based on low price-to-sales ratio of the UK size and value/growth style indices is better predictable and exploitable by means of quantitative or FTSE 100 index returns. Applying different long-only and long-short strategies, we find that the value/growth rotation is not profitable regardless of the method used for choosing a style. Alternatively, both quantitative and momentum based small/large rotation is profitable at easily feasible levels of transaction costs for both ETFs and institutional traders, with quantitative rotation having an edge over the momentum one, in terms of generated end of period wealth and Sharpe ratios.

1. INTRODUCTION

The concept of equity investment styles is nowadays widely accepted in the investment community. This can be seen both from the large number of funds following style investing strategies and from the proliferation of style indices published by several companies. Although most of those funds focus on one style at a time, where for example we can identify value or growth and small capitalisation funds, there is extensive evidence which suggests that each of those styles does not persistently outperform the market or the remaining styles. Therefore, there is a scope for generating higher returns when switching from one style to another, for example, growth stocks to value, when we have an outlook that value stocks will outperform or from large capitalisation stocks to small, when the forecast shows that the latter will perform better and vice versa.

With focus on UK equity style management, we apply a forecasting model which we believe is feasible by practitioners. We assess the potential profitability of equity style rotation strategies using a set of variables chosen for their ability to predict the direction of the style spread. These variables are market related, macroeconomic and fundamental factors. Additionally, we apply widely accepted FTSE 100 returns in the relative past returns of value/growth and small/large styles separately, to investigate if such simple strategies could yield a more profitable result of style rotation. Our style rotation strategies are based on small-capitalisation, large-capitalisation, value and growth segments of the market, using the appropriate style benchmark indices as proxies for styles. We believe that there are two relatively simple and cheap ways in which the suggested rotation strategies can be applied in reality. Firstly, the increased popularity of exchange traded funds (ETFs) is enabling investors to buy and sell indices at a very low comparable cost. Secondly, the recent availability of futures contracts on style indices enables investors to apply the suggested strategies more cost effectively, due to low transaction costs, low tracking error and high liquidity of the futures contract. Furthermore, we should mention that our study specifically focuses on the UK equity market. The reasons for this are two-fold: Firstly, a host of empirical work on this topic is usually concentrated on the well-documented US equity market; and secondly, although institutional and ...