Researchers have discovered that stocks listed on the market for between 10 and 20 years could be in a sweet spot for investment.
The new study from the University of Waterloo suggests that investing in stocks listed on the market for between 10 and 20 years could – on average – increase your expected returns.
“It is widely believed that smaller companies generally outperform larger companies on the stock market,” said Tony Wirjanto, a professor jointly appointed in Waterloo’s School of Accounting and Finance and Department of Statistics and Actuarial Science. “But we have found that in the last 20 years, the age of a stock has a much more profound effect on the expected return. The idea is that you shouldn’t just look at the size, but the age of the stocks, if you actually want to do well on the market.”
In undertaking the study, the researchers conducted an exhaustive analysis of the stock market. They constructed 16 portfolios of stocks that were listed on the market between 1926 and 2016. Next, they sorted the stocks into four size groups and four age groups – with the youngest 25 per cent in one group, followed by the next youngest 25 per cent, and so on.
The age effect was clearly observed in all size groups, and the size effect was evident in all age groups. It was, however, noticed that when the stocks were divided into four age groups, returns increased with age over the first three groups, but were flat or dropped a little for the oldest group.
To verify their findings, they built two portfolios of current stocks. One was a rebalanced portfolio where they randomly picked a number of stocks from the market and then invested equally in each. At the end of the month, they did a rebalancing, meaning they adjusted the weight for each stock so they were equal, as the weight of the winners would have increased. In this process, they sold some winners and bought some losers.
They also randomly selected some stocks to invest in at the beginning of each month, which is called a bootstrap portfolio. In the rebalanced portfolio they didn’t trade stocks unless they were delisted, while in the bootstrapped portfolio, they kept refreshing the components, so the stocks were younger in age.
“Our study found that when the stocks in the rebalanced portfolio matured (10-20 years old), they performed better. But as they got older their performance weakened,” said Danqiao Guo, a PhD candidate in Waterloo’s Department of Statistics & Actuarial Science, who undertakes this research as part of her PhD thesis, co-supervised by Wirjanto and Chengguo Weng, an associate professor in Waterloo’s Department of Statistics & Actuarial Science.
“One possible reason behind this surprising result is that rebalanced portfolios very likely contain high-performing stocks that were issued early on and have been successful throughout the years. The bootstrapped portfolios, however, may miss out on these respected companies by liquidating the portfolio each month.”
You can download a preliminary report of the study, Age Matters, by Waterloo’s Faculty of Mathematics researchers Guo, Weng, Wirjanto, and Phelim Boyle, a renowned professor of finance from Wilfrid Laurier’s Lazaridis School of Business and Economics who jump-started this research by discussing a recently published paper with the rest of the team.
This material should not be construed as investment advice.
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