Question

You are managing a portfolio and considering whether to adopt either one of two trading strategies. In the value strategy, you would hold a portfolio consisting of the 300 stocks with the highest book-to-market ratio. In the seasonality strategy, you would hold a portfolio consisting of the 300 stocks with the highest returns in the upcoming calendar month of the previous year. In both cases, you would rebalance portfolios at the end of each month. Suppose you forecast that both strategies would earn the same average monthly return (before trading costs) and same monthly standard deviation. Which strategy would you follow and why?

Answer 1

I would prefer the Seasonality strategy because its well established in equity markets, Stock prices tend to follow the same seasonal directions every year. Further Logically adding the reason to believe why it works seasonally, All the investor tend to follow the market patern, for eg. if whether forcast is good, People tend to buy shares of companies into Agri sector, if Festives is arriving and we know it would lead to high consumer demand in capital goods like automobile industry, electronic industry, people tend to buy shares of those companies.

Also, There are some disadvantages to value strategy, Companies might have High book to market ratio but it would be riskier if the company have most of its net assets spent on R&D and no tangible assets, whereas this strategy holds good in cases where Mostly the shareholder's equity is invested in Liquid Assets. Since it shows how much investor wants to pay for per dollar invested in Net asset.