Quantitative Value Strategy Beats the Market

The objective of this paper is to test if Quantitative Value Strategy works in Canadian market. Combining different value investment strategies from researchers and industry pioneers, a slightly revised existing strategy is used to back-­‐test historical returns in the Canadian stock market. All the value strategies, commonly used by others, are small deviations from three main strategies mentioned in the literature review. In order to identify stocks that have greater intrinsic value but at cheap prices, numerous ratios have been used in the screening process. There are main three steps for identifying the wanted stocks. First of all, eliminate all stocks with high possible earning manipulations. Next, identify cheap stocks using various financial ratios. Lastly, find the best quality stocks. Rankings are based on prior year-­‐end financial data collected from Bloomberg. A long-­‐short strategy is applied with one hundred twenty percent long and twenty percent in short positions. Based on prior year-­‐end market capitalization, weights are assigned to each selected stocks. Once the portfolio is formed, these securities follow buy-­‐and-­‐hold strategy until the next rebalance cycle, which is the following year end. After back-­‐testing ten-­‐year data from 2002 to 2012, the 120/20 portfolio annualized return is 11.53%, which is 4.92% higher than the annual SP/TSX index return. When looking at the returns alone, the constructed portfolio does outperform; however, the excess return is not risk adjusted as indicated in regression test. The value strategy is able to beat the market, but the excess returns mainly come from excess risks that the strategy has been taken. After risk adjustment, the constructed portfolio no longer beats the market; in other words, the famous value strategy fails to beat the market after taking consideration of risk factors. Moreover, there are several potential implementation issues that could erode the performance return, such as transaction costs, dividend reinvestment and look-­‐ ahead issue. Also, some financial behaviors are observed to prevent from beating the benchmark returns.