Style Migration in Europe

• Author: Jussi Mikkonen,Vesa Puttonen,John Paul Broussard
• Date: 01 November 2016
• DOI: http://doi.org/10.1111/eufm.12083
• Published date: 01 November 2016

Style Migration in Europe

John Paul Broussard

Rutgers University School of Business –Camden, 227 Penn Street, BSB 440, Camden, NJ 08102, USA,

and Middlesex University Business School

E-mail: john.broussard@rutgers.edu

Jussi Mikkonen

Walpe Oy, Armfeltsv€

agen 7, 00150 Helsingfors, Finland

E-mail: jussi.mikkonen@walpe.com

Vesa Puttonen

Aalto University School of Business, Runeberginkatu 22–24, 00100 Helsinki, Finland

E-mail: vesa.puttonen@aalto.fi

Abstract

This paper complements the literature on style migration by examining value and

size premiums throughout Europe. Information from more than 25 European

markets indicates an average value premium of 9.58% per year. The primary

determinants of the persistent value outperformance are: 1) value firms migrating

to a neutral or growth portfolio, and 2) growth stocks migrating to neutral or value

portfolios. The financial health metric F_SCORE helps uncover outperforming

stocks ex ante, and provides preliminary evidence on the probability of migration,

but only for small stocks.

Keywords: migration, value, growth, F_SCORE

JEL classification: G11, G15

1. Introduction

Within an efficient market context, investors should not be able to consistently

outperform the market using investment strategies based on style or market

capitalisation. They should also not be able to consistently find mispriced securities

using fundamental analytical techniques. A plethora of research, however, details

anomalous behaviour in financial markets. Much of this research relates to investment

style (value vs. growth) or firm size (small-cap or large-cap) effects. The consensus in the

We thank Sheng-Hung Chen, Antti Lehtoranta, Mikko Niemenmaa, Tuomo Vuolteenaho,

two anonymous reviewers, and participants at the FMA Conference (2013 Luxembourg)

for helpful comments.

European Financial Management, Vol. 22, No. 5, 2016, 797–816

doi: 10.1111/eufm.12083

© 2016 John Wiley & Sons, Ltd.

literature indicates that style and size are characteristics that may help generate above-

market returns.

The focus of this paper is to evaluate the effects of style and size premia when firms

migrate across various style–size classifications. Two questions are addressed. First,

what are the impacts of migration on stock returns in Europe? Second, how might the

incorporation of a fundamental financial health metric provide a better understanding of

the migration issue? We address the first question by providing an out-of-sample test of

Fama and French (2007a) ‘migration’using European data. We address the second

question by applying the methodology of Piotroski (2000), namely, the F_SCORE

metric, to our data.

A large European database incorporating variables associated with style, size and

financial health covering the period 1980–2011 yields the following results. First,

migration plays a major role in driving both value and size effects in European stock

markets. The value effect is found to be 9.58%, on average, and is caused mainly by value

stocks migrating to a growth category. Stocks that do not migrate contribute very little to

the value premium. Second, size effects exist only in the early years of the data. Over the

entire period evaluated, the size effect is found to be an insignificant –0.23%.

Finally, we show that the Piotroski (2000) F_SCORE is able to indicate the increased

returns of investment style decisions, but only for small stocks. Small-cap stocks with a

very high F_SCORE are more likely to migrate favourably than stocks with a very low

score.

After a review of the literature, a discussion of the data used and the incorporated

portfolio formation specifics follows. Results are then presented, followed by concluding

remarks.

2. Literature Review

The origins of differential investment strategy performance can be traced to Graham

and Dodd (1934), who argue that value strategies outperform the market. One way

of explaining the outperformance of value strategies is that such strategies are

fundamentally riskier. The most notable proponents of this explanation are Fama and

French (1992), who argue that investors who follow a value strategy take on more risk.

The riskiness of value stocks can also be interpreted as increased risk of financial distress

(Piotroski, 2000). Fama and French (2006) find that low Price-to-Book (P/BV)

companies have a consistently lower return on equity than high P/BV companies.

Further, Chen and Zhang (1998) and Fama and French (1992) find a clear relationship

between low P/BV, high amounts of debt and other financial measures of risk.

The behavioural school of thought offers an alternative point of view on why the value

effect exists. Lakonishok et al. (1994) argue that the risk-based explanation for the

outperformance of value strategies lacks support; their explanation is behavioural.

Investors simply make consistent mistakes in estimating stock prospects. Since rosy

projections turn out to be too optimistic, glamour (or growth) stocks subsequently

underperform. Past winners become losers, and non-glamour (or value) stocks become

winners.

Fama and French (2007a) focus on migration in the US markets over the period 1927–

2006. The value premium is due to value stocks migrating to neutral or growth portfolios.

Also, growth stocks that earn low returns and migrate to neutral or value portfolios also

contribute to the value premium. The final determinant of the value premium is that value

© 2016 John Wiley & Sons, Ltd.

798 John Paul Broussard, Jussi Mikkonen and Vesa Puttonen