Question

In active portfolio management, anomaly-based investment strategies are common. Identify and explain these strategies. Also explain what would be the main factors that contribute to the high returns of these strategies.

Answer 1

Anomaly based are common in active portfolio management strategies because these are often leading to realignment of the portfolio according to the changing trends in the market such as-

A. Small firms tends to outperform-it is a common market anomaly which focuses that small firms are always outperforming the larger firms on a longer time frame because these smaller foryms are having a large potential of growth whereas large companies do not have that much potential for growth.

B. January effect- January effect focuses on those companies who have underperformed in the fourth quarter of last year will be outperforming in the new year in January.

C. Neglected stocks also tends to outperform the largest stock because they are not covered by various analyst and there is a low volume as well as and liquidity of those companies and when there is some attention shown to those companies, they will be outperforming the larger companies

D. Low book values- companies which are having low book value would be having a high potential to growth because they would be easily supported by investors and compared with the current market value.

E. Reversal of performance is another market anomaly which would be stating that Good stocks which have outperformed in the previous cycle will be underperforming in the next cycle and vice versa, so this is a sign of reversal in the performance of various stocks.

Factors which will be contributing to high returns of these strategies will be herd following and highly believed criteria because a large number of investors will be making position in the same direction, and that would flourish rate of return on these stocks based upon this market anomaly.