Investment Styles in the European Equity Market

Abstract

Equity investment styles have been in use for many years in US financial markets where they have proven to be a very powerful tool for analysis and allocation. The formation of a large European stock market gives institutional investors the opportunity to introduce these strategies.

In this paper we show that equity styles exist in the European market and have significant contrasting patterns in terms of cumulative returns. In addition, many of the equity investment strategies based on portfolio re-balancing towards a determined style (short/long overlay strategies) are shown to have positive returns.

To study style behaviours, we built style portfolios ranking the 561 stocks included in the MSCI Europe index and divided them among 5 portfolios (quintiles) on the basis of several fundamental indicators (Price to Book Value, Price to Earnings, Price to Cash Flow, Dividend Yield, Earnings Growth, Beta, Size and ROE), each one taken separately. We then calculated the return and turnover rate for each quintile and the percentage of positive movements for each portfolio and for each style strategy.

Another interesting aspect of this paper is the analysis of each portfolio style’s return in relation to the principal macroeconomic and European macromarket variables. For each portfolio, estimates of the sensitivity coefficients (betas) are calculated with respect to each economic variable. A significant contrast of figures is revealed between the value portfolio style (low P/E, low P/B, low P/CF, high DY) and the growth portfolio style (high ROE). The economic analysis of the portfolio is preceded by a partial correlation analysis on all the economic variables considered significant for the European economy.

Finally, following the recent literature, a multi-factor APT model with time-varying parameters are estimated for each portfolio. Both the state space and the ECM forms have been utilised and GARCH disturbances have been added in order to study the existing economic relationship between equity style and macroeconomic and macro-market variables.

We thank Teresa Grava and Loriana Pellizzon for their valid contribution to this work through their previous studies on equity style