1. OUTPERFORMING STOCK INDICES USING PROXIES FOR RISK AND RETURNS Vashishta Bhaskar Duquesne University Presented at QWAFAFEW September 9, 2014

2. Introduction Efficient markets Implications for investors Active equity portfolio management strategies Empirical results of sort by factor methodologies Expansion of existing quantitative techniques

3. Efficient Markets A market in which security prices rapidly reflect all available information Random walk (short term) Provide positive return (long term) Expected Returns are a function of Size, Relative Value (value-growth), Risk and Momentum

4. Implications for Investors and Money Managers Risk tolerance Diversification Passive investing Buy & hold portfolios Indexing

5. Active Equity Investing Fundamental Analysis Top-down Bottom-up Technical indicators Identify Attributes that provide superior returns

6. Empirical Results of Factor Based Strategies – Sort methodology Fama-French 1992 study concluded that small market equity portfolios performed better than large equity; And, higher book-to-market performed better than lower book-to-market.

7. Adapted from What Works on Wall Street. Size Effect 1952-2003 Market CapitalizationReturn %Standard Deviation Sharpe Ratio <25 million28.1247.510.63 25 million to <100 million15.9630.750.46 100 million to <250 million13.7224.850.46 250 million to < 500 million13.5621.460.47 500 million to <1 billion12.1819.340.44 >= 1 billion11.7516.980.45 Market Leaders*13.5217.370.54 Adapted from What Works on Wall Street pgs. 61-62 *Market leaders defined as: non-utility, market cap > avg., cf > avg., sales > 50% of avg. from COMPUSTAT.

8. Returns: Russell Indices 2004-2013 Summary Statistics - Russell.fld 12/1994-12/2013 Arithmetic Mean (%) Geometric Mean (%) Standard Deviatio n (%) Sharpe Ratio N Positive Periods Average Decline (%) Maximum Decline (%) Ending Index Value Russell 2000 TR11.079.2719.670.562713-12.87-34.8258,914 Russell 2500 TR12.6110.7719.690.640516-14.53-36.7977,3430 Russell 1000 TR11.319.3819.850.569916-37.17-37.660,0728

9. Returns by Cap 250M – 1B 1B–5B and > 5B. (1994-2013) Arithmetic Mean (%) Geometric Mean (%) Standard Deviation (%) Sharpe Ratio N Positive Periods Average Decline (%) Maximum Decline (%) Ending Index Value Small Cap10.968.8621.290.51513-12.65-40.6254,589 Mid Cap12.6910.8619.880.63814-15.33-34.8978,634 Large Cap12.5510.56200.627815-34.8-40.1674,458

10. High 100 CAPX and Low 100 CAPX Portfolio Returns by Cap Arithmetic Mean (%) Geometric Mean (%) Standard Deviation (%) Sharpe Ratio N Positive Periods Average Decline (%) Maximum Decline (%) Ending Index Value Small Cap High CAPX 10028.4624.0834.000.837116-14.48-41.06748,374 Small Cap Low CAPX 1005.813.2222.930.253511-27.13-53.7918,834 Mid Cap High CAPX 10022.7619.5927.510.827217-16.1-43.51358,013 Mid Cap Low CAPX 1008.296.3519.790.41912-21.28-50.4734,250 Large Cap High CAPX 10016.4114.1222.610.725915-21.12-37.36140,449 Large Cap Low CAPX 1007.845.4221.360.367114-47.34-50.4628,729

11. Small Cap High CAPX – Low CAPX ReturnSmall Cap High CAPX minus Period End High CAPXLow CAPX Dec941.15%-10.68%11.83% Dec9530.75%28.12%2.63% Dec9634.96%19.93%15.03% Dec9739.13%17.16%21.98% Dec98-7.54%-15.00%7.45% Dec9931.37%35.98%-4.62% Dec0034.58%-16.65%51.23% Dec0111.88%-6.28%18.16% Dec020.93%-18.60%19.53% Dec0373.35%43.32%30.03% Dec0450.68%8.80%41.89% Dec0528.81%-4.81%33.63% Dec0638.40%11.36%27.05% Dec0722.16%-15.04%37.20% Dec08-41.06%-45.61%4.55% Dec09118.92%29.06%89.86% Dec1048.88%13.89%34.98% Dec11-5.97%-15.53%9.56% Dec127.33%18.62%-11.29% Dec1354.90%30.89%24.01%

12. Why Z – Score? Expected return from Corporate Bonds = Risk free rate + bond risk premium Expected Return from Equity = Company specific bond rate + equity risk premium Z score model and calculation provided at the end of this presenation

13. 50 Stock portfolios based on high and low Z scores Arithmetic Mean (%) Geometric Mean (%) Standard Deviation (%) Sharpe Ratio N Positive Periods Average Decline (%) Maximum Decline (%) Ending Index Value Small Cap High CAPX High Z 5032.7527.9637.550.872115-10.22-35.881,385,930 Small Cap High CAPX Low Z 5024.6720.1232.980.748315-16.27-45.14391,135 Mid Cap High CAPX High Z 5029.7826.0732.190.925119-37.01 1,028,754 Mid Cap High CAPX Low Z 5015.1412.3225.060.604314-15.11-43.97102,201 Large Cap High CAPX High Z 5018.3316.0422.210.825415-18.53-39.14195,975 Large Cap High CAPX Low Z 5014.5111.8525.460.569814 -22.75-36.8593,915.37

14. Z Score effects Small Cap High z - Low Z High CAPX High ZLow Z 50 Return thru Dec946.09%-2.43%8.52% Dec9529.86%35.64%-5.78% Dec9636.03%34.08%1.95% Dec9746.46%30.49%15.96% Dec98-5.06%-15.39%10.33% Dec9949.14%23.78%25.37% Dec0037.11%44.47%-7.36% Dec0124.80%-2.36%27.16% Dec02-4.86%5.39%-10.25% Dec0367.24%69.87%-2.63% Dec0452.48%50.29%2.19% Dec0531.38%21.57%9.81% Dec0650.60%32.26%18.34% Dec0721.41%27.10%-5.69% Dec08-35.88%-45.14%9.26% Dec09147.21%91.94%55.27% Dec1053.78%38.82%14.96% Dec11-1.97%-15.11%13.14% Dec1212.29%0.04%12.24% Dec1346.29%69.09%-22.80%

15. Arithmetic Mean (%) Geometric Mean (%) Standard Deviation (%) Sharpe Ratio N Positive Periods N Negative Periods Average Decline (%) Maximum Decline (%)Starting Index = 10.,000 Ending Index Value Large Cap12.5510.5620.000.6278155-34.80-40.1674,458.7836 Large Cap High CAPX 10016.4114.1222.610.7259155-21.12-37.36140,448.9883 Large Cap High CAPX High Z 5018.3316.0422.210.8254155-18.53-39.14195,975.8426 Large Cap High CAPX Low Z 5014.5111.8525.460.5698146-22.75-36.8593,915.3658 Large Cap Low CAPX 1007.845.4221.360.3671146-47.34-50.4628,728.8504 Mid Cap12.6910.8619.880.6380146-15.33-34.8978,634.6707 Mid Cap High CAPX 10022.7619.5927.510.8272173-16.10-43.51358,013.2837 Mid Cap High CAPX High Z 5029.7826.0732.190.9251191-37.01 1,028,754.4758 Mid Cap High CAPX Low Z 5015.1412.3225.060.6043146-15.11-43.97102,201.3356 Mid Cap Low CAPX 1008.296.3519.790.4190128-21.28-50.4734,250.1741 Small Cap10.968.8621.290.5150137-12.65-40.6254,589.6128 Small Cap High Capx 10028.4624.0834.000.8371164-14.48-41.06748,374.3280 Small Cap High CAPX High Z 5032.7527.9637.550.8721155-10.22-35.881,385,930.5502 Small Cap High CAPX Low Z 5024.6720.1232.980.7483155-16.27-45.14391,135.1867 Small Cap Low CAPX 1005.813.2222.930.2535119-27.13-53.7918,833.9723 Summary Statistics - 12/1994-12/2013

16. Limited conclusions and further research CAPX is indicative of future returns Z score can be used as a further discriminant as a proxy for risk There are additional factors such as value and momentum that can be incorporated in an overall strategy Scaled CAPX or items such as retention ratio may be useful