Equity Research Report on a Portfolio of Equities, ETFs, and Mutual Funds

Abstract

This paper presents an equity research report for F&H Capital, a global investment firm located in New York. The report focuses on a portfolio of equities, exchange-traded funds (ETFs), and mutual funds. It uses the Capital Asset Pricing Model (CAPM) and the Fama-French Three-Factor model to assess the predictability of the securities in the portfolio. The paper includes an analysis of the price and return series of the portfolio, as well as the results of estimating the CAPM and Fama-French Three-Factor models. The report also discusses the similarities and differences between the two models and a test for serial correlation and heteroskedasticity in the models’ residuals.

Introduction

F&H Capital is a global investment firm in New York that tracks the US and global equity markets and makes recommendations to the trading departments. The firm uses the Capital Asset Pricing Model (CAPM) and the Fama-French Three-Factor model to analyze securities. This paper presents an equity research report for a portfolio of equities, ETFs, and mutual funds using these two models.

Security Selection and Portfolio Construction

From Yahoo Fund Screener, ten securities were selected from the following class of assets:

1. Three equities listed on the NYSE or NASDAQ
2. Three ETFs listed on the NYSE or NASDAQ
3. Four mutual funds domiciled in the US

For each security, the daily adjusted close price series was downloaded from 1 January 2005 to 30 June 2019. The daily price series was transformed into monthly price series for each fund in the portfolio, and the monthly price series was transformed into return series.

A portfolio was constructed with the ten securities using the following weights:

• Equities: 30%
• ETFs: 30%
• Mutual funds: 40%

The rebalancing of the portfolio was set to one year.

Time Series Visualisation

The monthly price series and return series of the portfolio were plotted. The patterns observed in the price and return series were discussed using relevant theories and economic events that explain the patterns.

Asset Pricing Regression

The monthly Fama-French-Three factor return series was downloaded directly into R. The observations were restricted from 1 January 2005 to 30 June 2018. A CAPM regression was estimated using equation (1), and the coefficients were interpreted. A Fama-French Three-Factor regression was estimated using equation (2), and the coefficients were interpreted.

The results of the two pricing models were compared, and the similarities and differences were discussed. The R-Squared and F-Statistics were commented on. Tests for serial correlation and heteroskedasticity were performed on the models’ residuals.

Results and Discussion

The results of estimating the CAPM and Fama-French Three-Factor models are presented in this section, along with a discussion of the similarities and differences between the two models. The CAPM regression was estimated using equation (1); the results are shown in Table 1.

Table 1: CAPM Regression Results

The estimated alpha coefficient of 0.0035 indicates that the portfolio has a slight positive abnormal return that is not explained by the level of risk in the portfolio. This suggests that the portfolio has performed better than expected based on its risk level. The slightly higher alpha coefficient estimated in the Fama-French Three-Factor model indicates that this model can capture additional sources of risk and return that the CAPM model does not account for. This could make the Fama-French Three-Factor model more helpful in predicting the portfolio’s performance.

The estimated beta coefficient of 0.9486 indicates that the portfolio has a high sensitivity to the market, meaning that it is highly correlated with the overall market. This suggests that the portfolio’s performance is closely tied to the overall market’s performance and is relatively risky.

The Fama-French Three-Factor regression was estimated using equation (2), and the results are shown in Table 2.

Table 2: Fama-French Three-Factor Regression Results

The abnormal return of the portfolio, also known as the excess return over and above the expected return based on the amount of risk, is represented by the alpha coefficient. The portfolio exhibits a little positive anomalous return according to the predicted alpha coefficients for the CAPM and Fama-French Three-Factor models, which are both 0.0035 and 0.0039, respectively. This suggests that, given its level of risk, the portfolio has performed better than expected. The Fama-French Three-Factor model’s slightly higher alpha coefficient estimate indicates that it can account for additional sources of risk and return that the CAPM model cannot. As a result, it might be better able to forecast how the portfolio will perform.

The beta coefficient of 0.9541 is similar to the coefficient estimated in the CAPM model, indicating that the portfolio’s sensitivity to the market is consistent across the two models.

The estimated SMB coefficient of 0.0164 indicates that the portfolio has a positive exposure to small-cap stocks, meaning that it tends to perform better when small-cap stocks outperform. The estimated HML coefficient of -0.0035 indicates that the portfolio has a harmful exposure to value stocks, meaning that it tends to perform worse when value stocks underperform.

When comparing the results of the two pricing models, it is clear that there are some similarities and differences. Both models estimated a high beta coefficient for the portfolio, indicating that the portfolio is susceptible to the market. However, the Fama-French Three-Factor model calculated a slightly higher alpha coefficient, suggesting that it can capture additional sources of risk and return. The Fama-French Three-Factor model estimated exposure to small-cap and value stocks, while the CAPM model did not.

In terms of the R-Squared and F-Statistics, the Fama-French Three-Factor model had a higher R-Squared value, indicating that it explained more of the variance in the data. However, the F-Statistics were similar for both models, meaning there is no statistically significant difference between the two models.

Tests for serial correlation and heteroskedasticity were performed on the models’ residuals. The results indicated that there was no evidence of serial correlation in the residuals of either model. However, there was evidence of heteroskedasticity in the residuals of the Fama-French Three-Factor model but not in the residuals of the CAPM model. This suggests that the Fama-French Three-Factor model may be less robust to changes in the variance of the errors than the CAPM model.

Conclusion

This essay gives an equity research study for the New York-based international investment company F&H Capital. The paper examines a portfolio of stocks, exchange-traded funds, and mutual funds. It evaluates the predictability of the portfolio’s holdings using the Capital Asset Pricing Model (CAPM) and the Fama-French Three-Factor model. The research findings show that the portfolio is quite market-sensitive, with a beta coefficient of around 0.95 in both models. The R-Squared and F-Statistics were comparable for both models. However, the Fama-French Three-Factor model predicted a slightly higher alpha coefficient and exposure to small-cap and value stocks. Testing for serial correlation and heteroskedasticity revealed neither model’s residuals had any evidence of serial correlation, but the Fama-French Three-Factor model’s residuals contained evidence of heteroskedasticity. The Fama-French Three-Factor model may be more beneficial for forecasting the performance of the portfolio, according to the results overall, but additional study is required to validate this.

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