Style Migration in Europe

Date01 November 2016
Published date01 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
Jussi Mikkonen
Walpe Oy, Armfeltsv
agen 7, 00150 Helsingfors, Finland
Vesa Puttonen
Aalto University School of Business, Runeberginkatu 2224, 00100 Helsinki, Finland
E-mail: vesa.puttonen@aalto.
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 rms migrating
to a neutral or growth portfolio, and 2) growth stocks migrating to neutral or value
portfolios. The nancial 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 efcient 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 nd mispriced securities
using fundamental analytical techniques. A plethora of research, however, details
anomalous behaviour in nancial markets. Much of this research relates to investment
style (value vs. growth) or rm 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, 797816
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 rms
migrate across various stylesize classications. Two questions are addressed. First,
what are the impacts of migration on stock returns in Europe? Second, how might the
incorporation of a fundamental nancial health metric provide a better understanding of
the migration issue? We address the rst question by providing an out-of-sample test of
Fama and French (2007a) migrationusing 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
nancial health covering the period 19802011 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 insignicant 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
After a review of the literature, a discussion of the data used and the incorporated
portfolio formation specics follows. Results are then presented, followed by concluding
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 nancial distress
(Piotroski, 2000). Fama and French (2006) nd 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) nd a clear relationship
between low P/BV, high amounts of debt and other nancial 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
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 nal determinant of the value premium is that value
© 2016 John Wiley & Sons, Ltd.
798 John Paul Broussard, Jussi Mikkonen and Vesa Puttonen

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