Australian Stock Indexes and the Four-Factor Model

Abstract

Stock indexes are passive ‘value-weighted’ portfolios and should not have alphas which are significantly different from zero. If an index produces an insignificant alpha, then significant alphas for equity funds using this index can be attributed solely to manager performance. However, recent literature suggests that US stock indexes can demonstrate significant alphas, which ultimately raise questions regarding equity fund manager performance in both the US and abroad. In this paper, we employ the Carhart four-factor model and newly available Asian-Pacific risk factors to generate alphas and risk factor loadings for eight Australian stock indexes from January 2004 to December 2012. We find that the initial full sample period analysis does not provide indication of significant alphas in the indexes examined. However, by carrying out 36-month rolling regressions, we discover at least four significant alphas in seven of the eight indexes and factor loading variability. As previously reported in the US, this paper confirms similar issues with the four-factor model using Australian stock indexes and performance benchmarking. In effectively measuring Australian equity fund manager performance, it is therefore essential to evaluate a fund’s alpha and risk factors relative to the alpha and risk factors of the appropriate benchmark index.

No more excuses! Performance of ESG‐integrated portfolios in Australia

“…The negative loadings on the high‐rated and Diff (H‐L) portfolios are expected because of the results from Costa et al . (2014), who find that, from 2004 to 2014, the Australian equity market had negative HML results for the S&P/ASX300 (market portfolio). These authors conclude that Australian equity markets were growth‐orientated over this period.…”

A Review of Corporate Social Responsibility and Real Estate Investment Trust Studies: An Australian Perspective

“…Following the approach of Costa et al . (), rolling risk‐adjusted returns could also be computed to provide a deeper understanding of A‐REIT risk‐adjusted return performance over time.…”

“…Similar to Newell and Lee (2012), further studies are also encouraged to include leverage in the Carhart model to analyse the impact of debt levels on A-REIT risk-adjusted return performance. Following the approach of Costa et al (2014), rolling risk-adjusted returns could also be computed to provide a deeper understanding of A-REIT risk-adjusted return performance over time.…”

Are covered calls the right option for Australian investors?

“…6 The S&P/ASX 20 is the narrowest capitalization-based index, covering 46% of Australian equity market capitalization (Standard and Poors, 2016). 7 Costa et al (2014) find that Australian capitalization indexes are highly positively correlated and demonstrate similar risk-return characteristics. 8 Although S&P/ASX 20 constituents and weightings are determined on a quarterly basis, it is possible that changes to the S&P/ASX 20 occur intra-quarter if a vacancy is created by an index deletion and/or market capitalizations fluctuate significantly (Standard and Poors, 2016).…”

“…To remain consistent withCosta et al (2014) we construct 36-month sub-periods for all portfolios under investigation. We achieve this by rolling both the beginning and ending months forward by one month to October 2010 and September 2013, respectively.…”