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7/29/2019 Value investing in emerging markets http://slidepdf.com/reader/full/value-investing-in-emerging-markets 1/98  1   Value  Investing in the Emerging  Markets Master thesis Marjo Riitta  Elisa  Pitkänen  Copenhagen  Business School  Finance and  Strategic Management  Supervisor:  Ole  Risager December  2011 Pages:  80,  Characters:  139,548 
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 Value Investing in the 

Emerging Markets 

Master thesis 

Marjo‐Riitta

 Elisa

 Pitkänen

 

Copenhagen Business School Finance and Strategic Management Supervisor: Ole Risager December 2011 Pages: 80, Characters: 139,548 

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 Acknowledgments 

Writing this master thesis has been an especially interesting journey into the fields of value

investing, different schools of thought within finance, as well as the emerging markets. It has

also nicely brought my academic journey from Psychology studies in the UK to Finance and

Strategic Management at Copenhagen Business School to an end; As well as helped in giving

direction for a future career in the field of asset management.

I would like to thank Ole Risager for his knowledgeable guidance and ideas and my family

for support and patience. It would not have been possible to write this thesis without such

guidance and support for which I am very thankful.

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Executive Summary  

First introduced in 1934 by Benjamin Graham and David Dodd, value investing involves

 purchasing securities that are undervalued by the markets when compared with the security’s

intrinsic value. It thus involves quite a bit of quantitative and qualitative research on the part

of an investor and once a stock qualifies as an investment target, it is held for long periods of 

time. Value stocks are generally defined as companies with low market-to-book, price-to-cash

or price-to-earnings ratios or a high dividend yield. Value companies are those without

significant technology, operating in mature and low growth industries.

Emerging markets have become popular investment targets due to their high GDP growth

 prospects, relatively low indebtedness and interesting structural and demographic changes

among other such trends. High GDP growth, however, does not necessarily imply higher 

equity returns as argued by Dimson, Marsh and Staunton (2010). As seen in this paper, value

investing is especially interesting also in the emerging markets and addressed by the main

research question: Is there a value premium in the emerging markets from 2001 to 2011?

There is a great deal of international evidence for a value premium. From US evidence by

Davis, Fama and French (2000) of 5.5 percent per year between 1929 and 1997, to emerging

markets evidence by Rouwenhorst (1999) of 9 percent per year between 1982 and 1997.

While there is great agreement on the existence of a value premium, there is less agreement as

to why it exists. Two schools of thought; traditional finance and behavioural finance, disagree

on the explanation. Traditional finance argues that markets are efficient, risk and return go

hand-in-hand and a value premium arises because value stocks are riskier than growth stocks.

Whereas behavioural finance argues that markets are not rational and mispricing occurs due to

various behavioural factors and human cognitive biases, which give rise to a value premium.

In this study, a value premium in selected emerging markets between 2001 and 2011 is found.

The value premiums with the market-to-book ratio and 50, 30 and 10 percent portfolios are

7.345, 10.315 and 141.854 percent. With price-to-cash as a sorting percentage, the value

 premiums are 9.330, 13.549 and 46.707 percent. It is also found that the standard deviation

and beta of the value portfolios are higher than those of growth. And that value investing is a

safer strategy in downmarkets with lower correlations among country returns than those found

with the growth strategy.

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When discussing these results, traditional finance view that value stocks are more risky is

looked into first. Standard risk measures are criticised as standard deviation does not

differentiate between upside and downside risk, and beta is easy to use in theory, but does not

adequately explain risk of stocks in practise. Downmarket correlation is an interesting risk 

measure and other downside risk measures for emerging market returns are called for.

Further, an analysis of the performance of emerging market value and growth strategies in

different economic states would be interesting. Nevertheless, it is concluded that behavioural

finance with their limits to arbitrage, framing and prospect theory explanations seem more

applicable in explaining value premiums. Broadly speaking, these theories look at mispricing

in the markets as arising from human cognitive biases that influence decision making

In the perspectives chapter, the real life growth and changes in the emerging markets will be

looked at with an eye on where value and profit opportunities exist. The major trends taking

 place in the emerging markets are highlighted with some examples. Where value could

currently be found in the emerging markets is a question that is addressed with a look on

which countries and equity markets could be benefiting from the current growth in especially

Asia with the driving force of China: And the focus is on Chile.

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Table of Contents

Acknowledgments ...................................................................................................................... 2 

Executive Summary ................................................................................................................... 3 

Chapter 1: Introduction .............................................................................................................. 7 

Research question

 .......................................................................................................................

 8 

Sub‐questions ..............................................................................................................................  8 

Structure ......................................................................................................................................  9 

Chapter 2: Value investing as an investment approach and evidence for value premium ....... 10  

 Value investing as an investment approach ............................................................................  10 

The main developed markets evidence for the  value premium ..............................................  11 

The main emerging markets evidence for the  value premium ..............................................  13 

Chapter 3: The Emerging Markets ........................................................................................... 14 

How to define the emerging markets.......................................................................................  14 

The increasing importance of  the emerging markets .............................................................  14 

GDP growth does not imply  superior returns .........................................................................  16 

Indebtedness of  nations and performance in downturns .......................................................  19 

Chapter 4: Theoretical background .......................................................................................... 21 

Traditional finance ............................................................................................................... 21 

Efficient‐market hypothesis ......................................................................................................  21 

Random  Walk

 ............................................................................................................................

 22

 

Investor rationality  ....................................................................................................................  22 

Expected Utility  Theory  ............................................................................................................  22 

Capital asset pricing model (CAPM) ........................................................................................  23 

Challenging the EMH ‐ Perfect information ...........................................................................  23 

Challenging the EMH ‐ Investor rationality  ...........................................................................  24 

Behavioural finance .............................................................................................................. 24 

Psychology  and limits to arbitrage ..........................................................................................  24 

Mental accounting .....................................................................................................................  25 

Myopic loss aversion .................................................................................................................  25 

Framing .....................................................................................................................................  26 

Prospect Theory  ........................................................................................................................  26 

Chapter 5: Empirical Research ................................................................................................. 29 

Method ..................................................................................................................................... 29 

Data and sources ................................................................................................................... 29 

Emerging markets

 .....................................................................................................................

 29

 

Data provider ............................................................................................................................  29 

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Time period ...............................................................................................................................  30 

Return index ..............................................................................................................................  30 

Portfolio construction ........................................................................................................... 30 

 Variables ....................................................................................................................................  30 

Sorting percentages

 ...................................................................................................................

 31

 

Returns and moments ........................................................................................................... 31 

Defining the returns ..................................................................................................................  31 

 Variance ......................................................................................................................................  32 

Skewness ....................................................................................................................................  32 

Kurtosis .......................................................................................................................................  33 

Portfolio risk ......................................................................................................................... 33 

Standard Deviation ....................................................................................................................  33 

Beta .............................................................................................................................................  33 

Correlations ...............................................................................................................................  34 

Results ...................................................................................................................................... 35 

Emerging market returns and moments ..................................................................................  35 

 Value premiums .........................................................................................................................  37 

Measures of risk ................................................................................................................... 45 

Standard deviation ...................................................................................................................  45 

Beta ............................................................................................................................................

 46

 

Correlation ................................................................................................................................  47 

Chapter 6: Discussion ............................................................................................................... 52 

Answering the research questions ........................................................................................ 52 

Traditional finance explanation ............................................................................................ 54 

Standard deviation ...................................................................................................................  54 

Beta ............................................................................................................................................  59 

Correlation 

................................................................................................................................ 

60 

Behavioural finance explanation .......................................................................................... 61 

Investor rationality  ....................................................................................................................  61 

 A  deeper look on risk ...............................................................................................................  62 

Chapter 7: Perspectives ............................................................................................................ 66 

Can the emerging markets drive the global economy out of doom? .................................... 66 

 Where in the emerging markets can  value be currently  found? ...........................................  69 

Conclusion ................................................................................................................................ 73 

References ................................................................................................................................ 76 

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Chapter 1: Introduction 

Value investing is an investment paradigm first introduced by Benjamin Graham and David

Dodd in 1934 and has by now become a broadly accepted approach. In the style of Graham

and Dodd, value investors recognise that a company has two prices, a price at which a

company is trading on the markets and the company’s intrinsic value. These investors then try

to find companies that are trading below their intrinsic value on the markets and purchase

these companies for the long-term. The existence of a value premium is a widely reported

 phenomenon with studies ranging from the developed markets since the 1930s to today, as

well as more recent studies in the emerging markets.

When looking at the emerging markets, they have become popular investment targets due to

their high GDP growth prospects, which are expected to translate into superior investment

results. Among others, Dimson, Marsh & Staunton (2010), however, find no connection

 between a country’s GDP growth and investment results when they research 83 countries

 between 1972 and 2009. In fact, countries with the lowest GDP growth have the highest

returns. This makes us question the idea of investing into the emerging markets with the

motivation of high returns due to growth, and turns heads towards other investment

approaches, such as value investing. Emerging markets also have high volatilities and risks.

From a value investors’ point-of-view, it can be even easier to find undervalued stocks in

more volatile markets. Value investing can be a ‘safe’ approach in such markets as investors

take care not to pay too high a price for a stock, thus mitigating downside risk.

Theoretically speaking, the existence of a value premium across markets goes against the

efficient-market hypothesis assumed by traditional finance. At least if the premium cannot be

explained with the notion that value stocks are riskier than growth stocks: An explanation that

seems to lack substantial evidence. Behavioural finance, on the other hand, explains the value

 premium with limitations in human cognitive ability and irrationalities and biases in

 behaviour that result in mispricing on the markets that do not immediately correct themselves.

Increasing interest in behavioural finance type of thinking resulting in contrarian investment

approaches, combined with the increasing importance of the emerging markets, this thesis

will investigate these topics and attempt to answer the following research question and sub-

questions.

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Research question 

Is there a value premium in the emerging markets between 2001 and 2011?

Sub‐questions 

1.  Does deep value investing in the emerging markets generate an even higher value

 premium?

2.  Are emerging market value stocks more risky than growth stocks when measured in

traditional risk measures beta and standard deviation?

3.  What are the correlations between selected emerging market country returns for value

and growth portfolios in downmarkets?

4.  Can the value premium be better explained with traditional finance theory or 

 behavioural finance?

5.  Where can value be currently found in the emerging markets?

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Structure 

1) This paper begins with a brief introduction, which highlights the research question and sub-

questions. 2) A deeper look into value investing as an investment approach is next and

followed by an overview of the evidence for a value premium in developed and emerging

markets. 3) The emerging markets will then be defined and their growth and importance

highlighted, as well as the argument that high GDP growth does not necessarily imply higher 

returns. 4) A theory section will outline the approaches of traditional finance and behavioural

finance in detail. 5) After which the empirical research begins: Method of the quantitative

study includes explanations for data and sources, portfolio construction, returns and moments

and portfolio risk. The results section highlights descriptive statistics of the emerging markets

returns, the value premiums found, and the risk measures of standard deviation, beta and

downmarket correlation. 6) In the discussion, the value premiums are explained with

traditional and behavioural finance approaches. 7) And last, in order to add perspective, the

trends taking place in the emerging markets are looked at in more detail and where value can

currently be found in the emerging markets.

1. Introduction

3. Emerging markets

5. Empirical research

4. Theory 

6. Discussion

7. Perspectives

2.  Value investing

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Chapter 2:  Value investing as an investment approach and evidence 

for  value premium 

Value investing  as an investment  approach 

Value investing as an investment paradigm was first introduced by Benjamin Graham andDavid Dodd at Columbia Business School in 1928. A pioneering text by these authors called

Security Analysis was published in 1934. Generally, value investing involves buying

securities that are underpriced by the market when compared with what is sometimes called

an intrinsic value of the security, which an investor derives through some form of 

fundamental analysis. In the view of Graham and Dodd (1934), equity prices include a

rational component reflecting the fundamentals of a company and an irrational component

capturing the emotions and psychology of investors at large. The rational component can be

estimated with careful analysis, but the irrational component varies a great deal, and hence so

do equity prices. They recommend buying a stock when it is underpriced by the market and

then holding it for long time periods, thus creating a margin of safety against losses.

Intelligent Investor by Benjamin Graham (1949), a book that made value investing accessible

to the individual investor, includes the following piece of advice: “If you speculate, you will

(most probably) lose your money in the end. Buy when most people are pessimistic and sell

when they are actively optimistic. Investigate, then invest. Rely on the time-tested principle of 

insurance, with wide diversification of risk.” (Graham, 1949, p. 3) The relevance of this

statement remains, because even though markets have changed, human nature and investment

 behaviour is likely to have remained much the same.

Value stocks are usually defined as companies that have low market-to-book ratio (M/B),

 price-to-cash ratio (P/C) or price-earnings ratio (P/E), or a high dividend yield. Value

companies are often mature companies with not such high growth prospects. In fact, low sales

growth is sometimes also used as a criterion to define value companies. Some may even call

these companies dull and boring, as they are usually not the ones with the newest technologies

and most exciting businesses. Examples of value companies from the Russell 1000 value

index in the US include Johnson & Johnson, AT&T, Procter & Gamble and JP Morgan

Chase. Growth stocks are usually of companies that are expected to grow at a rate that is

higher than average, often having high P/C, B/M and P/E ratios and low dividend yields.

These companies are the ones that appear a lot in the news with their newest technologies and

exciting businesses models. Examples of growth companies in the Russell 1000 growth index

in the US include Apple, Google, Wal Mart and Pepsico. (Risager, 2009)

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There is a great deal of international evidence showing that over long time periods, value

stocks produce higher returns than growth stocks. So much so that it is almost a universally

agreed upon fact that there exists a value premium in stock returns. Among others, Basu

(1977) finds that value portfolios generate higher returns than growth portfolios. Fama and

French (1992) also find a value premium after controlling for market risk and size.

Lakonishok, Shleifer and Vishny (1994) find that searching for deep value can also pay off.

The value premium evidence is especially strong for the United States (US), but also other 

countries, such as the United Kingdom (UK), Japan, other European countries as well as the

Emerging Markets. This evidence for the developed markets will be looked at next and the

evidence for the emerging markets right after.

The main

 developed 

 markets

 evidence

  fo r 

 the

 value

  premium

 

Perhaps the most prominent US evidence for the value premium comes from Davis, Fama and

French (2000) over the period 1929-1997 and including basically all industrial companies on

the New York Stock Exchange and later AMEX and Nasdaq. The stocks are sorted according

to their market-to-book (M/B) ratio with the 30 percent highest ratio stocks as the growth

 portfolio and the 30 percent lowest as the value portfolio. The average value premium found

is 0.46 percent per month, or 5.5 percent per year and it is statistically highly significant.

Lakonishok, Shleifer and Vishny (1994) find that it is even more profitable to search for deep

value by showing that the stocks with the 10 percent lowest M/B and P/C ratios have

significantly higher returns than the 30 percent lowest B/M stocks. Furthermore, they show

that it is beneficial to sort stocks according to more than one criterion, such as low M/B ratios

and low sales growth, with an average return as high as 22.1 for the value portfolio versus

11.4 percent for growth in the period 1963 to 1990.

Dimson, Nagel and Quigley (2003) provide evidence for a UK value premium from 1955 to

2001. Stocks are classified according to M/B ratios and size (Fama & French methodology).

They find a monthly value premium for small cap stocks of 0.48 and for large cap stocks of 

0.50, similar to Fama and French findings for the US. Dimson et al. (2003) find a significant

value premium when sorting stocks according to their dividend yields (D/P), although not as

high as that with the M/B classification.

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Chan, Hamao and Lakonishok (1991) demonstrate a value premium for the Japanese markets

over the period 1971 to 1988 using a large sample of firms listed on the Tokyo Stock 

Exchange. It is found regardless of whether stocks are sorted according to their M/B ratios,

earnings yields (E/P) or P/C. However, the highest and most significant value premium is

found using the M/B ratio and P/C. Cai (1997) sorts stocks according to M/B and P/C ratios

and uses data between 1971 and 1993. A significant value premium is found regardless of the

sorting method, although again, the M/B ratio produces the highest value premium. The

average annual M/B premium is 11.3 percent. Whereas, the average annual P/C premium is 6

 percent. In the Japanese market, the earnings yield does not have much predictive power,

which is due to the fact that earnings figures are often distorted in Japan for various tax

reasons. Cash-flow yields are a better measure in this market as they are less difficult to

manipulate.

The value premium exists also for other developed countries, although it is not as statistically

significant as that of the US, UK and Japan, most likely because of the small sample sizes.

The most comprehensive international study is that of Fama and French (1998) within a time-

frame of 1975-1995 and with MSCI data. A value premium is found in all countries: United

States, Japan, United Kingdom, France, Germany, Italy, the Netherlands, Belgium,

Switzerland, Sweden, Australia, Hong Kong and Singapore. The global portfolio has a value premium that is statistically significant, whereas the individual countries have positive value

 premiums, but they are not statistically significant except that of France. This is most likely

due to small sample sizes. France has a premium exceeding 6.5 percent per year. The value

 premium for Italy is only positive when stocks are sorted according to C/P and other studies

have also found that value investing does not necessarily work in Italy. Consistent with the

US findings, the most suitable sorting variables are B/M and C/P.

Bird & Whitaker (2003) study the value premium in France, Germany, Italy, Spain, the

 Netherlands and Switzerland between 1990 and 2002, which is a time-period when value

strategies did not perform very well. They use B/M as a sorting variable. The value premium

exists in all markets, but is significant only in France (5.5 percent) and Switzerland (7.5

 percent), again most likely due to small sample sizes. The authors find that it is less than 50

 percent of the value stocks that did very well, which implies that it could be beneficial to use

multiple sorting variables as in the studies for the US. Risager (2009) studies the value

 premium on the Danish market over a long time period of 1950-2008 using the P/E ratio as a

sorting variable and a 20 stock sample. The 10 stocks with the lowest P/E ratios are the value

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 portfolio and the 10 stocks with the highest P/E ratio are the growth stocks. With value

weighted portfolios, the value premium equals 4.3 percent and with equal weighting, it equals

6.3 percent. These results are statistically significant.

The main

 emerging

 markets

 evidence

  for 

 the

 value

  premium

 

In their international research on the value premium outlined above, Fama and French (1998)

also study the emerging markets between 1987 and 1995. The emerging market returns are

higher than those of the developed world, with an average annual excess return for the equal-

weight index of 24.47 percent and for the value-weight of 25.93 percent. When portfolios are

formed using B/M, E/P and size as the sorting factors, a value premium is found in emerging

market returns. The annual difference between high and low B/M portfolios is 16.91 percent

for value-weighted and 14.13 for equal-weighted portfolios. The value premium using E/P is

4.04 (for value-weighted) and 10.43 (for equal-weight). The returns are leptokurtic and

skewed to the right, making the statistical inference a bit questionable.

Rouwenhorst (1999) sorting stocks according to their B/M ratio finds a monthly premium of 

0.72 if stocks are weighted equally and 0.98 if countries are weighted equally for a portfolio

of 20 emerging markets between 1982 and 1997. This translates to an annual equally

weighted value premium of 9.00 percent. Drew & Veeraraghavan (2002) find a value

 premium in Malaysia. They report that small and high book-to-market equity (BE/ME) stocks

 produce higher returns than big and low BE/ME equity stocks. Using “high minus low” and

“small minus big” strategies, the respective annual returns are 17.70 percent and 17.69

 percent, while the annual market return is 1.92. Joshipura (2010), in a study between 1995 and

2008, finds a significant abnormal return over a three-year period for the contrarian strategy in

the Indian market. The methodology determines winner and loser stocks by past abnormal

returns over a 36-month period, followed by a three year testing period. They also show that

these profits are not a compensation for higher risk. Their results are consistent with those of 

Jegadeesh and Titman (1993). Further, Hameed and Ting (2000) finds that there seems to be

evidence for markets overreacting and thus for the existence of contrarian profits in Malaysia

and Kang (2002) finds a short term premium for contrarian investing in the Chinese stock 

market (2002).

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Chapter  3: The Emerging Markets 

How  to define the emerging  markets 

Generally, the criteria used to define whether a country is an emerging market or not include

the size and openness of its economy, income per capita, the state at which its integration

within the global marketplace is and its political, legal and financial institutions with their 

strength (Marr and Reynard, 2009). Listing the emerging markets countries is not as simple as

it seems, as even the major stock market index providers do not agree on a listing. There are,

however, 19 common countries that the Financial Times Stock Exchange (FTSE), Morgan

Stanley Composite Index (MSCI) and Standard & Poor (S&P) list as emerging markets and

they are the following: China, India, Indonesia, Malaysia, Philippines, Taiwan, Thailand,

Czech Republic, Hungary, Poland, Russia, Turkey, Brazil, Chile, Mexico, Peru, Egypt,Morocco, South Africa. The emerging markets are generally split into four regions (in

 brackets the representative countries for each region): Asia (China, India, Indonesia,

Malaysia, Philippines, Taiwan, Thailand), Europe (Czech Republic, Hungary, Poland, Russia,

Turkey), Latin America (Brazil, Chile, Mexico, Peru) and Africa and Middle East (Egypt,

Morocco, South Africa).

The increasing importance of  the emerging  markets 

Whichever way they are defined, it is undeniable that the importance of the emerging markets

is remarkable and increasing every moment. Already currently, four fifths of the world’s

entire population is in the emerging markets (five times the number of developed markets)

and approximately three-quarters of the lands are covered by these countries (two times that

of developed markets) (Dimson et al., 2010) Around half of the world’s GDP, close to half of 

the world’s exports as well as energy consumption comes from these economies. (Marr &

Reynard, 2009)

The GDP growth of the emerging markets as a whole has also been significantly faster than

that of the developed world recently. Figure 1 below depicts a PricewaterhouseCoopers

 provided view of world GDP growth projections written by Hawksworth and Cookson and

 based on latest available data. It shows that the emerging markets, led by the BRICs, are

likely to continue growing fast. In fact, the E7 economies (meaning the seven largest

emerging market’s economies) will be 50 percent larger than the G7 economies by 2050.

China will outpace the US as the leading world economy already around 2020 and India will

follow suit by 2050. Brazil and Russia will reach just below US by 2050. These trends will

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decrease the relative importance of leading developed nations like the US, Japan and

Germany. One must note, however, that these are projections and unexpected events result in

growth patterns that are not fully predictable. The world is nevertheless changing at a

remarkable speed. (Dimson et al., 2010)

Figure 1: Developed and emerging market GDP growth 1950-2050

Source: Dimson et al., 2010

The reasons for high growth of emerging markets include relatively low indebtedness, high

 possible productivity, strengthening in domestic demand and consumption, good

demographics and richness in commodities in many emerging countries. Government policies

are expansionary and firms have substantial cash resources. Consumer sentiment is alsoimproving, all of which supports this growth. (Herrmann, Wassermann and Von

Liechtenstein, 2011)

Growth in the different emerging market regions since February 1995 until February 2011 is

shown in figure 2 below. It is clear that Asia has become the most growing part of Asia,

especially in the past ten years, followed by relatively stable performance of Middle East &

Africa, CEE and Russia and Latin America. As a result, Asia also did not suffer to such a

great extent in the previous economic crisis, as seen in the figure below.

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Figure 2: Emerging markets regional performance comparison

Source: Emerging Markets – a differentiated view, Global Economic Research, 2011

GDP   growth does not  imply superior  returns 

A typical reason to invest in the emerging markets is the high economic growth prospects that

these countries promise as opposed to the developed world when measured by GDP growth. It

thus becomes very interesting and relevant to firstly question how strong the link between

GDP growth and returns on the equity markets actually is. Research shows it is much weaker 

than many think, in fact there seems to be no positive link between a country’s GDP growth

and stock market returns. For instance, Dimson et al. (2010) find no connection between a

country’s GDP growth and investment results when they research 83 countries between 1972

and 2009. In fact, countries with the lowest GDP growth have the highest returns. The

Chinese equity market serves as an example about the difficulties of investing into the

emerging markets for growth prospects. Although investors have seen the Chinese economy

grows rapidly over the past decade or so, its equity markets have not developed very much.

What this shows is that GDP growth does not automatically imply profitable companies and

shareholder returns. It is important to remember that no matter where one is investing

geographically, what one is essentially investing in, is companies’ profitability, cash flows

and their return on equity or assets. A good example of this is Latin America: A region that

despite significantly lower GDP rates has outperformed emerging Asia, because the

 profitability of companies in Latin America has been higher (Marr & Reynard, 2009).

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Secondly, it should be realised that markets anticipate economic growth, just as they

anticipate growth in returns in the case of growth companies. Thus this growth is often priced

into securities. Historically, a strategy of investing into countries with high anticipated

economic growth rates has underperformed a similar strategy of investing into countries with

lower economic growth rates. In the same fashion as growth stocks are often overpriced

compared to their relatively cheaper companions in the value family that could have higher 

upward potential, thus translating into higher potential for future profits. (Dimson et al., 2010)

Let us next look into what kinds of stock returns the emerging and developed stock markets

have provided over the past 25 years. As seen in figure 3, equity investors investing in

developed markets have had a difficult time in the 2000s with annual returns close to zero as

shown by the MSCI world index. The emerging markets on the other hand have returned

close to 10 percent annually during the same time. When comparing emerging market returns

with the returns of the developed markets, it becomes clear to see why these markets have

gained so much attention in especially recent times. Looking at figure 3, the only period when

the MSCI world index outperformed the Emerging market index by a significant amount is

the 1980s with a return of 20 percent and outperformance of about 8 percent. In 1976-79 both

returned similar amounts and same goes for the 1990s, with a slight outperformance of the

MSCI world index. And as already mentioned; in the 2000s, the emerging markets returnedabout 10 percent, while the world index returned strikingly low returns of close to zero

 percent. The trend for the MSCI world index returns is first an increase from 1976-79 to the

1980s and ever since a clear declining returns pattern until today’s near zero returns. While

relatively stable returns of around 10 percent persist for the emerging markets index over the

entire 25 year period.

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Figure 3: Emerging and developed market risk and return between 1976 and 2009

Source: Dimson et al., 2009

When looking at risk, some argue that the gap between the developed and emerging markets

is getting narrower. The current sovereign debt crisis in the European Union and the

continuing instability and risk of a double dip and recession in the US are real concerns. Let

us look at the historical standard deviations. As seen in figure 3 above, it is clear that the

emerging markets are more volatile compared with the MSCI world index throughout the 25

years. For both the MSCI world index and emerging markets index, the standard deviations in

the 2000s are about 5 percent higher than they were in the 1970s. It is also worth a mention

that the standard deviations of individual emerging markets shown by the light blue bars are

significantly higher than those of a diversified portfolio of these markets shown by the gray

 bars. But even a diversified portfolio of emerging markets is riskier than the MSCI world

index. While the returns of the MSCI world index are on a decreasing trend over time, the

volatilities of these markets have increased. For the emerging markets, increased volatility has

 been coupled with relatively stable returns that are highly positive also in the 2000s.

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Indebtedness of  nations and   per formance in  downturns 

What is also relevant to risk is the indebtedness of nations. Government debt as a percentage

of GDP in emerging markets as a broad categorisation is overall quite significantly lower than

debt in developed markets. According to IMF estimates, the debt-to-GDP ratio of emerging

market governments fell by 0.2 percent between 2007 and 2010, whereas the same number for 

the developed markets increased by 26 percent. As seen in figure 4, this development is likely

to continue between 2010 and 2015 as well. Some of this difference is due to favourable

demographic trends, such as the rapidly increasing middle-class population, but government

 policy in times of crisis cannot be ignored. Including tighter fiscal and monetary policy to

 build-up of foreign reserves, as well as strenuous capital requirements and lending limits to

 banks in the case of emerging markets. (Country Indebtedness An Update, 2011) With this in

mind, it seems that the emerging markets will keep growing and nevertheless still keep their 

 balance sheets relatively healthy. This is very relevant today as we are living in the midst of a

developed world sovereign debt crisis where government debt seems to be packaged again

and again, as well as moved around, but no long-term solution is in sight.

Figure 4: Change in ratio of government debt to GDP for the G20

Source: Country Indebtedness An Update, 2011

In order to further highlight the relevance of the risk issue between developed and emerging

markets, let us look into how equities in these markets have performed during downturns.

What we see is that even though in the past, the emerging markets have performed relatively

worse compared to the developed markets in downturns, that does not seem to be the case to

the same extent with the recent crisis. Figure 5 below shows the performance of developed

and emerging markets equities during downturns between 1990 and 2011. In the past, the

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emerging markets have consistently shown worse performance during downturns, implying

that these markets are highly volatile and risky especially during recessions. It is interesting to

observe, however, how in the recent downturn between May 2011 and August 2011, the

returns of the developed and emerging markets are very close to each other with developed

market outperformance of only 1.2 percent. Whether this is a persisting trend or not, time will

tell, and it is probably too early to say. Nonetheless, it is definitely one to keep an eye on. In

chapter 7 on pages 66-69 we will further look at how the emerging markets are in fact

 becoming quite independent of the developed world at least in some ways, which could be a

factor playing its part also here.

Figure 5: Performance of developed and emerging market equities during downturns between

August 1990 and August 2011

Source: The Way Forward: Measuring the Impact of Short-Term and Structural Growth

Drivers on Emerging Market Investing, 2011

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Chapter 4: Theoretical background 

While there is broad agreement on the existence of a value premium, there is much less

agreement on why it exists. Is it a market anomaly or can it be explained by showing that

value stocks are riskier than growth stocks? Two schools of thought, Traditional finance and

Behavioural finance, have different explanations for the value premium.

Traditional finance with their Efficient-market hypothesis (EMH) believes that investors are

rational, markets are efficient and follow a random walk, and risk and return go hand-in-hand.

Expected utility theory explains how individuals act in ways that maximise their expected

utility when faced with a risky situation. The capital asset pricing model, on the other hand, is

a model that explains asset returns and risk. As any theoretical explanations, however, these

do somewhat lack explanatory power in the real world.

Behavioural finance takes into account the influence of human psychology on financial

decision making. It attempts to patch the shortcomings of the EMH and find more accurate

ways to explain investor behaviour and thus find an approach that has more explanatory

 power in real life. It disregards the assumption of the EMH that human beings are rational and

rather investigates the key role that psychology and emotions play in financial decision

making. Financial markets are not expected to be efficient; in fact according to behavioural

finance, market efficiency arises only rarely. In the following, these two schools of thought

and their main assumptions will be presented.

Traditional finance 

Efficient‐market hypothesis 

According to the Efficient-market Hypothesis (EMH), financial markets are informationally

efficient, meaning that all publicly available information is fully reflected in stock prices,

which always reflect the fundamental value of a company. This implies that it is not possible

to consistently make returns that are above the average market returns, because all

information is publicly available at the time an investment is made. There is no investment

strategy based on publicly available information that could generate excess market returns.

There are three forms of the EMH where assumptions are more relaxed, the weaker the form.

These are the weak, semi-strong and strong forms of EMH. (Brealey, Myers & Allen, 2008)According to the EMH (especially the stronger forms), the best strategy would be to simply

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invest in the market portfolio as active portfolio management would not generate superior 

returns (Shleifer, 2000). The EMH assumes that there is no systematic pattern in the asset

 prices, as this could be taken advantage of by active money managers, implying that stock 

markets follow a random walk, outlined in the following.

Random Walk  

The idea that stock market prices move according to a random walk process and thus cannot

 be predicted, can be traced back to a French broker Jules Regnault in 1863. It was also

discovered by Kendall in 1953 and written about by Fama in 1965. What is broadly meant by

the random walk hypothesis is that price movements are independent of one another. To

illustrate how, consider a game of tossing a coin, where each outcome is independent of the

other outcomes and then plotting these outcomes into a graph that ends up looking like the

stock market.

Investor  rationality 

The theoretical foundations of the EMH rely on assumptions of human behaviour. Investors

are assumed to be rational and thus naturally also value securities rationally for their 

fundamental value (using the discounted cash flow method, in brief DCF). When new

information is revealed, the prices are immediately bid up or down, almost automatically.

Where investors are not rational does not matter, because their trades are relatively few and

random and cancel each other out thus not affecting overall price levels. Where investors are

irrational in ways that are similar also does not matter as rational arbitrageurs will eliminate

the influence of irrational investors on prices. (Shleifer, 2000)

Expected  Utility Theory  

The Expected Utility (EUT) theory was first initiated by Daniel Bernoulli in 1978 and states

generally that when individuals are faced with a risky choice, they will make a decision that

maximises their expected utility. Hence decision making is based on the expected utilities of 

risky prospects. Expected utility means the expected use of wealth rather than the actual

value. In an equation, the weighted sums of the utilities of outcomes are multiplied by the

 probabilities of these outcomes, then ranked and the ones with the highest expected utility will

 be chosen. Furthermore, most individuals are risk averse and thus have a concave utility

function, see figure 6 below. The EUT and risk aversion are commonly accepted principles in

traditional finance and can be used to predict decisions under risk. However, psychological

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factors challenge the EUT. For challenges relating to the EUT, see the part on Prospect

Theory on pages 26-28.

Figure 6: Expected Utility FunctionSource: Own creation

Capital  asset  pri cing model  (CAPM) 

In traditional finance, a widely used model to for example estimate cost of capital for firms is

the Capital Asset Pricing Model (CAPM) by William Sharpe (1964) and John Lintner (1965).

In this model, risk is shown by the beta ( β ) of a security. According to the CAPM, all

variation in  β  is compensated in returns and thus risk and return always go hand-in-hand.

Unfortunately, the empirical evidence for using the CAPM to measure risk and the relation

 between risk and return is poor. So much so that it invalidates its wide use in this context. For 

example, Fama & French (2006) find that even though the CAPM is sufficient in explaining

the value premiums from 1926 to 1963, it cannot explain the premiums of a more recent

 period from 1963 to 2004. In the more recent period, growth stocks seem to have larger  β s

than value stocks, and yet value stocks outperform growth stocks. Thus, although CAPM is

widely regarded as a useful model, one could argue that its risk measure  β  does not help inexplaining the value premium in the real world to the extent that would encourage as wide a

use as the model currently has.

Challenging the EMH  ‐ Perfect information  

The assumption of perfect information has been challenged with findings that show that all

information is not reflected in stock prices immediately, like EMH assumes. Some important

information may never be public and investors tend to invest when the market is going up and

sell when it is going down, thus engaging in herd behaviour. (Wärneryd, 2001) There have

Utility

Wealth

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 been tests of the weak, semi-strong and strong forms of the EMH. The strong and semi-strong

forms have been shown not to hold in practice and even the weak form has been challenged.

In most cases, it is the weak form if any that may hold. Also, in real life, investors rarely

follow the passive investment strategies recommended by the EMH (Shleifer, 2000).

Challenging the EMH  ‐ Investor  rationality 

It is difficult to prove that investors are rational. As simple as this assumption seems, it is

unlikely to be reality. Black (1986) argued that investors trade on noise, rather than

information. Common mistakes include trading too much, blindly following the advice of 

financial gurus, failing to diversify, selling winning stocks and holding too long onto losing

ones, buying actively managed expensive mutual funds and following stock patterns and

models. (Black, 1986: cited in Shleifer 2000)

In behavioural finance, the assumption of investor rationality is relaxed and investor 

 behaviour is rather looked at through psychological explanations. For example, when

assessing situations that involve risk, investors do not assess the possible final wealth, but

gains and losses relative to a reference point. They also try to avoid losses, called loss

aversion, resulting in a loss function that is steeper than that of gains. Kahneman and Tversky

(1979) model this behaviour as the Prospect Theory, discussed on pages 26-28. In finance,

irrational thinking and behaviour of investors leads to phenomena such as an aversion to

holding stocks, called the equity premium puzzle and the reluctance to sell stocks that lose

value and thus realise that a particular investment was a bad one.

Behavioural finance 

Psychology and  limits to  arbitrage 

Arbitrage refers to a situation where there is a mispricing in the market that is quickly

corrected by rational investors gaining from this situation and thus correcting the market.

Barbaris & Thaler (2002) argue that there are limits to such arbitrage corrections as often

times corrective moves would be costly and risky to these rational investors and thus are not

carried out to the extent and at the speed assumed by the school of Traditional finance. The

limits to arbitrage include the risk that markets may not correct themselves after the rational

investor has attempted to go in with a corrective more, but actually get further mispriced. Thisis called the Noise Trader Risk and was introduced by De Long et al. in 1990 and results

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when irrational investors trading behaviour keeps moving an already mispriced security in the

same direction, despite the moves of some rational investors. Furthermore, transaction costs

 present in the market limit arbitrage possibilities and make correction attempts costly on top

of their riskiness, thus limiting this type of behaviour further.

 Mental  accounting  

Mental accounting involves a process by which individuals use cognitive operations to

organise, evaluate and keep track of their financial activities. It helps understand the

 psychology of decision making, because mental accounting decisions affect perceived

attractiveness of choices. Mental accounting violates economic fungibility, meaning that

money placed in one mental account is not a perfect substitute for money placed in another account. Three components of mental accounting are the following. First, outcomes are

 perceived and experienced. Then decisions are made and afterwards evaluated. Mental

accounting gives inputs for this ex ante and ex post decision making. Second, activities are

grouped into categories, including the sources (income, investments, pension etc.) and use of 

funds (housing, food, spare time etc.). Third, the accounting activities are balanced either 

daily, weekly, monthly or yearly, depending on the preferences of the person. (Thaler, 1999)

 Myopic loss aversion  

According to Kahneman, Tversky and Schwarz (1997), humans are more sensitive to

decreases in their wealth than they are to increases, as seen in the value function of the

Prospect Theory discussed later on (see figure 7). It has been empirically shown that losses

are valued approximately twice as heavily as gains (for example Kahneman and Tversky,

1992). Investors engage in mental accounting and when considering financial transactions, it

involves grouping of transactions either one at a time or in portfolios and the frequency withwhich these portfolios are evaluated. A myopic investor is defined as someone who tends to

make narrow framing of decisions and outcomes. In other words, make short-term rather than

long-term decisions and evaluate gains and losses frequently.

A real life example of this related to investing would be the following and the outcome would

depend on the time horizon of the investor. Think about two investors, one of them myopic,

and the other one not. The investment choices are stocks with returns of about 7 percent and

safe assets with a return of 1 percent. The myopic investor would check their gains and losses

in wealth more often and due to this be more likely to observe a loss. Since losses are more

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 painful, it is more likely that such an investor over time will invest in securities with lower 

risk, such as bonds. The other one would check their wealth less often and thus be more likely

to invest in stocks with higher returns. (Kahneman, Wakker and Sarin, 1997) Later, mental

accounting and myopic loss aversion were incorporated into a theory called the Prospect

Theory, discussed later on.

Framing 

The term “decision frame” used by Tversky and Kahneman (1981) refers to the acts,

outcomes and contingencies that a decision maker associates with some choice. This frame

depends on their norms, habits and personal characteristics as well as how the problem is

formulated. It is possible to formulate a decision problem in many different ways. Changingthe way in which a problem is framed can also result in changing preferences. Kahneman and

Tversky (1981) find that when a question is framed in different ways, choices that involve

gains are risk averse and choices that involve losses are risk taking. According to Kahneman

and Tversky (1981), “Individuals who face a decision problem and have a definite preference

(i) might have a different preference in a different framing of the same problem, (ii) are

normally unaware of alternative frames and of their potential effects on the relative

attractiveness of options, (iii) would wish their preferences to be independent of frame, but 

(iv) are often uncertain how to resolve detected inconsistencies.” (Kahneman and Tversky,

1981, p. 457) In relating this to the Prospect Theory described next, the phase at which

framing occurs is the editing phase.

Prospect Theory  

Developed by Kahneman and Tversky in 1979, Prospect Theory is an alternative theory to

analyse decision making in situations that involve risk. Traditional finance uses the ExpectedUtility Theory (EUT) to analyse decision making, but it is violated in situations that involve

risk. In risky situations irrational behaviour results in attitudes that differ from the EUT state.

In the following, the shortcomings of EUT will be briefly outlined and afterwards the main

aspects of Prospect Theory highlighted.

First, in EUT, utilities receive a weight according to their probabilities. In reality, however,

 people tend to overweight possibilities that are certain as opposed to those that are only

 possible. This is called the certainty effect and has been demonstrated in experimental tests by

Allais (1953). When respondents were for instance asked whether they would rather choose a)

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4000 (units of money) with 80 percent certainty or b) 3000 (units of money) with certainty, 80

 percent of respondents chose answer b. This finding cannot be explained by EUT.

Second, what happens when the choices become ones that involve possible losses? Here, a

 phenomena called the reflection effect steps into the picture. This means that what was risk 

aversion in the previous case becomes risk seeking when negative outcomes are possible. In

the example above, for instance, most respondents were willing to accept the risk of losing

4000 units with 80 percent certainty when presented with the option of losing 3000 for sure.

This, again, is not in alignment with EUT, as in this example the gamble is the choice with a

lower expected value, yet not widely selected. To sum up, certainty increases how desirable

gains are perceived and how aversive losses are perceived. In other words, respondents are far 

more likely to choose sure gains and avoid sure losses than EUT would predict.

Third, in what is called the isolation effect, in situations that involve two isolated events,

choice is not determined only by probabilities of the final states. In fact, respondents often

ignore shared components and place much emphasis on components that distinguish the

alternatives from each other. For example, consider a situation where one may invest money

in a venture with a probability to lose what has been invested if the project fails. There is a

choice between a fixed return and a certain percentage of earnings in case of success. Eventhough the risky venture has the same probabilities and outcomes of success, the certainty that

the fixed return has, increases the relative attractiveness of this option.

Fourth, probabilistic insurance means purchasing an insurance against losses. It is thought of 

as good evidence for the notion that the utility function is concave. According to EUT,

 probabilistic insurance is superior to regular insurance. What Kahneman & Tversky (1979)

find, however, is that probabilistic insurance (which in practice means acts such as installing a burglar alarm or changing the old tires of a car) is usually not very attractive.

In Prospect Theory, the focus is on gains and losses as opposed to wealth, which is most often

used in traditional finance theories. Also, decision weights replace probabilities and loss

aversion is used instead of risk aversion. An outcome is called a prospect and involves a

decision with some risk. Decision processes are made up of two stages, the editing and

evaluation stage. In the editing stage, possible outcomes are put in order according to some

sort of heuristic. Basically, people look at the outcomes and make a mental note of an

approximate and possible average outcome. Using this average as a reference point, they then

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order lower outcomes as losses and higher ones as gains. This makes sense also in real life,

where for example temperature is regarded as cold or hot (or something in between)

according to the temperature one is used to. Hence value is treated as a function of the

reference point and the distance of the value to the reference point. This has been validated

with many experiments that show how humans rather focus on gains and losses rather than

final wealth, thus opposing EUT. (Tversky and Kahneman, 1979)

The value function is shown in figure 7. As shown through experiments, losses have a larger 

impact than gains, what is called loss aversion. In the realm of losses, the function is steep and

convex, whereas with gains, it is not so steep and concave. Again, this opposes EUT,

according to which the utility function is concave (see figure 7). There is also a function w,

called the probability weighting function, which shows that small probability events are

overreacted to, whereas medium or large probability events show under reaction. (Tversky

and Kahneman, 1979)

Figure 7: Value Function of Prospect Theory

Source: Own creation

Losses Gains

Value

Outcome

Reference point

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Chapter 5: Empirical Research 

Method 

Data 

and 

sources 

Emerging markets 

The emerging markets chosen for this study are Brazil, Chile, China, India, Indonesia,

Malaysia, Mexico, Philippines, Poland, South Africa, Taiwan and Turkey, altogether twelve

countries. When considering which emerging markets to include in the sample, the countries

categorised as emerging markets by the three main data providers Financial Times Stock 

Exchange (FTSE), Morgan Stanley Composite Index (MSCI) and Standard & Poor (S&P)

were considered. Out of the 19 countries classified as emerging markets by the main providers, Czech Republic, Egypt, Hungary, Morocco, Peru and Russia are left out due to not

enough necessary data from the chosen data provider.

Data  prov ider  

All data are downloaded from Datastream, a highly reliable and commonly used information

 platform provided by Thomson Reuters and with access through Copenhagen Business

School. The data is taken from S&P Broad Market Index (BMI) for each of the sample

countries and the returns are thus in US Dollars. These specific twelve countries are chosen

due to availability of enough data from S&P BMI. Other emerging markets were considered,

as highlighted above, but left out due to lack of enough necessary data from the chosen data

 provider. The S&P BMI indices comprise of small, medium, and large-cap stocks. Thus, the

country samples can be considered applicable representations of the stock markets of each

individual country. Previous studies that cover the value premium in the emerging markets

(Fama & French (1998) and Rouwenhorst (1999)) have used S&P/IFCI and MSCI index data.The constituent lists for these indices are not available through the Copenhagen Business

School access for Datastream and thus the S&P BMI indices are used. All of these indices are,

however, highly comparable. Using an index as a representative sample of the whole stock 

market of a country, results in a sectoral bias. This bias depends on the criteria that the S&P

BMI indices use to pick the stocks. The most frequently traded companies are the ones

commonly included, but this is an issue with most indices.

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Time  per iod  

The data used in this study is monthly data from July 2001 to June 2011, a time period of 10

years. Only companies that have the required ratios for the entire sample period are included.

 Not including companies that have been listed and de-listed during the sample period results

in a survival bias. It is, however, also an issue in comparable studies that investigate the

emerging markets value premium.

Return index 

In order to calculate the returns of each strategy, the return index (RI) is used. The return

index comprises of a price holding and assumes dividends are re-invested and used to buy

additional shares at closing price and on the ex-dividend date while ignoring taxes and anycharges occurring from the re-investment. The RI is thus defined as:

1  

Where, PI shows the price-index, DY the dividend yield and n the number of days in the

financial year.

Portfolio construction 

Variables 

The variables used for forming the value and growth portfolios are the market-to-book value

(M/B) and price-to-cash value (P/C). These ratios are available for the same sample of stocks

for all countries, making the value premiums highly comparable. The data for market-to-book 

and price-to-cash ratios and the return index are downloaded and only the companies that

have all three required ratios for the whole sample period from July 2001 to June 2011 are

included. In order to be able to compare the two investment strategies, namely value and

growth investing, value and growth portfolios are made respectively with the M/B and P/C

ratios. Separate portfolios are made with each ratio, but they include the same companies for 

each country.

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In the case of multi-class shares for China (H and A class), only the H class shares of 

companies in mainland China that are available also for foreign traders through the Hong-

Kong Stock exchange are included. For Brazil, there are common and preferred shares (ON

and PN shares) in which case only the common shares are included. Also, for other countries,

in case of companies with two types of shares listed, only the share with less voting rights is

included.

The price-to-earnings (P/E) ratios were available for a smaller sample of stocks for the entire

time-period and thus not a comparable sample to the other two ratios. It was therefore chosen

not to use the P/E ratio as a sorting ratio in this study. The number of stocks with available

P/E ratios was especially small for countries with relatively few stocks in the respective BMI

indices, 10 for Poland, 20 for Mexico and 22 for the Philippines, which are not enough stocks

for the purposes of this study.

Sorting  percentages  

The value portfolio includes stocks with the lowest 50, 30 or 10 percent ratios and growth

 portfolio with the highest 50, 30 or 10 percent ratios. The ratios are the ones mentioned above,

market-to-book and price-to-cash. Value and growth portfolios are made with these three

different sorting percentages 50, 30 and 10 percent in order to see whether there is a value

 premium in the emerging markets and whether deep value investing pays off. The portfolios

are rebalanced yearly, so that each year the value and growth portfolios include the lowest and

highest ratio stocks respectively. Sorting stocks with the 10 percent ratio results in small

 portfolios with less than five stocks for individual countries such as Poland and Philippines

with small overall sample sizes. The overall portfolios for all the 12 emerging markets

nevertheless contain enough stocks for a comprehensive analysis, even with the lowest sorting

 percentage.

Returns and moments 

Defining the  returns 

The monthly portfolio returns of the value and growth portfolios are calculated by dividing

the change in value by the beginning value. After this is done, returns that are above 200

 percent per month are removed from both sets of data (data sets being the P/C and M/Breturns) for the 50 and 30 percent sorting percentages. This results in the removal of 4 values

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 per data set with the 50 percent portfolios and in the removal of 12 and 13 values per dataset

with the 30 percent portfolios. With the 10 percent portfolios, returns are much more volatile,

and thus it becomes appropriate to remove only values that are higher than 2000 percent per 

month, resulting in the removal of 5 and 7 and values per dataset. When calculating the value

 premiums across markets, stocks and countries are equally weighted. This implies that an

investor would invest the same amount in each emerging markets, independent of the size of 

the markets or number of stocks in the respective portfolios. This was considered the most

applicable approach as it allows for the most emerging market country diversification.

Variance 

In observing risk, a measure such as variance or standard deviation is often used and describes

deviation from the mean value. The formula for standard deviation is the following:

 1  

Where n is the number of observations, the observed outcome and the mean value of .Skewness 

Skewness, also called the third moment, describes departures from symmetry. A positive

skewness implies a long right tail, whereas a negative skewness implies a long left tail.

Whether a distribution of returns tends more towards the left or right is significant for an

investor, as this shows whether deviations tend more towards positive or negative returns. The

formula for skewness (and the test statistic) is:

1 1 ̂ / 

 6/ 

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Kurtosis 

Kurtosis describes the fatness of tails and the normal distribution has kurtosis of 3. A kurtosis

higher than 3 implies fatter tails and a greater likelihood of large values, positive or negative.

Return series often have extreme observations and fatter tails, than assumptions of normality

would allow. This is especially often found in stock indices, as used in this study, rather than

in individual stocks (Tsay, 2005).

1 1 ̂/ 3 

 24/ 

Portfolio risk 

Standard  Deviation 

In observing risk, a measure such as variance or standard deviation is often used. Such a

measure, in our case of monthly observations, is useful in determining the risks of differentmarkets, and especially those of the value and growth portfolios and whether one portfolio is

riskier in terms of its standard deviation. For formula, see page 32.

Beta 

Another risk measure is the beta, which measures the systematic risk of an investment

strategy relative to the market portfolio. It is a standard finance measure that shows the

tendency of the movements of a stock or a portfolio relative to the movements of the market

and is normally used in the Capital Asset Pricing Model (CAPM). In this case the measure

will be the portfolio beta of the different investment strategies, value and growth. To obtain

the portfolio beta, it will be necessary to calculate it using the following formula:

 

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Where, the covariance between the returns of the stocks in the market and the respective

 portfolio are divided by the variance of the market. First, the betas for each individual

emerging market in our sample are calculated using monthly data between the sample period

of 2001 and 2011 and then an overall average beta for the sample is deducted. This is done

separately for each sorting variable and percentage. According to traditional finance theory,

we would expect betas of value stocks to be higher than betas of growth stocks.

Correlations 

In addition to the aforementioned risk measures, the risk of a portfolio is also influenced by

the correlations of the stocks in the portfolio. An investor can reduce portfolio variance or risk 

 by holding securities that are not highly correlated. Indeed, the total risk of a portfolio isstrongly influenced by the correlations between the components in the portfolio. Correlation

essentially measures the co-movement or dependence between variables and can be defined

 by the following equation:

,  

It indicates the linear association between two variables. Correlation is between +1 and -1,

with perfect positive correlation indicated by +1 and perfect negative correlation by -1.

Correlation tends to increase when markets become more volatile (Zimmermann et al., 2003).

What we are interested in is downside volatility. If correlations are high in downturns, that is

 bad news. As increased correlations in downturns reduce the benefits of diversification and

hence increase the risk. If correlations of either the growth or value portfolio are higher in

downmarkets, that is negative news for that specific investment strategy. In order to look at

this, up and down market correlations between the monthly returns of the different countries

in each portfolio are calculated as shown in Zimmermann et al., 2003. A month is classified as

an “up-up” market, if the returns of both countries are above average for the country and

investment strategy (value or growth) and as “down-down” market if the returns are classified

as below average. Correlation coefficients are computed for up-up and down-down markets,

and an overall average up-up and down-down correlation calculated from those. It is

interesting to see, first of all, if down-down correlations are higher than up-up correlations.

Further, the average up-up and down-down correlations of the value and growth strategy are

compared with each other, with a special interest in downmarket correlations.

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Results 

Emerging market returns and  moments 

In table 1 below, the number of stocks, average return, standard deviation and minimum and

maximum returns in percentage are shown for each individual country in the sample, as well

as all countries together. For all countries with altogether 1178 stocks, the mean monthly

return is 2.0442 percent and standard deviation 7.8966, meaning that if the sample is assumed

to resemble normal distribution, then about 68 percent of the returns should lie within ±1

standard deviation, i.e. within ±10 percent. The minimum return in this set of data is -32.6429

 percent and maximum return 35.7953 percent, which is more than 4 standard deviations from

the mean.

Table 1: Descriptive statistics of the emerging markets included in the sample

Looking at the four moments, it can be seen that the overall variance for the sample is 0.6236,

skewness -15.7824 and kurtosis 177.7322. It is typical that stock index returns would have a

negative skew as is the case her. A longer left tail and more returns concentrated on the right,

meaning less negative returns. The high kurtosis value implies a leptokurtic distribution with

a higher peek and fatter tails than in normally distributed returns. The student’s t-test value of 

9.823323 further confirms that the returns are not normally distributed. The distribution of 

returns of the emerging markets included in the sample in graphical format can be seen in

figure 8.

Country

Number of

Firms

Mean in

percent

Standard

Deviation

Min return

in percent

Max return

in percent

Brazil 65 2.6430 7.2320 -26.1176 23.2505

Chile 36 1.6750 5.3587 -13.4059 23.5413

China 176 1.3399 7.8833 -18.9890 22.1752

India 169 2.1388 8.3124 -25.8128 25.1665

Indonesia 47 2.7816 8.1312 -19.7072 25.8972

Malaysia 88 1.6661 5.2373 -15.9761 17.9410

Mexico 34 3.3186 9.4635 -27.7255 29.0739

Philippines 30 1.3678 6.7113 -23.2341 21.0991

Poland 28 2.2622 9.3181 -24.5002 32.0366

South Africa 96 1.6436 5.2365 -18.8477 12.4720

Taiwan 351 1.2621 9.2234 -25.3622 25.3635

Turkey 58 2.4314 10.4664 -32.6429 35.7953

All countries 1178 2.0442 7.8966 -32.6429 35.7953

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Table 2: Four moments for each of the emerging markets included in the sample

Figure 8: Distribution of returns for the emerging markets included in the sample

Country Mean Variance Skew ness Kurtosis

Brazil 0,0264 0,0052 -0,0214 2,2738

Chile 0,0168 0,0029 0,3825 1,7384

China 0,0134 0,0062 -0,3545 0,3068

India 0,0214 0,0069 -0,4830 1,3421

Indonesia 0,0278 0,0066 0,0074 0,7610

Malaysia 0,0167 0,0027 -0,4167 1,3498

Mexico 0,0332 0,0090 -0,2311 0,6102

Philippines 0,0137 0,0045 -0,1596 1,2170

Poland 0,0226 0,0087 -0,2160 1,1222

South Africa 0,0164 0,0027 -0,7036 1,1962

Taiw an 0,0126 0,0085 -0,4376 0,6023

Turkey 0,0243 0,0110 0,0793 1,9235

All countries 0,0204 0,0062 -0,1578 1,7773

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Value  premiums 

With market-to-book value as a sorting variable and when portfolios are constructed with the

50 percent highest and lowest values, there is a monthly value premium of 0.61 percent across

the 12 emerging markets. This translates into an annual value premium of 7.345 percent. The

respective paired t-test value of 1.2 is not statistically significant. The critical value is 1.96

when n → ∞. Therefore, even though a value premium of this magnitude is found, it cannot

 be statistically proven that there is a significant value premium in the selected emerging

markets. With market-to-book as a sorting variable, the value portfolio returns 32.521 percent

annually and the growth portfolio 25.176 percent. There is a value premium in 7 out of 11

years and the value premium disappears in 2001, 2007-2008 and 2011. This is shown in table

3 below.

Table 3: Year-by-year value and growth portfolio average returns with market-to-book ratio

as a sorting variable and 50 percent portfolios

Year Value Growth Difference

2001 -0.0079 0.0169 -0.0248 

2002 0.0214 0.0030 0.0184 

2003 0.0590 0.0379 0.0211 

2004 0.0427 0.0236 0.0191 

2005 0.0323 0.0199 0.0124 

2006 0.0423 0.0399 0.0024 

2007 0.0276 0.0340 -0.0064 

2008 -0.0470 -0.0373 -0.0097 

2009 0.0673 0.0499 0.0174 

2010 0.0303 0.0274 0.0029 

2011 -0.0014 0.0061 -0.0075 

Monthly Mean 0.0271 0.0210 0.0061

Yearly Mean 0.3252 0.2518  0.0735 

Yearly Mean in % 32.521% 25.176% 7.345%

T-test 1.2

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The monthly value premium using price-to-cash value as the sorting variable and 50 percent

as the sorting percentage is 0.78 percent and the annual premium 9.33 percent across the 12

emerging markets used in this study. With a paired t-test value of 1.42, the value premium is

again not statistically significant, as the critical value is 1.96 when n → ∞. It thus cannot be

said that value stocks generate significantly higher returns with 50 percent sorting percentage

and price-to-cash ratio as sorting ratio, even though a premium is found. With price-to-cash as

a sorting variable, the value portfolio returns an annual average of 34 percent and growth

 portfolio 24.669 percent. There is a value premium in 9 out of 11 years and the years in which

there is no value premium are 2001 and 2008. These results are shown in table 4 below.

Table 4: Year-by-year value and growth portfolio average returns with price-to-cash ratio as asorting variable and 50 percent portfolios

Year Value Growth Difference

2001 -0.0004 0.0192 -0.0196 

2002 0.0136 0.0095 0.0040 

2003 0.0617 0.0323 0.0294 

2004 0.0269 0.0264 0.0006 

2005 0.0298 0.0166 0.0132 

2006 0.0511 0.0350 0.0161 

2007 0.0367 0.0356 0.0011 

2008 -0.0490 -0.0349 -0.0141 

2009 0.0676 0.0518 0.0158 

2010 0.0422 0.0227 0.0195 

2011 0.0059 0.0021 0.0038 

Monthly Mean 0.0283 0.0206 0.0078

Yearly Mean 0.3400 0.2467  0.0933 

Yearly Mean in % 34.000% 24.669% 9.330%

T-test 1.42

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When sorting the portfolios with market-to-book value with the 30 percent highest and lowest

values, there is a monthly value premium of 0.86 percent across the 12 emerging markets.

This translates into an annual value premium of 10.315 percent. The respective paired t-test

value of 1.24 is not statistically significant, as the critical value is 1.96 when n →  ∞.

Therefore, it cannot be said that there is a statistically significant value premium in the

selected emerging markets using these sorting criteria. With market-to-book as a sorting

variable, the value portfolio returns 39.637 percent annually and the growth portfolio 29.321

 percent. There is a value premium in 6 out of 11 years. The value premium disappears in

2001, 2006, 2008 and 2010-2011. As shown in table 5 below.

Table 5: Year-by-year value and growth portfolio average returns with market-to-book ratio

as a sorting variable and 30 percent portfolios

Year Value Growth Difference

2001 0.0101 0.0106 -0.0005 

2002 0.0332 0.0103 0.0229 

2003 0.0679 0.0434 0.0246 

2004 0.0563 0.0266 0.0297 

2005 0.0378 0.0228 0.0150 

2006 0.0419 0.0482 -0.0063 

2007 0.0507 0.0426 0.0080 

2008 -0.0585 -0.0391 -0.0194 

2009 0.0758 0.0515 0.0243 

2010 0.0236 0.0350 -0.0115 

2011 -0.0046 -0.0043 -0.0002 

Monthly Mean 0.0330 0.0244 0.0086

Yearly Mean 0.3964 0.2932  0.1032 

Yearly Mean in % 39.637% 29.321% 10.315%

T-test 1.24

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The monthly value premium using price-to-cash value as the sorting variable and 30 percent

 portfolios, a value premium is found again, but it is not statistically significant. The monthly

value premium is 1.13 percent and the annual premium 13.549 percent. With a paired t-test

value of 1.49, the value premium is not statistically significant and it can thus not be

concluded that value stocks generate significantly higher returns than growth stocks. When

looking at the portfolio returns of value and growth, the value portfolio returns an annual

average of 43.046 percent and growth portfolio 29.497 percent. There is a value premium in 9

out of 11 years and the years in which there is no value premium are 2002 and 2008. These

results are depicted in table 6 below.

Table 6: Year-by-year value and growth portfolio average returns with price-to-cash ratio as asorting variable and 30 percent portfolios

Year Value Growth Difference

2001 0.0165 0.0154 0.0011 

2002 0.0054 0.0202 -0.0149 

2003 0.0557 0.0377 0.0179 

2004 0.0717 0.0382 0.0335 

2005 0.0374 0.0286 0.0087 

2006 0.0607 0.0314 0.0293 

2007 0.0387 0.0321 0.0066 

2008 -0.0569 -0.0006 -0.0563 

2009 0.0903 0.0255 0.0648 2010 0.0396 0.0213 0.0182 

2011 0.0161 0.0074 0.0087 

Monthly Mean 0.0359 0.0246 0.0113

Yearly Mean 0.4305 0.2950  0.1355 

Yearly Mean in % 43.046% 29.497% 13.549%

T-test 1.49

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Let us look what happens when portfolios are constructed with 10 percent highest and lowest

market-to-book value. There is a monthly value premium of 11.82 percent across the 12

emerging markets. This translates into an annual value premium of 141.854 percent. The

respective paired t-test value of 2.17 is statistically significant (with a critical value of 1.96

when n → ∞). Thus, it can be said that value stock generate significantly higher returns when

sorted with market-to-book variable and with 10 percent largest and highest value stocks in

the portfolios. The value portfolio returns an average of 278.811 percent annually and the

growth portfolio 136.957 percent. There is a value premium in 10 out of 11 years and it only

disappears in 2007. Results depicted in table 7 below.

Table 7: Year-by-year value and growth portfolio average returns with market-to-book ratio

as a sorting variable and 10 percent portfolios

Year Value Growth Difference

2001 0.0829 0.0171 0.0657 

2002 0.2518 0.0382 0.2136 

2003 0.1437 0.0605 0.0832 

2004 0.2875 0.0494 0.2381 

2005 0.2063 0.0858 0.1205 

2006 0.2280 0.0959 0.1321 

2007 0.3137 0.3657 -0.0520 

2008 0.1685 0.0875 0.0809 

2009 0.3579 0.3121 0.0458 

2010 0.2182 0.0294 0.1888 

2011 0.2141 0.0156 0.1985 

Monthly Mean 0.2323 0.1141 0.1182

Yearly Mean 2.7881 1.3696  1.4185 

Yearly Mean in % 278.811% 136.957% 141.854%

T-test 2.17

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Using price-to-cash as the sorting variable and 10 percent as the sorting percentage, the

monthly value premium is 3.89 percent, whereas the annual premium is 46.707 percent. In

testing for significance, a paired t-test value of 1.12 is found and it can be concluded that this

result is not statistically significant (with a critical value of 1.96 when n → ∞). Hence value

stocks do not generate significantly higher returns than growth stocks, even though a value

 premium of this magnitude is found. With price-to-cash as a sorting variable, the value

 portfolio returns an annual average of 171.073 percent and growth portfolio 124.365 percent.

There is a value premium in 8 out of 11 years and the years in which it disappears are 2008

and 2010. These results are shown in tabular format below.

Table 8: Year-by-year value and growth portfolio average returns with price-to-cash ratio as a

sorting variable and 10 percent portfolios

Year Value Growth Difference

2001 0.0106 0.0023 0.0083 

2002 0.3276 0.2044 0.1232 

2003 0.0967 0.0350 0.0617 

2004 0.2490 0.1170 0.1320 

2005 0.0851 0.0619 0.0232 

2006 0.3171 0.0777 0.2394 

2007 0.1075 0.1031 0.0044 

2008 0.0004 0.1672 -0.1669 

2009 0.0857 0.1247 -0.0390 

2010 0.0588 0.1371 -0.0783 

2011 0.1851 0.0142 0.1709 

Monthly Mean 0.1426 0.1036 0.0389

Yearly Mean 1.7107 1.2437  0.4671 

Yearly Mean in % 171.073% 124.365% 46.707%

T-test 1.12

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To sum up the results described above, the value premiums are shown in tables 9 and 10

 below. The value premiums with market-to-book ratio get higher as the sorting percentage

gets lower with annual value premiums from 7.345 percent with 50 percent sorting

 percentage, to 10.315 percent and 141.854 percent with 30 and 10 sorting percentage

respectively. Thus deep value investing in the emerging markets seems to pay off. The value

 premium is only statistically significant with 10 percent sorting percentage.

Table 9: Value premiums with sorting percentages 50, 30 and 10 percent and with market-to-

 book ratio as the sorting variable

The value premiums with price-to-cash ratio also increase as the sorting percentage gets

smaller. The annual premiums are 9.330 percent with 50 percent sorting percentage, 13.549

 percent and 46.707 percent with 30 and 10 percent sorting percentage respectively. This,

again, implies that also when using the price-to-cash ratio as a sorting percentage deep value

investing in the emerging markets used in this study seems to pay off. The value premiumsare, however, not statistically significant.

Table 10: Value premiums with sorting percentages 50, 30 and 10 percent and with price-to-cash ratio as the sorting variable

Sorting percent Value Growth Difference

50 percent 32.521% 25.176% 7.345%

30 percent 39.637% 29.321% 10.315%

10 percent 278.811% 136.957% 141.854%

Sorting percent Value Growth Difference

50 percent 34.000% 24.669% 9.330%

30 percent 43.046% 29.497% 13.549%

10 percent 171.073% 124.365% 46.707%

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These results with the 50 percent portfolio sorting percentages and both market-to-book and

 price-to-cash ratios are in alignment with historical value premiums found in the emerging

markets. Rouwenhorst (1999) for example, found an annual premium of 9.0 percent and Fama

& French (1998) reported an annual premium of 7.60 percent, both using market-to-book 

ratios and 30 percent sorting percentages. When considering the sorting percentage, it should

 be noted that the number of countries and stocks in the portfolios of these studies is higher,

resulting in a higher sample size. Thus, it could be concluded that perhaps the 50 percent

sorting percentage gives a value premium similar to previous studies for this reason and is

thus the most suitable sorting percentage for the number of stock returns included in our 

study. At least the portfolios are large enough so that returns of single stocks do not move the

overall averages as much as with the lower sorting percentages. Thus, the results with the 50

 percent sorting percentage over the entire time period from 2001 to 2011 are graphically

depicted below.

Figure 9: Year-by-year value premiums for both market-to-book and price-to-cash ratios for 

the time period of 2001-2011

-3%

-2%

-1%

0%

1%

2%

3%

4%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Price-to-cash Market-to-book

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Measures of  risk 

Standard  deviation 

When looking at the standard deviations of the market-to-book value and growth portfolios, it

can be seen that value stocks have a higher average standard deviation across all countries for 

the time period of 2001 to 2011. Value standard deviations for the 50, 30 and 10 percent

 portfolios and market-to-book ratios are 16.44, 23.56 and 166.15 percent respectively,

whereas growth standard deviations are 10.43, 14.49 and 87.05 percent. With price-to-cash

ratio as a sorting variable, standard deviations are 15.81, 21.82 and 109.22 percent for value

and 11.77, 19.14 and 74.84 percent for growth. These findings are seen in tables 11 and 12.

Table 11: Average standard deviations of the market-to-book value and growth portfolios

Table 12: Average standard deviations of the price-to-cash value and growth portfolios

The difference is about 6 percent with the 50 percent portfolios, 9.1 percent with 30 percent

 portfolios and 7.91 percent with the 10 percent portfolios. The findings are somewhat smaller 

when stocks are sorted according to the price-to-cash ratios with differences of 4.0 percent,

2.7 percent and 3.44 percent with the 50, 30 and 10 percent portfolios. 

When looking at the yearly standard deviations of the value and growth portfolios with the 30

 percent portfolios and market-to-book ratio (figure 10) and price-to-cash ratio (figure 11), it

can be seen that the standard deviations are closer to each other in certain years. With market-

to-book ratio, growth stocks have a higher standard deviation in 2010 and both portfolios

come close together in 2002. With price-to-cash, the standard deviations of growth stocks are

higher in 2002 and around 2008. Considering these time periods, it could be interpreted that

growth stocks become more volatile or risky during and after stock market crises. Such as the

stock market bubble at the turn of the century and the current financial crisis that started in

2008, but hit the Emerging Markets with a delay.

Portfolio Value Growth Difference

Market-to-book - 50 percent 0.1644 0.1043 0.0601

Market-to-book - 30 percent 0.2356 0.1449 0.0907

Market-to-book - 10 percent 1.6615 0.8705 0.7910

Portfolio Value Growth Difference

Price-to-cash - 50 percent 0.1581 0.1177 0.0404

Price-to-cash - 30 percent 0.2182 0.1914 0.0268

Price-to-cash - 10 percent 1.0922 0.7484 0.3437

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Figure 10: Average yearly standard deviations of the market-to-book value and growth

 portfolios with 30 percent sorting percentage and between 2001 and 2011

Figure 11: Average yearly standard deviations of the price-to-cash value and growth

 portfolios with 30 percent sorting percentage and between 2001 and 2011

Beta 

The betas for the value and growth portfolios with the different sorting variables and

 percentages can be seen in tables 13 and 14. As shown in the tables, the value portfolio betas

are slightly higher across the board, except with market-to-book and 10 percent portfolios,

where the growth portfolio has a higher beta. Thus, according to their betas, value stocks

seem to be riskier than growth stocks in our sample, as shown below.

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

2001 2003 2005 2007 2009 2011

Value

Growth

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

2001 2003 2005 2007 2009 2011

Value

Growth

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Table 13: Average betas of the market-to-book value and growth portfolios

Table 14: Average betas of the price-to-cash value and growth portfolios

According to the asset pricing theory, the market has a beta of approximately one and it is

difficult to form portfolios with better diversification than that. A beta that is smaller than one

implies volatility that is lower than that of the market. A higher than one beta means greater 

volatility than that of the market. (Elton, Gruber, Brown, & Goetzmann, 2003) In our results,

the growth portfolio has a beta that is lower than one with the 30 and 50 percent portfolios,

implying that investing in growth stocks is less risky than investing in the market, which is

somewhat surprising. Also, the value portfolio with market-to-book sorting variable and 10

 percent portfolios has a beta of 0.5565, also surprising. The betas of the value portfolio with

30 and 50 percent sorting percentages are all above one, meaning that value investing is

somewhat riskier than investing in the market portfolio.

Correlation 

With regards to correlations, it will be investigated whether correlations are higher in

downmarkets than upmarkets. This is significant for an investor, as it is exactly in

downmarkets that protection from diversification would be most useful and if correlations are

higher in downmarkets, then that is bad news for the investor. Second, we will see if there is a

difference in correlations for the value and growth portfolios, especially in downmarkets.

Lower correlation for one investment strategy would imply that strategy is less risky.

First of all, let us look at results with market-to-book ratio and 50 percent portfolios. As seen

in tables 15 and 16, downmarket correlations are higher than upmarket correlations for both

the value and growth portfolio. In the case of value portfolio, the downmarket correlation is

0.16645 and upmarket correlation 0.05440. In the case of growth portfolio, the downmarket

correlation is 0.29222 and upmarket correlation 0.06811. This is bad news for both the value

Portfolio Value Growth Difference

Market-to-book - 50 percent 1.0506 0.9044 0.1462

Market-to-book - 30 percent 1.0914 0.9043 0.1871

Market-to-book - 10 percent 0.5565 1.7592 -1.2027

Portfolio Value Growth Difference

Price-to-cash - 50 percent 1.0727 0.8510 0.2217

Price-to-cash - 30 percent 1.0775 0.9469 0.1306

Price-to-cash - 10 percent 1.2098 1.0041 0.2057

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and growth investor as it implies that due to higher correlation in both portfolios during

downmarkets, the diversification benefits are lower just when protection is most needed.

Tables 15 and 16: Up-up and down-down market correlations with market-to-book ratio as asorting variable and 50 percent portfolios

 Now, moving onto look at value versus growth portfolio correlations in down and upmarkets.

They are quite similar during upmarkets with a correlation for value portfolio of 0.05440 and

correlation for growth slightly higher 0.06811. In downmarkets, however, value portfolio

correlation 0.16645 is lower than growth portfolio correlation of 0.29222. This implies that

the value portfolio enjoys better diversification benefits in downmarkets than the growth

 portfolio. Since a lower correlation implies that the returns of countries move in differentdirections, having such a situation especially in downmarkets is preferable as it decreases

 portfolio risk. This implies that when looking at correlations between the selected emerging

markets country returns in a portfolio as an indicator of risk, the value portfolio is less risky in

downmarkets due to diversification benefits. The significance of this difference between the

correlations of value and growth portfolio remains somewhat questionable however.

Correlations Matrix - Value

Brazil Chile China India Indonesia Malaysia Mexico Philippines Poland South Africa Taiwan Turkey

Brazil -0.1473153 0.311982016 0.218829735 0.243274658 0.145575523 -0.1403037 0.053609702 0.047507405 0.02719715 -0.15233197 0.424670471

Chile 0.251322941 -0.12717474 -0.11107071 -0.188475 -0.08933796 0.090660878 -0.11894111 -0.12827487 -0.08176214 0.101765012 0.127576861China 0.158573215 -0.1426769 0.348713582 0.163553056 0.101853943 -0.148087 0.186395943 -0.02461329 -0.13486888 0.039246572 0.372367207

India 0.507805667 -0.04392562 0.365067615 0.196320113 -0.04032146 0.077279758 0.190415137 -0.01900249 -0.13105801 0.316149612 0.330119778

Indonesia -0.0743119 -0.11419087 0.268460535 0.094263033 0.061376522 0.09002019 0.225466508 -0.05619373 0.237004994 0.122557231 0.350444648

Malaysia 0.012139648 -0.20198853 0.257670421 0.178014027 0.148823677 -0.01135693 -0.05495081 -0.14264487 -0.02536561 -0.24120123 0.078553466

Mexico 0.252379302 0.429044795 0.372547754 0.479661586 0.308506972 0.015765153 0.006279718 0.00419251 -0.14805675 0.111277548 0.020998013

Philippines 0.290262649 0.225833431 0.101738467 0.229064596 0.361799892 0.260580056 0.304133798 0.10529153 0.186340644 0.275246771 0.493411148

Poland 0.114058575 0.123069712 0.04981019 0.179201661 0.16843207 0.00529873 0.086299008 -0.01862572 -0.02914449 -0.12301224 -0.14683655

South Africa 0.167834163 0.058500675 0.002272102 0.249115121 0.449745365 -0.09519928 0.453246224 0.256292738 0.071552012 -0.21605322 0.03803108

Taiwan 0.151697563 0.006092583 0.218876318 0.245754145 0.105698503 0.409772089 0.152184819 0.230724849 -0.24065224 0.125459648 0.046860838

Turkey 0.194972434 0.200063104 0.429851538 0.241489699 0.026417016 0.003257138 0.356763628 0.319698921 0.076977266 0.007874836 0.111426149

Mean - up 0.054403976

Mean - down 0.166540436

Correlations Matrix - Growth

Brazil Chile China India Indonesia Malaysia Mexico Philippines Poland South Africa Taiwan TurkeyBrazil 0.043418567 0.013577343 0.295444301 0.089219335 0.052586136 -0.23290712 -0.23791795 -0.23014983 -0.07623562 -0.17704139 -0.20838082

Chile 0.669231259 0.428815226 0.118643212 0.25886553 0.110290041 0.102117542 0.482119118 0.149065299 0.114904863 0.061606008 0.013587469

China 0.342117504 0.292471779 0.456720644 0.25000491 -0.14572855 0.120126166 0.311582287 0.014089706 0.086977708 0.095497462 0.310899192

India 0.557698609 0.379475656 0.630079692 0.273990858 -0.07734015 0.121249463 0.099604244 -0.06429171 -0.0093653 0.028696561 0.143775015

Indonesia 0.281083442 0.259308268 0.200687295 0.136927208 0.04040452 0.019804225 0.284519869 0.027939452 0.247630831 -0.09593287 -0.17021341

Malaysia 0.252970673 0.125143668 -0.0283078 0.186319256 0.37333493 0.245544273 0.043750497 0.011287839 0.037947953 -0.07431897 -0.23452281

Mexico 0.295046674 0.069876908 0.162583556 0.126407471 0.325943709 0.094392041 0.183101005 -0.23109894 0.180837518 0.177617345 -0.15687999

Philippines 0.274921529 0.245748011 0.112835657 0.291366892 0.444578027 0.143660875 0.206622975 0.296643409 0.016241357 0.147391361 -0.07090229

Poland 0.506510333 0.300786908 0.328501608 0.429836025 0.257170395 -0.10485249 0.38739782 0.293538804 -0.01223032 -0.12952126 -0.21633042

South Africa 0.62661926 0.184497749 0.314031259 0.625093188 0.256728619 0.165504081 0.298677195 0.420236061 0.452288315 0.518645806 0.029631075

Taiwan 0.289388101 0.261376475 0.465328763 0.119729801 0.351757673 0.098002936 0.401155205 0.104682257 0.277569069 0.203099391 0.190736759

Turkey 0.320742808 0.379309325 0.465357588 0.394199849 0.269089941 0.0415558 0.184111692 0.300860939 0.214390636 0.47232201 0.477447223

Mean - up 0.068118781

Mean - down 0.292220733

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When looking at the results with the market-to-book ratio and 30 percent portfolios, as shown

in tables 17 and 18, the story is the following. Downmarket correlation for the value portfolio

is 0.06621 and upmarket correlation -0.00389. For the growth portfolio, downmarket

correlation is 0.21217 and upmarket correlation is 0.02297. This is again bad news for both

value and growth investors, as downmarket correlations are higher implying lower 

diversification benefits at riskier economic conditions. The difference is much higher for the

growth portfolio, as see in the numbers.

Tables 17 and 18: Up-up and down-down market correlations with market-to-book ratio as asorting variable and 30 percent portfolios

When comparing value and growth portfolio correlations in down and upmarkets, we can

observe the following. In upmarkets, the value portfolio correlation is -0.00389, very close to

zero and the growth portfolio correlation is 0.02297 - also close to zero. In downmarkets, the

value portfolio has a correlation of 0.06621 and growth portfolio 0.21217. Again, we can see

that the value portfolio correlation is lower than that of the growth portfolio in downmarkets,

which is good news for the value investor who has more diversification at economic

downturns when it is crucial. This result is similar to that obtained with the market-to-book 

and 50 percent portfolios.

Correlations Matrix - Value

Brazil Chile China India Indonesia Malaysia Mexico Philippines Poland South Africa Taiwan Turkey

Brazil -0.04942115 -0.16632742 -0.00383487 0.118217422 -0.00050428 -0.00549208 -0.00162627 -0.13872675 0.178966307 -0.14021482 -0.01949695

Chile 0.292727814 -0.01638519 -0.07836463 -0.04859334 0.139519104 0.101561554 0.046537221 -0.05887363 -0.03441954 -0.07760224 0.314215494

China 0.282713114 0.199212603 -0.23320694 -0.03135672 0.280389566 -0.09767502 -0.03048434 0.077835742 -0.21948961 0.130719111 -0.20062058

India 0.137444624 0.145501953 0.119961531 -0.20656747 -0.21896734 0.116646939 0.285613989 -0.04610957 -0.02496173 -0.0793457 0.038292527

Indonesia 0.054291441 -0.04763866 0.175970073 -0.01432493 -0.0084455 -0.28315024 0.185520577 0.014186689 -0.12008238 0.117490744 0.024017803

Malaysia 0.115779873 -0.10345001 0.288606422 -0.08391812 0.29613148 -0.0735147 0.060636199 -0.25045665 0.55755364 -0.21151114 -0.36374039

Mexico -0.13673251 -0.20604678 -0.07327784 -0.16467135 -0.17377985 0.022060523 0.098108571 0.088672222 -0.12779353 0.110348328 0.091799744

Philippines 0.183884605 -0.08958122 0.273129292 0.238670455 -0.02391397 0.142279842 -0.15873627 0.012903303 0.157866094 -0.23329668 0.587468372

Poland 0.093985145 -0.13076133 0.32262865 0.06861287 0.423919196 0.123884944 -0.10218293 0.290222567 -0.01366106 0.144301563 -0.11910624

South Africa -0.02377433 -0.01210467 0.151241493 -0.06777767 -0.37098262 -0.0973871 0.230348236 0.203846426 -0.1648498 -0.13738271 -0.23738946

Taiwan -0.07060643 -0.22811871 0.366755116 -0.04984392 -0.06652591 0.277220478 -0.20928473 0.264038431 0.04778668 0.216612186 0.072318037

Turkey -0.01674717 -0.09217757 -0.02590099 0.101389285 -0.13443923 0.18709437 0.236082084 0.191814413 0.120658551 0.334144426 0.288695136

Mean - up -0.00388624

Mean - down 0.066209238

Correlations Matrix - Growth

Brazil Chile China India Indonesia Malaysia Mexico Philippines Poland South Africa Taiwan Turkey

Brazil -0.06066407 -0.22641628 -0.20775319 0.146231577 -0.0868567 0.361059378 0.214425217 0.049089347 0.0510295 0.022887406 -0.11701923

Chile 0.119152701 -0.3222914 0.090550132 -0.17464439 0.155114864 0.108499464 0.411788917 0.171071249 -0.10693084 -0.13204306 -0.19643584

China 0.067273606 0.136725682 0.492292896 0.419769438 -0.01475543 0.23497169 -0.1455471 -0.08657734 -0.16416137 -0.08805551 -0.02810609

India 0.090590089 0.254360418 0.36654551 -0.03861905 -0.20913495 -0.06497789 -0.07424887 0.137126339 0.051450616 0.000928265 -0.14936295

Indonesia 0.364209656 0.492900372 0.308622238 0.566157883 0.348454409 0.062736366 -0.01803957 0.018424503 0.210810066 0.035353097 0.220010779

Malaysia 0.376042961 0.387414716 0.295120628 0.293167075 0.57700782 0.037195326 -0.06140577 -0.07246429 0.090825707 0.326220004 -0.39167231

Mexico 0.036611882 0.403323437 0.413941341 0.228235241 0.3409771 -0.0177066 0.2798897 0.355509306 0.064284238 0.241011998 -0.1605848

Philippines 0.068773139 -0.04321366 0.153926164 0.24283939 0.033295914 -0.01853212 -0.02804621 -0.01579633 0.225931552 -0.00285677 -0.06515771

Poland 0.16888998 0.165188759 0.355826543 0.461804242 0.382239135 0.052948597 0.323620304 0.101805514 -0.22192145 -0.02465378 -0.18186097

South Africa 0.105803556 0.282133857 0.114491644 0.297706584 0.340980758 0.155322696 0.087812522 0.020716344 0.149650215 0.217805124 -0.30294934

Taiwan 0.117275464 0.044311857 0.173407548 0.208560912 0.216511284 0.107993305 0.428986586 0.337006203 0.151213965 0.291606413 -0.12302633

Turkey 0.225169262 -0.06244387 0.167719875 0.379506518 0.370864552 -0.00889502 0.343955851 0.198465996 -0.06043802 0.032333968 0.263567803

Mean - up 0.022966022

Mean - down 0.212171789

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When looking at the correlations with price-to-book ratio, the results paint the following

 picture. With 50 percent portfolios shown in tables 19 and 20, the downmarket correlations

are again higher than the upmarket correlations. For the value portfolio, downmarket

correlation is 0.18564 and upmarket correlation 0.11054. For the growth portfolio,

downmarket correlation is 0.23582 and upmarket correlation 0.03116. Overall, this is again

 bad news for investors as correlations are higher in downmarkets when protection would be

most desirable.

Tables 19 and 20: Up-up and down-down market correlations with price-to-cash ratio as asorting variable and 50 percent portfolios

As evident, correlations during upmarkets are higher for the value portfolios with the value

0.11054 versus that for the growth portfolio of 0.03116. The opposite is true in downmarkets

where correlation for the growth portfolio is 0.23582 and that of the value portfolio is

0.18564. Thus, we can conclude that when stocks are sorted according to their price-to-cash

ratios and 50 percent portfolios, value investors enjoy higher diversification benefits in

downmarkets than do growth investors. This result is in alignment with the earlier results

using market-to-book ratio as a sorting variable.

Correlations Matrix - Value

Brazil Chile China India Indonesia Malaysia Mexico Philippines Poland South Africa Taiwan Turkey

Brazil 0.241464081 0.044212735 0.067719194 -0.05259816 0.129063669 -0.10408155 0.181091495 -0.03857169 -0.14192807 0.456840012 -0.10355168

Chile -0.17186387 0.228958487 -0.04418519 -0.0366451 0.290261512 -0.01401026 0.296720284 0.068686054 -0.21162812 -0.01156125 0.201611302

China 0.066876335 0.154291978 0.318360457 0.131151462 0.139699324 -0.08641943 0.285107275 0.115010421 0.102094638 0.263801327 0.231643369

India 0.319861493 0.110054076 0.263809347 0.578889939 -0.00315404 0.206504483 0.003215797 0.234095365 -0.08398025 0.223659532 0.257566669

Indonesia 0.229891765 0.061346183 0.238569518 0.22486552 0.27180386 0.192935772 0.058937593 0.153535861 -0.25389958 0.095709828 0.170307582

Malaysia 0.009419031 0.193920735 0.034152526 0.103569246 0.078628277 0.426526118 0.107093933 -0.04906711 -0.07112962 -0.07766994 0.035331119

Mexico 0.666355586 -0.02377175 0.090456047 0.506392363 0.442369292 0.141784563 0.135575528 -0.07367768 0.190846728 0.181668147 0.25924939

Philippines 0.559038967 0.475012395 0.248221864 0.47272672 0.274557864 0.09588176 0.433923799 0.307933483 -0.12922225 0.030013533 -0.07794824

Poland 0.1136922 0.081750514 -0.07549938 0.052113076 0.250689096 0.024851989 -0.08265248 0.127845682 0.149373666 0.590181815 0.260603792

South Africa -0.06275473 0.088343094 -0.00593697 -0.03367065 0.490492437 0.224785325 0.291209697 0.276872027 0.203994316 0.044887622 -0.012345

Taiwan 0.616804024 -0.20370074 0.087292589 0.601700551 0.280045588 0.265605309 0.060574378 0.291262712 0.003699054 -0.02872787 0.012846981

Turkey 0.102788774 -0.01802648 0.260193278 0.393273636 0.317543638 -0.09830541 -0.04963957 0.291221734 0.288181161 0.085888707 0.438000942

Mean - up 0.110538137

Mean - down 0.185638528

Correlations Matrix - Growth

Brazil Chile China India Indonesia Malaysia Mexico Philippines Poland South Africa Taiwan Turkey

Brazil 0.262992876 0.261835841 0.100117964 0.063313444 0.231611388 -0.33170691 0.080944039 0.282006089 0.00886515 0.012982579 -0.33225357

Chile 0.034654475 0.013384455 0.106913056 -0.22662878 0.469071554 0.178261244 -0.08537526 0.027480176 0.004859387 -0.13791367 -0.11077258

China 0.268550461 0.21410465 0.217496898 0.158423445 0.302438658 -0.10908478 0.392134567 0.2549398 0.012869575 0.107591193 0.083752241

India 0.172866777 0.234256896 0.318534614 0.372537427 0.089863435 -0.13676713 0.09564198 0.091232625 0.303675382 0.129184691 -0.09989946

Indonesia 0.223985353 0.245002631 0.227857076 0.296550526 -0.16638839 -0.15551066 0.238444924 0.036752148 0.070138811 0.058388869 -0.15680773

Malaysia 0.274890843 0.008116583 0.435108755 0.439025506 0.565473728 -0.03808201 -0.14024601 -0.12564261 0.215919005 -0.18988834 -0.30060319

Mexico -0.0276635 0.141562592 -0.00411484 0.226100213 -0.04379209 0.03309534 0.085789657 0.110818651 -0.17992282 -0.13099384 -0.11201232

Philippines 0.020920843 -0.07186812 0.096064397 0.23604097 0.718524455 0.202284462 0.108934803 0.089806949 -0.22165519 0.09508874 0.138283538

Poland 0.640180036 0.529568117 0.494694037 0.642392012 0.239689749 0.23857221 0.16603387 0.225211581 0.028294917 -0.26509395 -0.09844699

South Africa 0.132670213 0.03610004 0.096181424 0.544836277 0.047835822 0.270340834 0.172129258 0.344868148 0.305805733 -0.03385112 0.14824602

Taiwan 0.184834698 -0.16166396 0.398061374 0.087001303 0.386787915 0.332930099 0.256479754 0.446390234 0.182530045 0.295798602 -0.09014004

Turkey 0.320356636 0.425320136 0.354801183 0.34790015 0.08927894 0.04230939 -0.09841036 0.07807374 0.339673835 0.219115262 0.314169358

Mean - up 0.031162213

Mean - down 0.23581691

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The results with price-to-cash ratio and 30 percent portfolios reveal the following. Correlation

for value portfolio is 0.16059 in downmarkets and 0.09525 in upmarkets. The correlation for 

growth portfolio is 0.13935 in downmarkets and 0.07589 in upmarkets. This is again bad

news for both value and growth investors, because correlations are higher in downmarkets

when diversification would be most desirable. The correlation in upmarkets for the value

 portfolio is higher than that of the growth portfolio and the correlation in downmarkets is also

slightly higher for the value portfolio. Meaning that value portfolio has higher risks in up and

downmarkets. However, the difference is not great. Nevertheless, this result of higher 

correlation for the value portfolio in downmarkets is the opposite from the previous results

 presented above and not desirable for the value investor.

Tables 21 and 22: Up-up and down-down market correlations with price-to-cash ratio as asorting variable and 30 percent portfolios

All in all, however, the correlation of the value portfolio in downmarkets when diversification

is needed the most seems to be higher than the correlation of the growth portfolio with all

sorting ratios and portfolios with the exception of price-to-cash and 30 percent portfolios. We

can thus conclude that when looking at country-to-country correlations with those emerging

markets that are included in the sample, value investing seems to be a safer approach

especially in downmarkets. This is good news for value investors. It is, however, difficult to

explain theoretically as we will see later on in chapter 6 on pages 60-61.

Correlations Matrix - Value

Brazil Chile China India Indonesia Malaysia Mexico Philippines Poland South Africa Taiwan Turkey

Brazil -0.06324129 0.169636557 -0.19397992 -0.00011038 0.126214919 -0.26725568 -0.10668007 0.824007459 0.348070058 0.512950609 0.599771253

Chile 0.240983546 0.090004115 -0.17433849 -0.08438261 0.456904152 -0.09360099 -0.09784388 0.026609409 0.175136533 0.579472733 0.217990673

China -0.04883421 -0.08061152 0.345336693 0.117732684 0.095255104 0.0188329 -0.12032171 0.104816966 0.127704822 0.195213598 0.13212676

India 0.032959878 0.170952134 0.085687478 -0.02270527 0.291062209 0.220200544 -0.07766009 -0.25058351 0.304727587 -0.24435338 0.010319785

Indonesia 0.072370066 -0.06562967 0.312598761 -0.00693148 -0.18612402 -0.03296991 0.060876704 0.016171172 -0.09806181 0.105336887 0.193962434

Malaysia 0.175860313 0.206111423 0.196922898 0.477613418 0.112898927 -0.09519005 0.040945032 -0.08181461 0.180506454 0.130037915 0.003812998

Mexico 0.248550549 -0.08703272 0.017013932 0.118893601 0.369607658 -0.03680674 0.163263489 -0.0244062 -0.21787458 0.066716006 -0.11639746

Philippines 0.057504114 0.206967658 0.355080515 0.265621735 0.442845488 0.100684686 0.712849757 -0.06311832 0.148391271 0.212875661 0.213332438

Poland -0.0955789 -0.03369733 0.200044011 -0.00957065 0.142633344 0.169971618 -0.03641754 -0.02471045 -0.17424098 0.348251825 0.148922464

South Africa 0.265902501 0.272967025 -0.03170859 0.470285345 0.17474306 0.426160257 0.557659229 0.437375718 -0.18386408 0.017308593 0.338436049

Taiwan 0.199045051 -0.00696007 0.280717173 0.072668201 0.462481386 0.243015508 0.089302583 0.276856171 0.081179109 0.1012538 0.69464771

Turkey 0.388193928 0.17277595 -0.02789119 0.004348996 0.196098742 0.098071668 0.037743874 0.29171578 -0.0349948 0.264741634 0.051763437

Mean - up 0.095252091

Mean - down 0.160591723

Correlations Matrix - Growth

Brazil Chile China India Indonesia Malaysia Mexico Philippines Poland South Africa Taiwan Turkey

Brazil 0.237745526 -0.13402254 0.029837394 0.012659074 0.378035021 0.37954937 -0.04110701 0.352738656 0.014927133 0.397615601 0.070113519

Chile -0.04605337 -0.13557614 -0.06080696 0.042153978 0.408820877 0.376408565 -0.02216426 -0.24601026 -0.066925 -0.01656678 -0.04422592

China 0.008190267 -0.040813 0.243110656 -0.06566021 0.08329042 0.093926391 0.250259601 0.071060712 0.447356948 0.120914961 0.043530764

India 0.18032615 0.068280299 0.48246232 -0.17322421 0.132286847 0.183863394 0.51336897 0.426348657 0.197841891 0.411664788 -0.17694405

Indonesia -0.11774226 0.202248943 0.174688593 0.144921733 -0.02823939 -0.14100418 -0.05726979 -0.05067753 -0.17097359 0.040616457 -0.02686755

Malaysia 0.008417641 0.040596185 0.316249496 0.320441064 0.141123957 0.345755133 -0.32835336 -0.17316291 -0.01881698 0.034955173 -0.19069639

Mexico 0.328758149 0.157664576 0.170976162 -0.02597995 0.287422561 -0.09008494 0.182945066 0.02393041 -0.08915603 0.492214316 -0.185448

Philippines 0.287507053 0.256515134 -0.06117423 0.309744126 -0.10103697 0.14358418 -0.1562076 0.31278637 -0.12208961 0.149594328 -0.06202896

Poland 0.17057204 0.234099911 0.269820671 0.151463617 0.199422355 0.124424736 0.305228904 0.04717578 0.739179596 -0.01741559 0.027424356

South Africa 0.404210864 -0.03915762 -0.07841822 0.159144172 -0.02331408 0.013322646 0.394612233 0.205197199 0.273272713 -0.30960026 -0.05298271

Taiwan -0.21703365 0.058238633 0.387578853 0.039275486 0.182769084 0.572739627 0.303817004 -0.18003592 0.288634956 0.075820567 -0.05203364

Turkey 0.371559082 0.148067838 -0.14032957 0.081305245 -0.07270082 0.138810547 0.33692949 0.096478937 -0.08223158 0.317440558 0.287869928

Mean - up 0.075890623

Mean - down 0.139350129

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Chapter 6: Discussion 

 Answering the research questions 

Is there a value  premium in  the emerging  markets between  2001 and   201 1?  

It is by now an established finding that value stocks generate higher returns over long periods

of time both in developed and emerging markets. The findings of this study are in alignment

with previous research and show that there is a value premium in selected emerging markets

over a time period from 2001 to 2011. The value premiums with the market-to-book ratio and

50, 30 and 10 percent portfolios are 7.345, 10.315 and 141.854 percent. With price-to-cash as

a sorting percentage, the value premiums are 9.330, 13.549 and 46.707 percent. One should,

however, note that these findings are not statistically significant. What is also interesting

when looking at the 30 or 50 percent sorting ratio with market-to-book value is that the value premium disappears in 2001, 2006-2008 and 2010-2011. These years correspond to economic

downturns and would thus imply that in downturns value investing generates more negative

returns than growth investing.

 1.  Does deep value investing in  the emerging markets  generate an  even 

higher  value  premium?  

It can be seen that the lower the sorting percentage, the higher the value premium. Deep value

investing thus seems to generate even higher returns. The value premium with market-to-book 

ratio and 10 percent portfolios is statistically significant, whereas the value premium with

 price-to-cash ratio and 10 percent portfolios is not.

 2.   Are emerging  market value stocks more risky than   growth stocks when 

measured  in  traditional  risk  measures beta  and  standard  deviation?  

When looking at whether value stocks are more risky than growth stocks when measured in

terms of standard risk measures, such as standard deviation and beta, we find that value stocks

do seem to have higher standard deviations and betas. What should be questioned, however, is

whether these standard measures are useful measures of risk and something that will be

looked into in the next sections. Also interesting is that with 30 percent portfolios, growth

stocks have higher standard deviations in the downturns of 2002 and 2007-2008 as seen in

figures 10 and 11 on page 46. This is especially interesting when remembering that the value

 premium disappears with market-to-book value and 30 percent portfolios in 2001, 2006, 2008

and 2010-2011. Thus one could conclude that even though the value premium disappears

during that time, the standard deviations of value stocks are at lowest points in those years,

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whereas the standard deviations of growth stocks increase. This shows that with these risk 

measures growth stocks are more risky at downturns and value stocks less risky.

 3.   What are the correlations  between  selected  emerging market country 

returns  for 

 value

 and 

  growth

  portfolio s

 in

 downmarkets? 

 

When looking at correlations between emerging market country returns for value and growth

 portfolios in down- and upmarkets, it is found that value stocks have lower correlations in

downmarkets. This answers the third sub-question and is good news for the value investor, as

it is exactly in downmarkets when protection is needed. This finding is difficult to explain

theoretically, but will be looked at in the following parts.

4.   Can value

  premium

 be

 better 

 explained 

 with

 standard 

  finance

 theory

 or 

 

behavioural   finance?  

While there is broad agreement on the existence of the value premium, there is much less

agreement on why it exists. As presented in the theory section, two schools of thought,

traditional finance and behavioural finance view the existence of the value premium from

different perspectives. Traditional finance works under the assumption of market efficiency

and according to their Efficient-market Hypothesis (EMH), a value premium can only exist

due to higher risk of value stocks as risk and return go hand-in-hand when investors arerational and markets efficient. In quite a contrary manner, behavioural finance does not have

much faith in the rationality of investors and argues that a value premium arises when naïve

investors get over-excited about the growth prospects of growth companies and purchase

these stocks when they are over-priced, thus behaving in a non-rational ways and creating

inefficiencies in the markets, which later result in corrections. In the following, the results of 

this study, as well as those of previous studies, will be looked at both through the lenses of 

traditional and behavioural finance to see how they stack up in explaining the value premium

as well as various risk measures also investigated in this study.

 5.  Where can value be currently  found  in  the emerging  markets?  

This question will be addressed in chapter 7 starting on page 66.

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Traditional finance explanation 

The traditional finance explanation for the value premium has its basis in the argument that

risk and return go hand in hand. According to traditional finance theory, for value stocks to

give higher returns than growth stocks as evidence shows, they must be a more risky

investment. According to Fama & French (1998) and other traditional finance theorists, the

value premium is in fact a risk premium and compensates for the higher risk of value

companies. Where that risk arises is debatable, but Fama & French (1998) call it broadly the

risk of financial distress. Let us now look at some traditional measures of risk, namely

standard deviation and beta, as well as downmarket correlation with the findings of this study.

Standard  deviation 

When looking at the standard deviations of the market-to-book and price-to-cash value and

growth portfolios, it is shown that value stocks have a higher average standard deviation

across all countries within the time period of 2001 to 2011 (see tables 11 and 12 on page 45).

The differences with market-to-book ratio are about 0.06 with the 50 percent portfolios, 0.091

with 30 percent portfolios and 0.791 with the 10 percent portfolios. The findings are smaller 

when stocks are sorted according to the price-to-cash ratios with differences of 0.04, 0.027

and 0.344 with the 50, 30 and 10 percent portfolios. Since the returns of the value stocks are

also higher, this finding does indeed go together with the assumption of traditional finance

that risk and return go hand-in-hand.

When looking at standard deviation as a measure of risk, however, there are aspects that one

should take into consideration. Lakonishok, Shleifer and Vishny (1994) for example find that

the distribution of returns for value stocks is more skewed to the right, meaning that value

stocks have more upside potential than growth stocks. It shows that standard deviation is a

 problematic measure of risk, because for it to show an unbiased result, the distribution should

not be skewed. In the case of emerging market returns, however, this is rarely the case. As

shown in figure 8 on page 36 (and figures 12-15 on pages 56-59), emerging market returns in

this study are not normally distributed and show signs of skewness. This is important, because

it is this upside potential that investors desire and if some of the higher standard deviations for 

the value portfolio in our study come from upside potential rather than downside risk, than

that is rather good than risky.

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Let us then investigate this argument further and look at the distributions of returns for our 

value and growth portfolios when sorted with the 50 percent sorting ratio and both variables.

We will only look at the results using this sorting percentage, because they return distributions

that are closest to normality as a higher number of stocks are included in the sample when

compared with smaller sorting percentages.

The value portfolio distribution with market-to-book ratio as a sorting variable and 50 percent

 portfolios is shown in figure 12 and the growth portfolio distribution in figure 13. When

looking at the standard deviations of both portfolios, it can be seen that the standard deviation

of the value portfolio 16.4412 is higher than that of the growth portfolio 10.4278. The

skewness for both portfolios is positive. This means that there are more returns that are

greater than the average than there are returns that are less than average. This is good news for 

the investor. With a value skewness of 2.3335 versus 0.9544 for growth, the number of values

that are greater than average is even higher for the value portfolio than for the growth

 portfolio. In other words, even though the standard deviation is also high for value, a greater 

deal of this comes from returns that are higher than the average in the case of value. Thus,

value stocks show greater upside potential. One must note, however, that even though outliers

are removed from data, the remaining large and small values may be a factor in the findings.

When looking at the maximum and minimum returns for value, the maximum of 1.9076 is

higher than the maximum return of 0.8446 for growth. And the minimum return of -0.6799

for value is lower than the minimum return of -0.9439 for growth. This is also seen in the

kurtosis value for value of 22.3775 versus 7.4499 for growth, i.e. both distributions have fat

tails and are peaked. All in all, value standard deviation and skewness are higher. Also, value

has a higher mean and higher maximum value, whereas growth has a lower mean and higher 

minimum value. This would imply that some of the standard deviation comes in fact fromvalues that are higher than the average, showing higher upside potential for value stocks,

rather than greater riskiness.

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Figure 12: Value portfolio distribution with market-to-book ratio as sorting variable and 50

 percent portfolios

Figure 13: Growth portfolio distribution with market-to-book ratio as sorting variable and 50

 percent portfolios

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When looking at the distributions with price-to-cash ratio as a sorting variable and 50 percent

 portfolios in figures 14 and 15, it can be seen that, again the standard deviation of returns of 

15.8128 is higher for value than it is for growth 11.7722. Both return distributions have a

 positive skew, but that of the value portfolio is again higher with 1.0044 versus 0.3493 for 

growth. The maximum and minimum values for both portfolios are relatively close to each

other. The maximum value return is 1.3732 and the maximum growth return is 0.9321.

Whereas, the minimum value return is -0.9439 and the minimum growth return is -0.9122,

very close to each other. Thus, it can again be interpreted that even though the standard

deviation of value is higher, value stocks have greater upside potential than growth stocks.

Figure 14: Value portfolio distribution with price-to-cash ratio as sorting variable and 50

 percent portfolios

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Figure 15: Growth portfolio distribution with price-to-cash ratio as sorting variable and 50

 percent portfolios

Thus, it can be concluded that even though value stocks in our sample seem to have higher 

standard deviations, their returns are also more skewed to the right. This means that a part of 

the higher standard deviation figure actually comes from upside potential and not downside

risk. Since it is precisely downside risk that is of concern to investors, we cannot conclude

that value stocks in our selection of emerging markets have higher downside risk than growth

stocks. More accurate risk measures for downside risk are called for and could have been

useful in further investigating the issue. Value at Risk is one such measure. However, it is

unfortunately mostly applicable for sets of data that have normal or close to normal

distributions. Emerging markets returns, as is commonly known, are notorious for their non-

normal distributions. Thus, the applicability of this measure for our sample is somewhat

limited, and seems also not to be commonly applied in other research. Nevertheless, other 

measures of downside risk would be useful in further investigating the riskiness of value and

growth investing strategies. One such measure is downmarket correlation and the findings of 

this study with this measure will be discussed shortly.

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Correlation 

Correlations of emerging market returns are generally low (Zimmermann et al., 2003).

Perhaps exactly due to this low correlation between emerging markets, a lot of their volatility

disappears when they are combined in a portfolio. This finding points to the benefits of 

investing in a diversified portfolio of emerging markets, rather than having a great deal of 

exposure in one or a few markets. Let us review what happens to the correlations of these

returns in downmarkets when protection is most desirable.

As seen in chapter 5 pages 48-52, first of all, emerging market correlations in downmarkets

are higher than upmarket correlations. This finding is in alignment with Zimmermann et al.,

2003 who investigated international stock market correlations using a similar method. It is

generally the case that correlations increase in periods of high volatility. In terms of volatility,

it is the downside that concerns investors. This is an interesting but concerning finding for 

investors as risks are higher exactly when protection would be needed, i.e. in high volatility

and downmarkets. Theoretically, this finding is difficult to explain, but has some interesting

implications for downside risk measures. From a behavioural finance point-of-view, which

will be looked at in more detail later, this finding may explain some of the observed

sensitivity to risk investors have: That losses are valued more greatly than gains.

It was also investigated whether downmarket correlations are higher for value or growth

 portfolios. Interestingly enough, downmarket correlations of the value portfolio for all ratios

and both 30 and 50 percent portfolios, except price-to-cash and 50-percent portfolios, are

lower than downmarket correlations of growth portfolios. This would imply that value

strategy is less risky than growth strategy in downmarkets. It is an interesting finding as we

are interested in downside risk of value versus growth investing; yet such measures are

slightly tricky for emerging market returns, as they are non-normal. This measure shows that

value investing is the preferred strategy if one measures risk in terms of downmarket

correlation.

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appealing, these risk measures do not seem to adequately capture the notion of risk in the real

world stock markets, as discussed above. So, traditional finance with their EMH thus fails to

explain the value premium sufficiently. Let us then look at further studies to see if value

stocks could nevertheless be riskier using other risk measures, and whether the value premium

could be explained this way or with investor irrationality as suggested by behavioural finance.

Lakonishok, Vishny, Shleifer and LaPorta (1997) show that growth stock prices decline and

value stock prices rise on earnings announcement dates. According to t-test, the finding is

highly significant (value of 5.65), time period is over 25 years and research is for the US

market. This cannot be explained by risk and the only possible way to explain it would be that

investors exactly at those days realise that these value stocks are less risky and have higher 

earnings potential resulting in corrections in the market. This supports the behavioural finance

notions that investors are irrational in making initial evaluations about these companies.

Considering the rigorous methodology and type of study here, this evidence can be viewed as

quite definite.

Chen and Zhang (1998) argue that value stocks are indeed riskier, because they are often

stocks of financially distressed companies. Furthermore, Petkova and Zhang (2005) find that

value stocks when compared with growth stocks are riskier in bear markets. However, it isworth a mention that both of these studies focus on a short-term investment horizon and value

investing is a long-term approach. Nevertheless, value stocks could be more risky and

 perform worse in certain markets when rating companies simply according to their market-to-

 book or price-to-cash ratios for example as done in this paper and other research as well.

Often times, however, value investors also evaluate companies in other ways including an

evaluation of their cash-flows and financial strength, quality of management, long-term

 business strategy and so on. Thus, in practise the risk to invest in financially distressedcompanies with the value approach is lower than simply looking at a few ratios as investment

criteria would imply it to be.

If a value premium were nevertheless a compensation for risk and thus a risk premium, and as

according to Fama & French (1998) a compensation for financial distress, then it would likely

change over time, be somewhat predictable and depend on economic conditions as well as

market sentiment. Zimmermann et al. (2003) among others, argue that the value premium

does correspond to economic cycles. In this fashion, value stocks seem to outperform growth

stocks in good economic conditions and vice versa. In this study, with 30 and 50 percent

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sorting ratio and market-to-book value, the value premium disappears in 2001, 2006-2008 and

2010-2011. These years do correspond to economic downturns and would thus imply that in

downturns value investing generates more negative returns than growth investing. However,

looking at our risk measure standard deviation, with 30 percent portfolios, growth stocks have

higher standard deviations in the downturns of 2002 and 2007-2008 as seen in figures 10 and

11 on page 46. Thus, even though the value premium disappears during these downturns, the

standard deviations of value stocks are at lowest points in those years, whereas the standard

deviations of growth stocks increase. This shows that with this risk measure growth stocks

 become more risky at downturns and value stocks less risky. We have already highlighted the

limitations of using standard deviation. When using downmarket correlation as a downside

risk measure, value portfolios have lower correlation than growth portfolios in downturns

(with all portfolios except price-to-cash and 30 percent portfolios). This also implies that a

value strategy is less risky relative to a growth strategy in downmarkets. Whether other 

measures of risk that capture the notion of financial distress would give more enlightening

results remains to be answered.

Even though performance of value and growth strategies in downturns is interesting, it is not

the focus of this study. Either way, considering the positive outlook of the emerging markets

relative to that of the developed world, broadly speaking this argument does not dispute thenotion of value investing in a diversified portfolio of emerging market stocks with a buy and

hold strategy. It merely sheds light on the option of investigating performance of value and

growth strategies in downturns and their relative riskiness and the possibility of active

 portfolio strategies with a combination of value and growth stocks: Where value stocks would

 be shorted when economic conditions worsen and growth stocks would be bought, and vice

versa (if the investor believes in value stocks generating lower returns in economic

downturns). This will not be looked at in more detail, though it is an interesting area of research, especially for those interested in international stock markets, drivers of risk for 

different investment strategies and active portfolio management.

Turning to more evidence on risk, Cooper, Gulen and Schill (2008) find that those firms that

have the lowest asset growth sorted by the lowest 10 percent asset expansion have 18 percent

yearly returns, versus the 10 percent highest asset growth companies with 5 percent annual

returns in the period 1968 to 2003. Interestingly, during this period, the growth stocks also

underperform Tresury Bills, as the risk free interest rate is 6.3 percent over a 35 year period.

This is indeed a puzzle, because according to the EMH, risk and return go hand in hand.

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Growth stocks were certainly riskier than Tresury Bills at this time-period, and yet yield lower 

returns, implying that risk does not explain adequately what goes on in the stock markets over 

long time periods.

Liu and Wang (2010) study the long-term (up to 30 years between 1975 and 2007) risk and

return characteristics of value and growth stocks in Scandinavia, Europe and Asia. They find

that in all markets, risks of value stocks are lower than risks of growth stocks. Using Value at

Risk, they define risk as only downside risk, which as highlighted in the previous section, is

more relevant for investors who do not worry about upside potential. Also interestingly, in

contradiction with the notion that risk and return go hand in hand, they find that as the

investment horizon increases, the Scandinavian market has the lowest risk and highest return

for both value and growth indexes when compared with the European and Asian markets.

What is especially interesting for an investor investing in the emerging markets is liquidity.

Could it then be that growth stocks are generally more liquid than value stocks and thus, the

value premium compensates for this difference in much desired liquidity? After all, if there is

not enough liquidity in the market for certain types of stocks this makes them more risky as it

limits the opportunities for selling and buying. Rouwenhorst (1999) examines the cross-

sectional relationship between emerging market returns and liquidity with a sample of 1705firms in 20 emerging markets between 1982 and 1997 and finds no relationship. In other 

words, the value premium could also not be explained by differences in liquidity between

growth and value stocks.

Thus we can conclude that risk and return do not always go hand-in-hand and risk does not

explain stock market returns over the long-term, no matter whether it is beta, standard

deviation or correlation that is used as the measure. Also, there is little evidence that valuestocks are more risky, at least based on conventional measures of systematic risk. It is more

likely that value stock under pricing is due to their risk and return characteristics for 

 behavioural reasons, broadly defined as investor irrationality.

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Chapter 7: Perspectives 

In order to get a better idea of the changes that are taking place in the emerging markets as

well as a view of profit opportunities from a value investor perspective, this final section will

address the fourth sub-question. The structural and demographic changes taking place in the

emerging markets are illustrated with some figures and examples to make it easier for the

reader to grasp what the enormous changes and growth in these markets means in practise.

Further, a few examples will be given of where value could currently be found in these

markets from the perspective of a value investor.

Can the emerging markets drive the global economy  out of  doom? 

As seen in chapter 3 pages 14 to 20, the emerging markets have indeed shown increasing

growth and decreasing risk especially in recent times. Considering the current state of many

Western economies especially in the EU as well as the US, the question then becomes

whether this growth in the emerging markets could help drive the global economy out of the

doom.

The question of whether the emerging world can pull the rest of the world out of the economic

crisis is questionable, as several of these regions, especially Asia, are becoming more andmore self-sufficient as shown in the following. Let us first look into the demographic changes

taking place. Consumption power is increasing at a rapid pace in the emerging markets

creating what many view as the buzz that is felt in several emerging cities. As seen in figure

16, approximately 125 million households will enter the middle class between 2010 and 2015,

in other words about 50 households join the middle class every minute. This represents an

increase of more than 70 percent and is incredibly significant, because once a household joins

the middle class their consumption power increases to a level where they can make

investments in areas such as electrical and household appliances, education, consumer goods

and holidays, and other services as seen in figure 17. This could be beneficial for Western

companies that have a large proportion of their exports going into these nations. BMW for 

example, could benefit from the increasing demand for automobiles in the emerging markets,

 both standard and luxury ones. As much as these trends increase export sales potential and

thus are a positive influence on the West, such companies also exist in the emerging markets

and have the benefit of superior local market knowledge. They do lack experience and brand

 power, however, and this is where the advantage is with companies like BMW.

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Figure 16: Number of households entering the middle class in Emerging markets

Source: Jin et al., 2010

Figure 17: Consumption patterns change radically as middle-class population grows

Source: Jin et al., 2010

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When thinking about Asia and especially China, what many Westerners do not seem to grasp

is exactly how self-sufficient and independent of Western companies the area is. This is

illustrated well by the vast and increasing amount of intra-Asian economic activity happening

in the region. When looking at the amount of shipping that takes place within Asia versus

 between Asia and the United States or Asia and Europe, for example, the activity within Asia

is far greater with China playing a huge role. This is shown below in figure 18 where it can be

seen how most of the activity taking place in Asian ports is shipping within the Asian region.

China is the world’s number one consumer in bikes and motorcycles, shoes, automobiles,

mobile phones and luxury goods and number two in home appliances, consumer electronics,

 jewellery and internet use. Therefore, the term ‘emerging market’ is actually somewhat

misleading, at least in these areas, although China is behind the West in export trade. China’s

main traditional energy source is still coal and demand for imported oil is so strong it is

considered a driver in oil prices. The import for food products is also high. China does not

have such an advanced pharmaceutical and health care as the West. (Stalk & Michael, 2011)

Although one must take notice that their approach to healthcare is also very different to

Western medicine and probably considered far behind due to vast differences. In higher 

education, foreign universities still play a big role. On the other hand, Chinese companies are

world leaders in wind-turbine and solar panels, high speed trains and electronic-transmissionequipment. The rate of adoption of new technologies is higher than in other developing

countries, with exceptionally fast rate at which people are getting connected to the internet

and adopting mobile telephony. (Stalk & Michael, 2011)

Figure 18: Activity in Asian ports with Asia and the rest of the world

Source: Stalk & Michael, 2011

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The idea that most of this economic activity and consumption takes place in Shanghai or 

Beijing could also not be more wrong. Smaller cities in what used to be rural areas are

growing at a rapid pace. China has around 90 cities with a population higher than 250, 000

and by 2020 it is projected to have 400 such cities, 50 of which will have more than one

 billion inhabitants. (Stalk & Michael, 2011) These are huge numbers and massive increases.

As seen in figure 17 depicting population movement into the middle-class, the disposable

income of residents in these cities is also likely to be higher than the average disposable

income of consumers in Shanghai or Beijing today.

In light of the above, for the West to rely on these countries to drag itself out of doom would

 be rather naïve. It is possible that further increases in trade and co-operation, as well as further 

opening of for example the Chinese economy can be beneficial for the West. Not to mention

the increasing purchasing power in these regions due to expansion of cities and movements

into the middle-class. But wherever there is opportunity, there is also a threat. And

considering the vast independence and growth of these regions with the example of China and

greater Asia above, these trends are undeniable. Innovation and openness to change cannot be

ignored and with the blurring of country boundaries and availability of information,

consumers will be able to choose from a wide array of options available to them. Thus, the old

saying, watch out for your neighbour, may now mean a distant neighbour continent.

Where in  the emerging  markets can value be currently  found?  

Considering the abovementioned growth, construction and movement into the middle-class

taking place in emerging markets, especially China, the question for an investor then becomes

how to benefit from these trends. There are infinite possibilities, but let us for a moment

return to the beginning of the paper and chapter 3 pages 16-18 where we made the analysis

that GDP growth does not necessarily mean higher return on equity. (Dimson et al., 2010)

With the example of China we highlighted that although the Chinese economy has developed

tremendously over the past years, as described in the previous section in great detail, its equity

markets lag behind. Indeed, the observation that GDP growth does not imply profitable

companies and shareholder returns is relevant. Another emerging region, namely Latin

America, on the other hand, has a great deal of profitable companies, considered very worthy

of investment. Furthermore, the region is rich is commodities. (Marr & Reynard, 2009).

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Let us explore this further and consider how one could benefit from the massive expansion of 

cities and construction taking place in China by investing in construction materials, for 

example Copper. This takes us to the Western shores of Latin America, to a country called

Chile. This country is in my view perhaps the most neglected emerging market with

exceptional opportunities also for value investors. Chile is a global leader in producing

minerals and its industry is largely weighted with utilities, resources and basic industry. The

vast mining industry in Chile is a real asset to the economy and the country is the largest

copper producer in the world. (Investopedia ULC, 2011) As seen below in figure 19, 55

 percent of its exports are copper.

Chile is the most competitive nation and has the most advanced financial system in Latin

America. It is also a leader in human development, income per capita, economic freedom and

low corruption, even though inequality is a major issue. Free market policies and a low

 probability for civil disorder are also factors that make Chile a top emerging market

investment target. When looking at figure 19 below, it is evident that Chile has a healthy

fiscal balance and the lowest government debt of all countries in Latin America. It has also

 performed well in the current global economic crisis and holds a credit rating of A+ (The

Global Competitiveness Report 2010-2011).

Figure 19: Chilean exports in percentages

Source: Credit Suisse Global Research Report on Chile Economy, November 2011

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Figure 20: Fiscal balance and gross government debt of Latin American countries in 2010

Source: Credit Suisse Trends, 2011

Considering the large and increasing amount of investment in infrastructure building in the

emerging markets, especially China, Chile is in a very beneficial position to benefit from the

need for copper wiring and other building purposes, which are very likely to continue

increasing the price and demand for Copper. In May 2011, copper exports were 51 percent

higher than in May 2010 with shipments of US$ 4.149 billion. In 2011, from January to May,

the value of copper sales was US$ 18.648. This is an increase of 23.1 percent compared with

the figure a year earlier (ChileiT, 2010). The price of copper, as well as many other 

commodities, has been increasing steadily for more than ten years with a large dip and pick-

up in December 2008. In figure 21, it can be seen that in a more short-term, the trend for price

of copper has nevertheless been downward, making it a good investment currently as it is notat a peak, yet still likely to increase in value over the long-term.

Figure 22 shows which commodities are at the moment perceived as under- and overvalued

 by Credit Suisse FX research. Other interesting undervalued ones that show long-term

 potential for increases include Nickel, Platinum, Palladium and Gold. After all, for a value

investor, the most important questions to ask when considering which industries, commodities

or markets to invest in would probably be along these lines. Is it relatively cheap and has it

 been underperforming over the past year?

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Figure 21: The price of copper between December 2010 and December 2011

Source: LME Copper price graph, 2011

Figure 22: Currently under- and overvalued Commodities, December 2011

Source: The year 2012 is likely to be challenging but there are still opportunities, 2011

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Conclusion 

Value investing is a long standing investment approach that has been alive since it was

introduced in the Security Analysis in 1934 by Benjamin Graham and David Dodd. It has

since been highly profitable for many investors, the most notable of whom is Warren Buffet.

What makes the approach so appealing is the safety it creates for the investor, as a stock is

 purchased only if it is trading far below its intrinsic value calculated by DCF and certain

ratios, such as market-to-book, price-to-cash and dividend yield, but also including an

analysis of the company’s industry, its management and at which part of the profit cycle the

company currently. And whether this combination shows the company is undervalued by the

market and is likely to increase in price in the future, viewed with a long-term perspective.

The value premium is by now an established finding in stock markets across the globe,

including both developed and emerging markets. Value investing is an especially interesting

investing strategy in the emerging markets as it has been shown that high GDP growth, which

is the reason great many investors invest in these regions, does not actually generate higher 

returns than low GDP growth, rather vice versa. Therefore, investment approaches other than

growth investing can create superior investment returns also in these regions.

When investigating whether there is a value premium in 12 selected emerging markets

 between 2001 and 2011, we use market-to-book and price-to-cash ratios when sorting stocks

into value and growth portfolios, as well as equal country weights. Value premiums of 7.345,

10.315 and 141.854 are found for the 50, 30 and 10 percent portfolios with market-to-book 

ratio as a sorting variable. Whereas value premiums of 9.330, 13.549 and 46.707 percent for 

the 50, 30 and 10 percent portfolios are found with price-to-cash ratio as a sorting variable.

When looking at standard risk measures, such as standard deviation and beta; with our data, it

does seem that value stocks are riskier than growth stocks. But using correlations, we observe

that value investing is a safer strategy in downmarkets with lower correlations among country

returns than those found with the growth strategy. When we look at the actual applicability

and usability of standard risk measures such as standard deviation and beta in practice, we

find that standard deviation does not differentiate between upside and downside potential.

And that our value portfolios seem to have more upside potential than the growth portfolios.

Furthermore, betas have not been sufficient in explaining stock markets risk in practice,

although the CAPM seems appealing from a theoretical point-of-view. Therefore, traditional

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finance with its standard risk measures and rigid assumptions about market efficiency seems

insufficient in explaining the value premium found in most stock markets in the world.

Behavioural finance, on the other hand, offers some rather interesting insights. When

investors are bombarded with a great deal of information through news, media and analyst

commentary, they tend to make short-cuts in decision making. Thus often buying into investor 

hype and purchasing securities often at high prices and without making a proper analysis of 

the company. Considering losses are valued more highly than gains, as suggested by the

 prospect theory, investors are especially cautious when it comes to investing in companies

that have low valuations and operate in fields with old technologies and are left unnoticed by

the mass media. Such companies, however, can be interesting for the value investor precisely

for the reason that they are underestimated by the majority. Thus, there exist mispricing in the

markets due to human cognitive biases and irrational decision making, which a value investor 

can take advantage of through industry and company analysis including quantitative and

qualitative factors. Then investing at a discount for the long-term and waiting for the rest of 

the investor community to catch-up, hopefully resulting in price increases and profits.

A study by Lakonishok, Vishny, Schleifer and LaPorta (1997) shows that value stock prices

rise on earnings announcement dates with a highly significant result. It is especiallyinteresting as the only reasonable explanation is that investors realise exactly on those dates

that value stocks are less risky and have higher earnings potential, thus resulting in corrections

in the market. Furthermore, Cooper, Gulen and Schill (2008) find that high asset growth

companies with a 5 percent annual return underperform Treasury Bills with a 6.3 percent risk-

free interest rate in the period 1968 to 2003. This is a puzzle for those who believe in efficient

markets and that risk and return go hand in hand. It thus gives further support for the

 behavioural financiers who see that market anomalies are indeed a reality.

With these thoughts in mind, it becomes interesting to look at where these bargains can be

found today? Well, considering that the emerging markets are our target, this is where we

look. And the first things that come to mind are the huge growth and demographic changes

taking place in China. With a deeper look, it is the construction industry among others that are

 benefiting from these shifts and especially the expansion of cities taking place over there.

What materials does the construction industry use and where in the world do these materials

come from? Naturally, there are many, but copper from Chile is currently an interesting

target. Not only because of the economically stable, yet underestimated host country, but also

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 because this material seems currently underpriced. Whether to invest directly into

commodities, or find companies that are in a beneficial position to benefit from these trends is

a choice to be made and investing in both should be profitable, though in different ways. Of 

course investing in China is also not a bad deal, but considering the more advanced and open

state of Latin American stock markets, perhaps this can wait. Either way, it is something to be

explored in another thesis, perhaps even a book.

With these words I would like to thank the reader for taking the time to read this material. I

hope it offered some interesting insights and inspired further thoughts and research.

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 Appendix 2:  Value and growth returns  with market‐to‐book ratio 

 50  percent  portfolios 

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 30  percent  portfolios 

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 10  percent  portfolios 

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 Appendix  3:  Value and growth returns  with price‐to‐cash ratio 

 50  percent  portfolios 

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 30  percent  portfolios 

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 10  percent  portfolios 

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 Appendix 4: Individual country  returns 

Country Value Growth Difference Difference in %

Brazil 0.0290 0.0271 0.0019 0.188%Chile 0.0337 0.0180 0.0157 1.572%

China 0.0146 0.0145 0.0001 0.008%

India 0.0408 0.0202 0.0206 2.056%

Indonesia 0.0219 0.0304 -0.0084 -0.844%

Malaysia 0.0235 0.0183 0.0052 0.519%

Mexico 0.0398 0.0250 0.0148 1.483%

Philippines 0.0309 0.0109 0.0200 1.999%

Poland 0.0200 0.0291 -0.0091 -0.909%

South Africa 0.0202 0.0174 0.0029 0.285%

Taiwan 0.0235 0.0134 0.0101 1.014%

Turkey 0.0272 0.0275 -0.0003 -0.031%

Monthly country specific value and growth portfolio average returns and the value

premium with market-to-book ratio and 50% sorting percentage

Country Value Growth Difference Difference in %

Brazil 0.0337 0.0294 0.0043 0.432%

Chile 0.0001 0.0220 -0.0219 -2.193%

China 0.0208 0.0188 0.0020 0.205%

India 0.0559 0.0183 0.0375 3.754%

Indonesia 0.0542 0.0365 0.0177 1.772%

Malaysia 0.0298 0.0169 0.0129 1.287%

Mexico 0.0060 0.0172 -0.0112 -1.116%

Philippines 0.0464 0.0150 0.0314 3.144%

Poland 0.0200 0.0473 -0.0273 -2.731%

South Africa 0.0326 0.0169 0.0157 1.574%

Taiwan 0.0476 0.0149 0.0327 3.271%

Turkey 0.0472 0.0401 0.0071 0.709%

Monthly country specific value and growth portfolio average returns and the value

premium with market-to-book ratio and 30% sorting percentage

Country Value Growth Difference Difference in %

Brazil 0.1225 0.6056 -0.4831 -48.309%

Chile 0.2942 0.0688 0.2254 22.544%

China 0.0390 0.0267 0.0122 1.225%

India 0.0802 0.0274 0.0528 5.284%

Indonesia 0.0891 0.0442 0.0449 4.487%

Malaysia 0.0732 0.0171 0.0560 5.605%

Mexico 1.5756 0.0985 1.4770 147.704%

Philippines 0.1134 0.0219 0.0915 9.147%

Poland 0.1545 0.1436 0.0109 1.089%

South Africa 0.1201 0.0194 0.1007 10.069%Taiwan 0.0991 0.0171 0.0820 8.201%

Turkey 0.0596 0.2806 -0.2209 -22.091%

Monthly country specific value and growth portfolio average returns and the value

premium with market-to-book ratio and 10% sorting percentage

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Country Value Growth Difference Difference in %

Brazil 0.0224 0.0209 0.0015 0.147%Chile 0.0230 0.0145 0.0086 0.857%

China 0.0147 0.0145 0.0002 0.025%

India 0.0430 0.0195 0.0235 2.345%

Indonesia 0.0381 0.0298 0.0083 0.826%

Malaysia 0.0217 0.0187 0.0030 0.297%

Mexico 0.0290 0.0188 0.0102 1.023%

Philippines 0.0288 0.0121 0.0168 1.676%

Poland 0.0346 0.0304 0.0043 0.427%

South Africa 0.0246 0.0194 0.0053 0.527%

Taiwan 0.0250 0.0117 0.0133 1.327%

Turkey 0.0350 0.0365 -0.0015 -0.150%

Monthly country specific value and growth portfolio average returns and the value

premium with price-to-cash ratio and 50% sorting percentage

Country Value Growth Difference Difference in %

Brazil 0.0289 0.0105 0.0185 1.847%

Chile 0.0333 0.0211 0.0122 1.218%

China 0.0183 0.0176 0.0007 0.072%

India 0.0399 0.0176 0.0222 2.224%

Indonesia 0.0412 0.0348 0.0064 0.644%

Malaysia 0.0335 0.0221 0.0114 1.142%

Mexico 0.0163 0.0234 -0.0071 -0.711%

Philippines 0.0449 0.0162 0.0287 2.868%

Poland 0.0342 0.0551 -0.0209 -2.093%

South Africa 0.0523 0.0362 0.0161 1.608%

Taiwan 0.0363 0.0215 0.0149 1.487%

Turkey 0.0510 0.0181 0.0329 3.287%

Monthly country specific value and growth portfolio average returns and the value

premium with price-to-cash ratio and 30% sorting percentage

Country Value Growth Difference Difference in %

Brazil 0.1147 0.0966 0.0182 1.817%

Chile 0.1705 0.0445 0.1260 12.598%

China 0.0185 0.0190 -0.0006 -0.056%

India 0.0997 0.0645 0.0352 3.519%

Indonesia 0.1342 0.3256 -0.1914 -19.142%

Malaysia 0.0501 0.0745 -0.0245 -2.446%

Mexico 0.2803 0.0248 0.2555 25.549%

Philippines 0.1681 0.0323 0.1357 13.573%

Poland 0.1516 0.1144 0.0372 3.722%

South Africa 0.1384 0.1705 -0.0320 -3.203%Taiwan 0.0476 0.0604 -0.0128 -1.277%

Turkey 0.3429 0.2185 0.1243 12.434%

Monthly country specific value and growth portfolio average returns and the value

premium with price-to-cash ratio and 10% sorting percentage

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 Appendix 5: Individual country  returns  with 50 percent portfolios 

 Market‐to‐book  ratio 

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 Appendix 6: Individual country  returns  with 50 percent portfolios 

Price‐to‐cash ratio 

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