Factor investing strategies: evidence from the Finnish stock market
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School of Business |
Master's thesis
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Date
2020
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Mcode
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Finance
Language
en
Pages
74+8
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Abstract
Although factor investing strategies have been well researched on major markets, evidence from smaller markets has been scarce. There are some studies focused on the Finnish market, but the research is limited and, to some extent, controversial. This paper studies factor performance on the Finnish stock market based on the most recent data available. Firstly, I study whether size, value, and momentum factors are priced. Secondly, I test whether value and momentum factors are more pronounced for small stocks. Thirdly, I investigate whether adding ROIC improves strategy performance. Finally, I examine whether these strategies can be implemented in practice. Overall, my results corroborate the existing findings suggesting there is little evidence on the size and value factors being priced for Finnish stocks. The size and value factors are found to generate insignificant annualized abnormal returns of minus 2,1% and 1,4%, respectively. Only the momentum factor is able to generate a significant positive abnormal return of 6,8% per annum. However, in contrast to some previous research, I found no evidence for a significant value premium for small stocks. I did not also find a significant momentum premium for a subsample of big stocks, but rather found it significant for small stocks. My results show that the value and momentum factor abnormal returns are higher for small stocks by 23 bps and 17 bps per month, respectively. However, these differences are not statistically significant. I found no consistent evidence for the ROIC ability to enhance factor performance. For small stocks, the enhanced value and momentum strategies generate higher alpha in comparison with traditional strategies by 89 bps and 26 bps, respectively. However, the difference is significant only for the value strategy. For big stocks, the enhanced momentum strategy actually decreases an abnormal return by 14 bps. Practical implementation of the strategies, which are found to generate significant returns, is unrealistic for both institutional and private investors. On average, daily turnover does not exceed 0,1 million euros for a median portfolio company. Liquidity rises to 6,3-14,9 million euros if these strategies are exercised among big stocks. Although being liquid, such strategies generate insignificant returns. Among single-sorted strategies, only the momentum is able to withstand minimum liquidity requirements. Thus, under 1,0 million euros in minimum daily turnover, alpha for the momentum strategy increases by 5 bps per month, while for the size and value factors, alpha decreases by 18 bps and 4 bps, respectively. The results imply that professional investors should look beyond traditional factor strategies on the Finnish market. In addition, unsophisticated retail investors should exercise good judgment and skepticism when approached by banks and other financial institutions offering financial products claimed to provide exposure to certain factors. Investors should have a clear understanding of how the offered strategies are different from the traditional ones that seem to perform poorly on the Finnish market.Description
Thesis advisor
Torstila, SamiKeywords
factor investing, size premium, value premium, momentum premium, Finnish market, stock markets, Finland