Industry Specific Hedging

Golden Toque CapitalCarrington Bradley

Patrick KanePete RudnickDennis Wu

February 26, 2004

Agenda

Introduction Industry and Factor Selection Screen Results Portfolio Performance Out of Sample Testing Optimization Parting Thoughts

Introduction

Industry Specific Comparison Are there certain industries that

over/under perform based vs. the market? Cam’s Merrill Lynch work

Starting point for variables Interest in using FactSet

Cool and powerful tool Get to use a $250,000 laptop

Industry Selection

Based on SIC Codes Two digit codes in FactSet Minimum of 100 companies listed

Banking, Energy, Food, Electronics, and Telecom

Compare to US Common Stock returns for same time periods

1990 to 2000 in-sample time period

Factor Selection

Based on Quant Stock Selection Class Expectational

Consensus forecast earnings estimate revision ratio Change in consensus FY estimates

Momentum 1 month Price change 3 month Price change

Fundamental Dividend Yield Rate of Reinvestment

Energy Screen Results

Energy Sector Screened By 1 Month Momentum

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

-1- -2- -3- -4- -5-

Annu

al V

alue

Wei

ghte

d R

etur

ns

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Stan

dard

Dev

iatio

n

Energy Screen Results

Energy Sector Screened By Reinvestment

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

1 2 3 4 5

Annu

al V

alue

Wei

ghte

d Re

turn

s

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Stan

dard

Dev

iatio

n

Banking Screen Results

Banking sector Screened By 1 Month Momentum

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

1 2 3 4 5

Annu

al V

alue

Wei

ghte

d Re

turn

s

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Stan

dard

Dev

iatio

n

Banking Screen Results

Banking Sector Screened By 3 Month Momentum

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

1 2 3 4 5

Annu

al V

alue

Wei

ghte

d Re

turn

s

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Stan

dard

Dev

iatio

n

Banking Bivariate Result

-1--2-

-3--4-

-5-

-1-

-2-

-3-

-4-

-5-

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

3.00

Valu

e W

eigh

ted

Retu

rn

One Month Price Momentum

Three Month Price Momentum

Out of Sample Results

Out of Sample Energy Sector Screened by Reinvestment

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

1 2 3 4 5

Annu

al V

alue

Wei

ghte

d Re

turn

s

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Stan

ard

Devi

atio

n

Energy Sector 2001-2002Out of Sample Energy Sector Screened by 1 Month Momentum

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

-1- -2- -3- -4- -5-

Annu

al V

alue

Wei

ghte

d Re

turn

s

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Stan

dard

Dev

iatio

n

1 month momentum Reinvestment

Out of Sample Banking Sector Screened by 3 Month Momentum

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

-1- -2- -3- -4- -5-Annu

al V

alue

Wei

ghte

d Re

turn

s

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Stan

dard

Dev

iatio

n

Banking Sector 2001-2002

Out of Sample Results

Out of Sample Banking Sector Screened by 1 Month Momentum

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

-1- -2- -3- -4- -5-

Anua

l Val

ue W

eigh

ted

Retu

rns

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Stan

dard

Dev

iatio

n

1 month momentum 3 month momentum

Factor Optimization

Code Weights E σSIC_13_F1_B1 - 0.1725 0.0032 0.0925SIC_13_F1_B5 0.3738 0.0226 0.1125SIC_13_F4_B1 0.8408 0.0177 0.0952SIC_13_F4_B5 - 0.0421 - 0.0008 0.1105

Portfolio 1.0000 0.0228 0.1000

Energy Sector with optimized weights

Double S&P Risk 27.3% Return

Factor Optimization Banking Sector with optimized weights

33% more risk than S&P 31.2% Return

Code Weights E σSIC_60_F1_B1 - 0.0923 0.0037 0.0580SIC_60_F1_B5 0.9038 0.0293 0.0627SIC_60_F2_B1 0.2438 0.0053 0.0572SIC_60_F2_B5 - 0.0554 0.0253 0.0726

Portfolio 1.0000 0.0260 0.0600

Parting Thoughts None of our 8 screening factors were

effective screens for total US stocks Screening by return and going long

yields average monthly return: Energy -0.26, Banking 0.16

Solver optimized weights had correct sign

Made lots of money, but did not consider trading costs

Additional Slides

Factors Code 1: 1 month price change

G_PRICE_1MCHG Code 2: 3 month price change

G_PRICE_3MCHG Code 3: Div yield

G_DIV_YLD(NR 0 L45D) Code 4: Rate of reinvestment

G_REINV_RATE(NR 0 L45D) Code 5: Consensus forecast earnings est. revision ratio

(IH_UP_FY1R(0)- IH_DOWN_FY1R(0))/IC_NEST_FY1R(0) Code 6: Change in consensus FY estimates

IH_MEAN_FY1R_3MCHG Code 7: Operating Cash Flow/Sales

G_CASH_FLOW/G_SALES Code 8: Interest Coverage

G_INT_COV

SIC 13 Summary Energy

Factor 1 1 2 3 4 5 Long/Short BenchmarkFractile returns 1.84% 8.50% 10.37% 19.93% 31.34% -29.51% 16.30%Std Dev 31.97% 28.83% 31.34% 31.27% 37.41% 24.07% 13.68%Avg Relative Performance 3.00 2.50 2.75 2.00 1.63

Factor 2 1 2 3 4 5 Long/Short BenchmarkFractile returns 3.32% 7.74% 14.82% 17.58% 21.98% -18.67% 16.30%Std Dev 35.53% 31.90% 29.12% 33.55% 37.27% 26.45% 13.68%Avg Relative Performance 3.06 2.56 2.19 2.25 1.81

Factor 3 1 2 3 4 5 Long/Short BenchmarkFractile returns 12.86% 15.60% 18.35% 33.33% 11.44% 1.42% 16.30%Std Dev 25.51% 33.32% 38.75% 63.94% 35.72% 16.11% 13.68%Avg Relative Performance 2.38 2.44 2.19 2.44 2.44

Factor 4 1 2 3 4 5 Long/Short BenchmarkFractile returns 22.03% 18.76% 13.23% 4.92% 1.82% 20.21% 16.30%Std Dev 34.81% 28.46% 26.94% 30.86% 37.79% 26.52% 13.68%Avg Relative Performance 1.63 2.06 2.31 2.94 2.94

SIC 60 Summary Banks

Factor 1 1 2 3 4 5 Long/Short BenchmarkFractile returns 5.09% 21.22% 19.55% 29.70% 39.03% -33.94% 16.30%Std Dev 20.40% 20.27% 21.42% 23.68% 22.48% 12.97% 13.68%Avg Relative Performance 3.63 2.56 2.63 1.94 1.13

Factor 2 1 2 3 4 5 Long/Short BenchmarkFractile returns 6.55% 18.08% 19.50% 21.38% 35.98% -29.42% 16.30%Std Dev 21.17% 19.60% 20.59% 22.73% 26.07% 17.29% 13.68%Avg Relative Performance 3.38 2.44 2.44 2.25 1.38

Factor 3 1 2 3 4 5 Long/Short BenchmarkFractile returns 32.95% 22.54% 16.49% 13.45% 17.90% 15.05% 16.30%Std Dev 23.20% 23.69% 22.44% 20.91% 23.22% 13.28% 13.68%Avg Relative Performance 1.25 2.13 2.69 3.06 2.75

Factor 4 1 2 3 4 5 Long/Short BenchmarkFractile returns 22.95% 18.25% 19.15% 15.67% 19.16% 3.79% 16.30%Std Dev 23.28% 22.03% 21.24% 21.09% 23.23% 15.01% 13.68%Avg Relative Performance 1.94 2.69 2.31 2.81 2.13