Exploring Momentum Investment in International Finance

Momentum Investment International Finance Finance 663 Prepared by: Derek Song German Hurtado Mustafa Jalil Qureshi Rodrigo De La Maza Fuqua School of Business, Duke University

Content 1. Introduction 2. Why the Insurance Industry? 3. Methodology applied 4. Results and Analysis 5. Conclusions Prepared by: Momentum Investment - Finance 663 Derek Song, German Hurtado, Mustafa Jalil Qureshi, Rodrigo De La Maza

1. Introduction Momentum Investing What is Momentum Strategy? Tendency of investments to persist in their current performance Go long on top performing stocks and short on bottom performing stock Should not exist in the Modigliani and Miller world of perfect market Plausible Explanations: Reward for the excessive Risk taken by the Investor Reward from herd mentality, lead lag, over under reaction Prepared by: Momentum Investment - Finance 663 Derek Song, German Hurtado, Mustafa Jalil Qureshi, Rodrigo De La Maza

2.Industry Insurance Criteria: Mature Industry Banking Bank Retail Ease of Data Availability No seasonal Impact Insuranc e Health Care Geography (Market); Developed Electronics Low Volatility / Market Fundamental Metals and Mining Hypothesis: Beverage R.E.I.T Momentum Investment in Insurance Industry will lead to XX% returns Prepared by: Momentum Investment - Finance 663 Derek Song, German Hurtado, Mustafa Jalil Qureshi, Rodrigo De La Maza

Formation Period F Formation Period F A B C D E F G H I J K L M N O B E H K O A N M L J I G F D C (Winners) (Winners) (Losers) (Losers)

Formation Period F Formation Period F + - Holding Period H Holding Period H

Return(+ ) > 0 - , 20% 15% 10% 5% 0% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 -5% -10% -15% -20%

F x H = 3 x 3 (n = 20 months) F x H = 3 x 3 (n = 20 months) 1 2 F 3 4 5 H 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 F H F H F H F H F H F H F H F H F H F H F H F H F H (n (n (F + H)) portfolios (F + H)) portfolios

Holding Period Month 1 Month 2 Month 3 R R R R R R R R R R R R R R R R R R R R R R R R 1 2 3 1 1 2 3 2 1 2 3 3 1 2 3 4 1 2 3 5 1 2 3 6 1 2 3 7 1 2 3 8 1 2 3 9 1 2 3 10 1 2 3 11 1 2 3 12 1 2 3 13 R R R R R R 1 2 3 14

Holding Period Month 1 Month 2 Month 3 1 2 3 AR ( ) AR ( ) AR ( ) , , , 1 2 3 AR ( ) AR ( ) AR ( ) , , , AR ( ) AR ( ) AR ( ) 1 2 3 , , , 1 2 3 AR ( ) AR ( ) AR ( ) , , , 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 AR ( ) AR ( ) AR ( ) , , ,

Holding Period Month 1 Month 2 Month 3 1 2 3 CAR1( ) CAR2( ) CAR3( ) CAR3( ) , , , , 1 2 3 ) CAR1( ) CAR2( ) CAR3( ) CAR3( , , , , ) CAR1( ) CAR2( ) CAR3( ) CAR3( 1 2 3 , , , , CAR1( ) CAR2( ) CAR3( ) CAR3( 1 2 3 , , , , ) 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 1 2 3 ) CAR1( ) CAR2( ) CAR3( ) CAR3( MCAR MCAR3 3 , 1 2 3 , , ,

Holding Period Month 1 R ( R ( R ( R ( Month 2 R ( R ( R ( R ( Month 3 R ( R ( R ( R ( ) ) ) ) ) ) ) ) ) ) ) ) 1 2 3 , , , 1 1 2 3 , , , 2 1 2 3 , , , 3 1 2 3 , , , 4 1 2 3 5 1 2 3 6 1 2 3 7 1 2 3 8 1 2 3 9 1 2 3 10 1 2 3 11 1 2 3 12 1 2 3 13 R ( ) R ( R ( ) ) , , , 1 2 3 14 MAR MAR2 2 MAR MAR3 3 MAR MAR1 1

TESTS: TESTS: 1) MCAR 1) MCARH H > 0 > 0 2) If, MCAR 2) If, MCARH H > 0; find > 0; find Optimal H Optimal H 3 3) Test of Statistical Significance ) Test of Statistical Significance 4) Analyze MARs 4) Analyze MARs

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4. Results and Analysis Mean Cumulative Average Returns - MCAR The will indicates how much the portfolios including winner and loser portfolios earn on average during test holding period. Test if Winners Losers > 0 We expected to prove our hypothesis that MCARw MCARl > 0, and based on the T-Stats results shown below for various MxN strategies, we concluded that our hypothesis was correct. Statistics of the Return MCARw - MCARL of portfolio applying the MxN Momentum Investment Strategy > 2 Also, we found particularly interesting the value seen in the 6X12 strategy, whereas the T-Stats value reached the highest value at 6.773 while providing the highest Mean/Variance ratio. Prepared by: Momentum Investment - Finance 663 Derek Song, German Hurtado, Mustafa Jalil Qureshi, Rodrigo De La Maza

4. Results and Analysis Mean Cumulative Average Returns - MCAR But, after analyzing all the historical data, which strategy is the optimal? We tested six momentum investment strategies with different formation periods (3 or 6 months) and holding periods (3, 6, 12 months). We can conclude that the longer formation period, the higher investment return. If we annualize the returns of all portfolios with different holding periods, we can find that, generally, the 6x12 strategy with 28.9% annualized return gives the highest value with the respective of Mean/Variance of 0.603. Annualized returns of portfolios with various holding periods Prepared by: Momentum Investment - Finance 663 Derek Song, German Hurtado, Mustafa Jalil Qureshi, Rodrigo De La Maza

4. Results and Analysis Mean Cumulative Average Returns - MCAR Although the accumulative returns of both loser and winner portfolio grows throughout the 12- month period, the pace of increase slows down during some periods. Even in the 2nd, 10th and 12th months, the MCAR of winner portfolio goes down. It may also be observed that MCAR of loser portfolio almost remains negative except in 6th and 10th month. It is important to note that the range of data we are testing covers two recessions and two rebounds. Thus, it becomes clear that regardless of the market direction, the difference of winner and loser remains positive and growing. MCAR of winner and loser portfolio for the testing period for 6x12 trading strategy 30.00% Winner MCAR 25.00% 20.00% Loser MCAR 15.00% 10.00% 5.00% 0.00% -5.00% -10.00% 1 2 3 4 5 6 7 8 9 10 11 12 Prepared by: Momentum Investment - Finance 663 Derek Song, German Hurtado, Mustafa Jalil Qureshi, Rodrigo De La Maza

4. Results and Analysis Mean Average Returns - MAR The MAR of a portfolio denotes the mean of the average return of the portfolio in the tth month of the testing period. The MAR test helps identify: (i) Whether it is the winner portfolio or loser portfolio that runs outs of momentum and if (ii) The returns of which portfolio (winner or loser) are reversed in the first instance. We calculated the difference between MARW and MARL. We can see that the overall MAR of our portfolios are positive in each month of the holding period. The mean of monthly returns is 2.4% and the standard deviation is 1.86%. The skewness is 1.39, which means we have a more positive returns greater than 2.4%. MARW minus MARL for 6x12 Strategy 8.00% 7.00% 6.00% 5.00% Returns 4.00% 3.00% 2.00% 1.00% 0.00% 1 2 3 4 5 6 7 8 9 10 11 12 Prepared by: Momentum Investment - Finance 663 Derek Song, German Hurtado, Mustafa Jalil Qureshi, Rodrigo De La Maza

Conclusions We validated the hypothesis about Momentum Investment: Assets that perform well over a 3 to 12 month period tend to continue to perform well into the future. Momentum profits provide fund managers with an excellent opportunity to create beta-neutral, superior-return portfolios. The insurance industry in the U.S is a pretty good investment target in order to implement this long-short momentum investment strategy. The average accumulative return during 12-months using this trading strategy is about 28.92%. - This figure is better than the return obtained using a passive investment strategy investing index or ETF. - The optimal formation period in this industry during 2001 2012 is 6 months and holding period is 12 months. Finally, we also showed that Momentum Investment may work well in case markets are positive or negative trending. Prepared by: Momentum Investment - Finance 663 Derek Song, German Hurtado, Mustafa Jalil Qureshi, Rodrigo De La Maza