Style investing and information conveyed by past returns in South Africa : an empirical analysis.
Mkwanazi, Sthabiso Tarrence.
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The aim of this study was to establish the long-run relationship between six selected South African indices (i.e., large cap, small cap, resources, value, growth and industrials). Long-run relationships were analyzed in relation to mutual funds’ style drift in an attempt to view the underlying diversification opportunities and potential risk faced by investors. The Engle-Granger two-step procedure and asset class factor models were used to encounter this territory. Using daily and weekly closing prices from 2006 to 2014 the results from the Engle-Granger two-step procedure show that there are drastic changes in long-run relationships between the six selected indices when broken into two year periods. In addition, the results reveal that a vast number of long-run relationships were established during the 2007 global financial crisis which indicates low diversification strategies during that period. The study captured a consistent, growing long-run relationship between three pairs of indices when the roll-over strategy was implemented. These pairs are small caps/ industrials, small caps/ large caps and small caps /value. The results from the asset class factor model show that there were two apparent style drifts and abundant stock picking in the period covered. However, the reported stock picking does not harm diversification properties since managers ensure that their moves are against binding long-run relationships. Furthermore, the results from the asset class factor model reveal that fund managers tend to follow one another’s moves. This is solid proof and confirmation of herding behaviour among fund managers. South African growth and value indices show complementary relationships when the literature pronounces them as substitutes. The literature declares them to be the opposite of each other. This study found that the growth and value indices possess strong positive linear relationships which are in contrast to what is documented in the literature. Changes in long-run relationships and dispersed asset allocations have direct implications for investors’ opportunities for diversification. Since positive long-run relationships erode diversifying properties, it is important to continue checking the long-run relationships between indices before investing as they are prone to drastic change in a short period of time, i.e., as little as two years.