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Assignment 1 FactorModels QEPM

This document outlines a case study assignment for an MSc in Finance course on quantitative equity portfolio management. The assignment involves three sections: 1) describing MSCI factor indices, 2) replicating a factor-based investment strategy from research reports, and 3) analyzing factor-based ETFs. For section 1, students will present on individual MSCI factor indices. Section 2 tasks students with building long-only and long/short portfolios based on a customized factor model and quant score, and then backtesting returns. For section 3, each student will analyze a single factor-based ETF and compare it to benchmarks. The assignment aims to provide hands-on experience with factor investing concepts discussed in class.

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Assignment 1 FactorModels QEPM

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AnshulSharma

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ALBA MSc in Finance

Advanced Equity Analysis & Portfolio Management, March 2016

Case Study #1 QEPM

Description
You will have to work on a group assignment using MSCI Factor Indices and selected
research reports by the quantitative teams of major Investment Banks. In addition, you
will use this knowledge to analyze related ETFs and answer some questions on portfolio
management topics.
The purpose is to gain deeper knowledge on the topics discussed in class by learning the
key factors used in Quantitative Equity portfolio management (QEPM) and applying a
similar approach to a custom dataset from Datastream. In addition, I want you to get
familiar with the family of MSCI Factor Indices as they are a product of the same
work/research and will potentially help you think of alternatives to finetune the existing
strategies presented by the quant teams of the investment banks that you will be
assigned.
The project is comprised of several sections and will be delivered gradually as we
proceed with our lectures.

Tasks to complete:
Section 1: Getting Insight on MSCI Factor Indices: Each team member has to describe
the key points of one subfamily of Factor Indices. Next week, you need to present the
key points of the methodology/intuition using any supporting material from the site (see
below Tools to be used for details)
Minimum required information:
a. definitions, methodology, # of companies/countries included and of course the
underlying theory/intuition
b. Weighting method: price weighted, value-weighted, equal-weighted
c. top 5 or 10 of companies/countries in the basket/index provided you have
access to constituents / members data.

In the Assignments\Factor models\ folder in Dropbox there is a spreadsheet with a specific

assignments by team member).
Max Size: 2 pages/index - Weight: 20%/Due: 16 March 2016

Instructor: Dimitris Leimonis, dleimonis@alba.edu.gr

ALBA MSc in Finance

Advanced Equity Analysis & Portfolio Management, March 2016

Section 2: Replicating a Factorbased Investment Strategy: I have selected some very

interesting research reports by JP Morgan (JPM) and Morgan Stanley (MS) quantitative
departments and your task will be to read them and try to replicate their approach.
There are 2 core papers I want you all to read that describe their core approach to
select stock using factors (JPM, GEM, The Q-Score 24.02.2012 and MS, Tools for
Stock Classification and Alpha Generation). In addition, take a quick look at the report
named Global Factor Performance Summary so that you get an insight of what works
and what does not (I include past 2 years report for those that want to check what was
working back then). Provided you have completed the previous section of the project and
studied the material on Stock screening and Ranking you are now ready to proceed with
this section. I want you to use primarily JPM material found in Assignments\Factor
models\ folder in Dropbox) and replicate the approach to rank stocks, making any
necessary adjustments based on your data availability. Eventually, you will build your
customized Z or Q-score based on the factors you select (and of course justify properly).
Regarding the selection of factors, you will have the opportunity to explore Datastream in
the following weeks and decide the ones you prefer. The selection of the factor should be
properly justified linking back to major academic papers each student should present a
summary of one academic paper referring to one of the factors your team will be selecting.
Starting from 2011, I need you to build 2 portfolios:

1 Long-Only portfolio with 10 stocks that have the best combined quant
score based on your customized methodology / selection of factors.

1 Long/Short Portfolio with 5 long positions and 5 short.

You can use similar factor weightings like JPM (or MS) or use equal weighting or apply your own weighting
scheme. You need to justify/elaborate on your selection though.

Those portfolio will be Buy and Hold but for those that want to take it further you can
decide/apply a rebalancing strategy, choose one from the following: quarterly, semiannually, annually(I will give extra credit for those that they apply the rebalancing
policy ).
Once you create your portfolios I want you to get stock price data 1 year earlier and
calculate their 12 month returns and compare those results with MSCI World and SPX
and write one paragraph with your comments on it.

Instructor: Dimitris Leimonis, dleimonis@alba.edu.gr

ALBA MSc in Finance

Advanced Equity Analysis & Portfolio Management, March 2016

Describe the building steps/process and the intuition behind your strategy and
present your results in a professional way, using references when needed.
Calculate and comment on the correlation of the several portfolios and the
benchmarks. What weaknesses did you discover on JPMs approach? Make a short
note max 1-11/2 paragraph.
Please justify your factor selections towards the creation of an optimal quantitative
stock selection strategy/approach?
Important instructions:
You need to apply a similar process in evaluating your strategy like JPM and backtest your
results. Your primary source of data should be Reuter s EIKON / Datastream but
you can also use a tool like FT, FinViz or any other decent screener to support your work
but I believe that the best route is to go with the EIKON choice.

Use monthly data and assume no transactions costs in your analysis.

In case you have outliers in your data, you can limit them to +/- 3 z-score (similar to
what quants are doing I will discuss this in our next lecture).
You need to justify the choice/weighting of factors by referencing the material on
Dropbox.

Max Size: total 6 pages // Weight: 50% // Due Date: 23 March 2016

Section 3: Factor-based ETFs: Capitalizing on the knowledge you have already; it is

time to look for ETFs that apply the principles above. Each team member should pick
and analyze one ETF that is factor-based and compare it with the ETFs selected by the
other team members as well as SPY and GLD ETFs (we will refer to them as benchmarkETFs).

Each student will work with 3year monthly returns of selected ETFs and your team will
have to reply to the following questions:

Instructor: Dimitris Leimonis, dleimonis@alba.edu.gr

ALBA MSc in Finance

Advanced Equity Analysis & Portfolio Management, March 2016

Q1: Calculate the realized returns for a hypothetical portfolio invested equally in the
three ETFs you selected. You may simply average the returns, assuming that each
month you are rebalancing the portfolio so that an equal value is invested in each
ETF. We will refer to this as the equally weighted portfolio. Calculate the mean
(average) realized return and standard deviation of the realized returns for each
ETF, the equally weighted portfolio, and the benchmark ETFs.

Compare and contrast the mean and standard deviations of these alternative
investments. What are the visible differences?

When choosing between the three individual ETFs and ignoring combinations of
these

investments,

which

would

you

suggest

for

yourself

given

your

questionnaire assignment? Why? (Each student will answer on this separately

and then you will combine your answers in the group report).

How does your answer change if you add the benchmark ETFs as allowable
investments to your portfolio (assume equalweighting)?

Instructor: Dimitris Leimonis, dleimonis@alba.edu.gr

ALBA MSc in Finance

Advanced Equity Analysis & Portfolio Management, March 2016

Q2: Calculate the correlation between each of the selected ETFs, the benchmark
ETFs and the equally weighted portfolio. What do the correlations between the
individual securities indicate? What insight is provided by the correlation between the
equally weighted portfolio and the benchmark ETFs?

Max Size: total 4 pages // Weight: 30% // Due Date: 23 March 2016

Resources / Tools to be used:

MSCI website (http://www.msci.com), with special focus on Factor Indices

section. You need to check the relevant factsheets, methodology docs, investor
insight papers, research papers as well as performance data and anything else
that will assist you mastering the indices you will have to analyze. Here are
some indicative links:
MSCI Factor Indices (Risk Premia)

http://www.msci.com/resources/factsheets/MSCI_Factor_Indices.pdf

Foundations of Factor Investing

http://www.msci.com/resources/pdfs/Foundations_of_Factor_Investing.pdf

An Analytical Framework for Factor Investing

http://www.msci.com/resources/pdfs/Introducing_MSCI_IndexMetrics.pdf

IPE Webinar: A Framework for Implementing Factor Based Equity Allocations

https://www.brighttalk.com/webcast/2163/93329/a-framework-for-implementingfactor-based-equity-allocations

Under the Assignments\Factor models\ folder in Dropbox you will find research
reports by the quantitative teams of major investment banks. All teams have to
go over

Quantitative Finance - Factor Models_Chapters_4_5 pdf file (located in

Dropbox and Melete): I have scanned and uploaded the chapters on Factor
Models so that to support your reading on the Stock Screening/Ranking topic
using z-score approach. Some of the topics discussed will be repeated in the
Investment Bank papers but..repetition is the mother of all learning! ;)

Instructor: Dimitris Leimonis, dleimonis@alba.edu.gr

ALBA MSc in Finance

Advanced Equity Analysis & Portfolio Management, March 2016

(optional) Under Supporting Material folder in Dropbox there is a quite

interesting document named A Practitioners Guide to Factor Models and a
thesis on Stock Ranking and Portfolio selection. You can use them as extra
references for your work.

REUTERN EIKON / DATASTREAM [MUST]

General remarks: The project has a strict timeline and you need to fulfill certain requests
on time. Failure to deliver the required assignments on time will result on penalties in
order to be fair to those that deliver on time.