Factor investing: A stock selection methodology for the European equity market

Abstract

This paper uses European high capitalization corporate data for the 1991–2019 period to demonstrate that a systematic active management portfolio based on the identification of value, profitability, and momentum factors can outperform competing benchmark strategies. Factor investment methodologies received significant attention in the literature in the U.S. market but their application to European corporates is more limited. The authors construct several systematic investment strategies combining different metrics measuring the three factors. Reported results show that a) combined (mixed/conditional) strategies deliver positive alphas and significantly outperform their pure strategy counterparts and b) while there exists a time changing performance of selected metrics the iterative combination of factors delivers the highest performance with average annualized compounded returns of up to about 17%. Three Key Takeaways: 1. This paper documents the existence of alpha-generating factor strategies based on a combination of value, profitability, and momentum metrics. Combined (mixed/conditional) portfolios significantly outperform their pure strategy counterparts. 2. The iterative combination of factors delivers the highest performance with annualized compounded returns of up to 17%. 3. In line with the recent literature, we find decaying returns to factor strategies.

This paper uses European high capitalization corporate data for the 1991–2019 period to demonstrate that a systematic active management portfolio based on the identification of value, profitability, and momentum factors can outperform competing benchmark strategies. Factor investment methodologies received significant attention in the literature in the U.S. market but their application to European corporates is more limited. The authors construct several systematic investment strategies combining different metrics measuring the three factors. Reported results show that a) combined (mixed/conditional) strategies deliver positive alphas and significantly outperform their pure strategy counterparts and b) while there exists a time changing performance of selected metrics the iterative combination of factors delivers the highest performance with average annualized compounded returns of up to about 17%. Three Key Takeaways: 1. This paper documents the existence of alpha-generating factor strategies based on a combination of value, profitability, and momentum metrics. Combined (mixed/conditional) portfolios significantly outperform their pure strategy counterparts. 2. The iterative combination of factors delivers the highest performance with annualized compounded returns of up to 17%. 3. In line with the recent literature, we find decaying returns to factor strategies.