E X H I B I T 1 0 Risk Analytics
Source: eVestment.
attribution of the founder-CEO index is concentrated in three primary sectors: IT, Health Care, and Con- sumer Discretionary. The IT sector generates 233.79% return (compared to 120.14% for the VUG bench- mark), the Health Care sector produces 587.37% return (versus 159.34% for the benchmark), and Consumer Discretionary provides 249.20% (versus 139.31% for VUG). Performance attribution represents a com- bination of security selection and asset allocation. As Exhibit 11 shows, of the 60.79% excess return, the vast majority (56.35% of 60.79%) corresponds to security selection. Only 4.43% corresponds to asset allocation. Notably, the founder-CEO index would have performed better if sector weights in the strong-performing Health Care and IT sectors matched the benchmark sector weights. 52 Continuing with the performance attribution analysis, Exhibit 11 illustrates how the founder-CEO index does not gain excess returns from sectors such as Industrials, Real Estate, Consumer Staples, Energy, Materials, and Utilities. We note that most of the weight of the index resides in three to four sectors (Consumer Discretionary, IT, Health Care, and Financials). When evaluating the performance of the founder- CEO index, we surmise that in addition to the market model, there are likely other factors that might be able to explain the 60% + excess return. Because our founder-CEO index has a strong bias toward three sec- tors (IT, Health Care, and Consumer Discretionary), a strong orientation toward growth, and a monthly return distribution that suggests momentum might be a consideration, we decide to first test for these factors. We first analyze our data against well-known factors Can Traditional Factor Models Explain Excess Returns?
to assess whether or not the founder-CEO factor might be redundant, or possibly better represented by some other factor. 53 Exhibit 12 shows the total active return of our founder-CEO index (blue line) versus the Fama– French three-factor model that examines market, value, and size. 54 As we can see from the Fama–French three-factor model, there is a significant gap between the blue line and all of the other lines. U.S. value represents − 6.53%, U.S. market provides − 0.36%, and among the three factors shown, U.S. size provides the dominant effect of 20.43%. This means out of the total active return (60.79%), the Fama–French model accounts for only 13.54%. Based on this analysis, it is unclear if any other factors, regardless of founder CEO, might be inf luential. We next decide to use another popular factor model (Carhart) that builds upon the Fama–French three-factor model by introducing the momentum factor. The Carhart model is shown in Exhibit 13. The Carhart model includes the same factors as before, but it still resides well below the blue line of total active return. U.S. value represents − 6.53%, U.S. market − 0.36%, U.S. size 20.43%, and the new momentum factor adds 2.17%. The momentum factor of 2.17% provides an improvement from the prior model, although it still leaves much of the total active return without explana- tion. Total active return of the founder-CEO index is 60.79%, and the Carhart model accounts for 15.71% of that amount, leaving a balance of 45.08% without explanation. 55 We next decide to examine a more exhaustive factor model (on Bloomberg) that incorporates virtually every known factor into the analysis. The results may be surprising to many academics and seasoned profes- sional investors and might very well be a major empirical finding in the academic literature. 56
L EADERSHIP M ATTERS : C RAFTING A S MART B ETA P ORTFOLIO WITH A F OUNDER -CEO T WIST
W INTER 2017
Made with FlippingBook - Online magazine maker