Emerging Financial Markets 8: The Top-Down and Bottom-up Approaches
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Transcript of Emerging Financial Markets 8: The Top-Down and Bottom-up Approaches
Emerging Financial Markets 8: The Top-Down and Bottom-up Approaches
Prof. J.P. Mei
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Active Asset Management in Emerging Markets
The predictability of emerging market returns Market over-reaction or excessive risk
premium required by investors Time-varying expected return and risk require
a dynamic asset allocation model Objective: Outperform the benchmark with
careful risk management
Sorting by One Variable PE & DY: The HK experience The BEHV Paper
– Sorting by Different Variables– Form portfolios and track returns out of
sample– Quarterly re-balancing– High, Middle, and Low Portfolios and three
weighting schemes
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T h e F u t u r e 1 0 - Y e a r R e t u r n s W h e n S t o c k s a r e
P u r c h a s e d a t D i f f e r e n t D / P i n H o n g K o n g
0 %
5 %
1 0 %
1 5 %
2 0 %
2 5 %
3 0 %
D Y > 6 D Y < 6 D Y < 5 D Y < 4 D Y < 3
H i g h Y i e ld < - - - - - - - - - - - - - - - - - - - - - - - - - - > L o w Y i e ld
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T h e F u t u r e 1 0 - Y e a r R e t u r n s W h e n S t o c k s a r e
P u r c h a s e d a t D i f f e r e n t P / E i n H o n g K o n g
0 %
5 %
1 0 %
1 5 %
2 0 %
2 5 %
3 0 %
P E < 1 0 P E > 1 0 P E > 1 3 P E > 1 6 P E > 1 9
L o w M u l t i p l e < - - - - - - - - - - - - - - - - - - - - - - - - - - > H i g h M u l t i p l e
S o u r c e : M a l k i e l a n d M e i ( 1 9 9 8 )
The Smith Barney Model:Put It Together
What variables to use? How do we group them? What weight do we assign to each
group? What weight do we assign to each
variables within each group? Good modeling is similar to cooking.
The Smith Barney Model (50%, 5%, 20%, 5%, 20%)
Valuation: P/E, P/E(Forecasted), P/B and Earning Yield Gap
Growth: Earnings and GDP Growth for Next Year Risk: Current account/GDP, Real exchange rate
over-valuation, Beta Interest rate: Real Rate Change Momentum: Earnings revision and Price Change Question: How do they translate rankings into
weightings?
Strength and Weakness of The Smith Barney Model
Strong marketing appeal: Intuitive and easy to understand.
Flexibility: variables and weights used can be adjusted to changing market conditions.
Timely information: the use of market information Multi-colinearity: Similar Information Failure to adjust for political and other risk factors. Transaction cost could be higher than indexing.
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A Cautious Note for the Value Approach P/B does not work in every countries P/Cash flow does not work everywhere P/E Trailing & Prospective does not
work everywhere Buy on dip, sell on rally may not work
(Thai example)
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THAILAND-DS MARKET $ - PRICE INDEXFROM 1-5-95 TO 2-28-00 WEEKLY
1995 1996 1997 1998 1999 20000
200
400
600
800
1000
1200
HIGH 1100.99 2-8-96 LOW 117.06 9-3-98 LAST 251.62Source: DATASTREAM
How to Allocate Resources Among Stock Pickers
The Bottom-Up Approach Company Analysis and Stock Selection Applying Valuation Models to Emerging
Market Stocks (Mariscal & Lee Model)– A link between debt and equity market– A framework to estimate country-risk adjusted PE
Price/Book Value (P/BV) and Price/Cash Flow (P/CF) Ratios
Industry Analysis: High growth potential Overall portfolio balance
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The Momentum Trading Strategy (Rowenhorst)
Sort all stocks by lagged returns into decile portfolios Adjust for beta risk Country neutral portfolio (sort by return in each
country) Size neutral portfolio (sort by return in each size
decile) Size/country neutral and risk adjustment The Momentum Strategy (Chan, Hammed, and Tong)
-Most profits come from Emerging markets.
-Hardly any trading profits after transaction costs.
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Size/country-neutral Relative Strength Portfolios