Master’s Degree programme – Second Cycle
(D.M. 270/2004)
in Economia - Economics
Final Thesis
Dollar Cost Averaging
Vs
Suited Dollar Cost Averaging
Supervisor
Dott. Domenico Dall’Olio
Graduand
Eleonora Donà
811236
Academic Year
2014 / 2015
Dedicato a
Anita & Carlo
Index
Introduction ... 10
1. Investment Companies ... 13
1.1 Classification of the Investment Companies ... 14
1.1.1 Unit Investment Trusts ... 14
1.1.2 Closed-End Funds ... 14
1.1.3 Open-End Funds ... 15
1.2 Mutual Funds ... 16
1.3 Exchange Traded Funds ... 18
2. Periodic Payment Plans ... 22
2.1 Investing Strategies ... 22
2.1.1 Lump Sum Investing ... 22
2.1.2 Buy And Hold Strategy ... 23
2.1.3 Value Averaging ... 23
2.1.4 Dollar Cost Averaging ... 23
2.2 The Dollar Cost Averaging in the literature ... 29
2.3 Description of Periodic Payment Plan ... 33
2.4 Advantages and Disadvantages of Periodic Payment Plans ... 34
3. Standard Dollar Cost Averaging ... 38
3.1 The ETFs’ choice ... 38
3.2 Implementation of the Dollar Cost Averaging ... 42
3.3 Analysis on each market ... 46
3.3.1 Standard DCA on S&P500 ... 47
3.3.2 Standard DCA on FTSE100 ... 49
3.3.3 Standard DCA on NIKKEI225 ... 52
3.3.4 Standard DCA on CECE ... 54
3.4 Aggregate Results ... 55
4. Suited Dollar Cost Averaging ... 58
4.1 The Implementation The Suited DCA ... 58
4.2 The results ... 63
4.2.1 Suited DCA on S&P500 ... 63
References ... 83
Appendix A Standard DCA ... 89
Appendix A.1 Standard DCA on S&P500 ... 89
Appendix A.2 Standard DCA on S&P500 Performances ... 92
Appendix A.3 Standard DCA on S&P500 Performances with dividends ... 95
Appendix A.4 Standard DCA on S&P500 Costs’ Impact ... 98
Appendix A.5 Standard DCA on S&P500 Costs’ Impact with dividends ... 99
Appendix A.6 Standard DCA on FTSE100 ... 100
Appendix A.7 Standard DCA on FTSE100 Performances... 103
Appendix A.8 Standard DCA on FTSE100 Performance with dividends ... 106
Appendix A.9 Standard DCA on FTSE100 Costs’ Impact ... 109
Appendix A.10 Standard DCA on FTSE100 Costs’ Impact with dividends ... 110
Appendix A.11 Standard DCA on NIKKEI225... 111
Appendix A.12 Standard DCA on NIKKEI225 Performances ... 114
Appendix A.13 Standard DCA on NIKKEI225 Performanceswith dividends ... 117
Appendix A.14 Standard DCA on NIKKEI225 Costs’ Impact ... 120
Appendix A.15 Standard DCA on NIKKEI225 Costs’ Impact with dividends ... 121
Appendix A.16 Standard DCA on CECE ... 122
Appendix A.17 Standard DCA on CECE Performances ... 125
Appendix A.18 Standard DCA on CECE Performanceswith dividends ... 128
Appendix A.19 Standard DCA on CECE Costs’ Impact ... 131
Appendix A.20 Standard DCA on CECE Costs’ Impact with dividends... 132
Appendix A.21 Standard DCA Aggregate Performances ... 133
Appendix B Suited DCA... 136
Appendix B.1 Suited DCA on S&P500 ... 136
Appendix B.2 Suited DCA on S&P500 Performances ... 139
Appendix B.3 Suited DCA on S&P500 Performances with dividends ... 142
Appendix B.4 Suited DCA on S&P500 Costs’ Impact ... 145
Appendix B.5 Suited DCA on S&P500 Costs’ Impact with dividends ... 146
Appendix B.6 Suited DCA on FTSE100 ... 147
Appendix B.7 suited DCA on FTSE100 Performances ... 150
Appendix B.8 Suited DCA on FTSE100 Performances with dividends... 153
Appendix B.9 Suited DCA on FTSE100 Costs’ Impact ... 156
Appendix B.10 Suited DCA on FTSE100 Costs’ Impact with dividends ... 157
Appendix B.11 Suited DCA on NIKKEI225 ... 158
Appendix B.12 Suited DCA on Nikkei225 Performances ... 161
Appendix B.15 Suited DCA on NIKKEI225 Costs’ Impact with dividends ... 168
Appendix B.16 Suited DCA on CECE ... 169
Appendix B.15 Suited DCA on CECE Performances ... 172
Appendix B.18 Suited DCA on CECE Performances with dividends ... 175
Appendix B.19 Suited DCA on CECE Costs’ Impact ... 178
Appendix B.20 Suited DCA on CECE Costs’ Impact with dividends ... 179
Figure 1.1 - Source www.icifactbook.org ... 16
Figure 1.2 - Source: Deville(2007) Primary and Secondary ETF Market Structure ... 19
Figure 1.3 - Source: http://www.morningstar.it/it/news/80458/etf-una-lezione-di-storia.aspx ... 20
Figure 2.1 Comparison between Returns ... 29
Figure 3.1 S&P500 Last Price from January 1999 to March 2015 ... 39
Figure 3.2 FTSE100 Last Price from January 1999 to March 2015 ... 40
Figure 3.3 NIKKEI225 Last Price from January 1999 to March 2015... 40
Figure 3.4 CECE Last Price from January 1999 to March 2015 ... 41
Figure 3.5 Standard DCA on S&P500 Returns... 47
Figure 3.6 Standard DCA on S&P500 Net Returns ... 48
Figure 3.7 Standard DCA on S&P500 Exchange Rates' Impact ... 48
Figure 3.8 Returns Euro based over perform Returns Dollar based ... 49
Figure 3.9 Standard DCA on FTSE100 Returns ... 50
Figure 3.10 Standard DCA on FTSE100 Net Returns ... 50
Figure 3.11Standard DCA on FTSE100 Exchange Rates' Impact ... 51
Figure 3.12 Returns Euro-based over perform Returns Pound-based ... 51
Figure 3.13 Standard DCA on NIKKEI225 Net Returns... 52
Figure 3.14 Standard DCA on NIKKEI225 Returns ... 53
Figure 3.15 Standard DCA on NIKKEI225 Exchange Rates' Impact ... 53
Figure 3.16 Returns Euro based overperform Returns Yen based ... 54
Figure 3.17 Standard DCA on CECE Net Returns ... 54
Figure 3.18 Standard DCA on CECE Returns ... 55
Figure 3.19 Standard DCA Aggregate Returns ... 56
Figure 3.20 Impact of each ETF on the aggregate portfolio ... 57
Figure 3.21 Impact of CECE - Net Returns ... 57
Figure 3.22 Difference between Net Returns and Net Returns without CECE ... 57
Figure 4.1 20-days high S&P500 on Metastock (example) ... 60
Figure 4.2 Threshold 5% and 10% on Metastock (example) ... 61
Figure 4.3 First Accumulated Plan on S&P500 ... 62
Figure 4.4 Last Accumulated Plan on S&P500 ... 62
Figure 4.5 First Accumulated Plan on CECE ... 63
Figure 4.6 Last Accumulated Plan on CECE ... 63
Figure 4.7 Suited DCA on S&P500 Returns... 64
Figure 4.8 Suited DCA on S&P500 Net Returns ... 64
Figure 4.9 Suited DCA on S&P500 Exchange Rates' Impact ... 65
Figure 4.10 Returns Euro based over perform Returns Dollar based ... 65
Figure 4.11 Suited DCA Returns over perform Standard DCA Returns - S&P500 ... 66
Figure 4.12 Suited DCA on FTSE100 Returns ... 67
Figure 4.13 Suited DCA on FTSE100 Net Returns ... 67
Figure 4.14 Suited DCA on FTSE100 Exchange Rates' Impact ... 68
Figure 4.15 Returns Euro based over perform Returns Pound based ... 68
Figure 4.16 Statistical Analysis on Suited DCA and Standard DCA Differences - FTSE100 ... 68
Figure 4.17 Suited DCA Returns over perform Standard DCA Returns - FTSE100 ... 69
Figure 4.18 Suited DCA on NIKKEI225 Returns ... 70
Figure 4.19 Suited DCA on NIKKEI225 Exchange Rates' Impact ... 70
Figure 4.20 Returns Euro based over perform Returns Yen based ... 70
Figure 4.21 Suited DCA on NIKKEI225 Net Returns... 71
Figure 4.22 Statistical Analysis on Suited DCA and Standard DCA Differences - NIKKEI225... 71
Figure 4.25 Suited DCA on CECE Net Returns ... 73
Figure 4.26 Statistical Analysis on Suited DCA and Standard DCA Differences - CECE ... 73
Figure 4.27 Suited DCA Returns over perform Standard DCA Returns - CECE ... 74
Figure 4.28 20 Impact of each ETF on the aggregate portfolio ... 75
Figure 4.29 Suited DCA Aggregate Returns ... 76
Figure 4.30 21 Impact of CECE - Net Returns ... 76
Table 2.1 Buy and Hold example: increasing trend ... 24
Table 2.2 Value Averaging example: increasing trend ... 25
Table 2.3 Dollar Cost Averaging example: increasing trend ... 26
Table 2.4 Buy and Hold example: constant trend ... 26
Table 2.5 Value Averaging example: constant trend ... 27
Table 2.6 Dollar Cost Averaging example: constant trend ... 27
Table 2.7 Buy and Hold example: decreasing trend ... 28
Table 2.8 Value Averaging example: decreasing trend ... 28
Table 2.9 Dollar Cost Averaging example: decreasing trend ... 28
Table 3.1 Correlation between Stock Exchange Indexes ... 41
Table 3.2 Statistical Analysis on Standard DCA on S&P500 ... 47
Table 3.3 Standard DCA on S&P500 Costs' Impact on Average ... 47
Table 3.4 Standard DCA on S&P500 Exchange Rates' Impact ... 48
Table 3.5 2 Statistical Analysis on Standard DCA on FTSE100 ... 49
Table 3.6 Standard DCA on FTSE100 Costs' Impact on Average ... 50
Table 3.7 Standard DCA on FTSE100 Exchange Rates' Impact ... 51
Table 3.8 Statistical Analysis on Standard DCA on NIKKEI225 ... 52
Table 3.9Standard DCA on NIKKEI225 Costs' Impact on Average ... 53
Table 3.10 Standard DCA on NIKKEI225 Exchange Rates' Impact ... 53
Table 3.11 Statistical Analysis on Standard DCA on CECE ... 54
Table 3.12Standard DCA on CECE Costs' Impact on Average ... 55
Table 3.13 Statistical Analysis on Aggregate Results Standard DCA ... 56
Table 4.1 Number of payments for each ETFs ... 61
Table 4.2 Statistical Analysis on Suited DCA on S&P500 ... 64
Table 4.3 Suited DCA on S&P500 Costs' Impact on Average ... 64
Table 4.4 Statistical Analysis on Suited DCA and Standard DCA Differences - S&P500 ... 66
Table 4.5 Statistical Analysis on Suited DCA on FTSE100 ... 67
Table 4.6 Suited DCA on FTSE100 Costs' Impact on Average ... 67
Table 4.7 Statistical Analysis on Suited DCA on NIKKEI225 ... 69
Table 4.8 Suited DCA on NIKKEI225 Costs' Impact on Average ... 70
Table 4.9 Statistical Analysis on Suited DCA on CECE ... 72
Table 4.10 Suited DCA on CECE Costs' Impact on Average ... 73
Table 4.11 Statistical Analysis on Aggregate Results Suited DCA ... 74
Table 4.12 Statistical Analysis on the difference between Net Returns ... 77
Introduction
The high volatility, faced by the market after the recent crisis, has contributed to the
development of several investment strategies, aimed to reduce the problem associated to
the choice of the best moment to make an investment.
One of the main employed strategy is Periodic Payment Plan, also known in Italian as
Piano di Accumulo del Capitale. Based on the Dollar Cost Averaging (DCA), it consists
in periodic investments of equal dollar amount, also small installments, into Mutual
Funds or ETFs.
The benefits associated to this strategy consists into avoiding the difficult to figure out
the best time to invest. Indeed through the DCA it is possible to transform the down
turns into investment opportunities. Basically, through this, investor will buy more
shares when prices are low and less shares when prices are high.
Doing frequent, but, at the same time, small payments, positively influences the
psychological component of an investment, since it reduces fears associated to the
wrong choice of the moment to invest, that characterizes Lump Sum investments (which
consist in investing all the capital in a single shot).
Since this strategy can be viewed not only as an investment plan but also as a saving
plan, it has been supposed to be a private investor who does not handle the entire capital
in the beginning. Who wants to accumulate installment after installment a certain
amount of money.
The thesis is structured as follows. In the first chapter it has been described the different
kind of investment companies. It has been made the point on the mutual funds and on
the ETFs, since generally, in Italy, the DCA is designed in order to invest in those
funds.
In the second chapter it has been presented different types of investment strategies, such
as the Buy and Hold, the Lump Sum, the Value Averaging and The Dollar Cost
Averaging. It has been explained how those work, by an example, through three
applied the standard DCA on four different ETFs, one belonging to emerging market
and the others to developed markets. It has been designed 75 plans, through a rolling
window, covering the last 16 years. The first plan starts in January 1999 and it ends in
December 2008, while the last plan starts in April 2005 and it ends in March 2015. In
this way it has been tried to include as much as possible different market trends. For
each plan it has be taken into consideration transaction costs, such as commissions and
taxes. Once all the plans have been designed, it has been evaluated the performance on
average of the entire investment strategy, both on each ETF and on the aggregate
portfolio. It has been compared the gross returns with the net returns, the dividends’
impact and the costs’ impact. Moreover, since ETFs employed are not all traded in euro,
it has been taken into account the influence of the exchange rate, where applicable.
In the last chapter, it has been designed a different strategy, called Suited Dollar Cost
Averaging, since it has been changed the investment timing. In the previous chapter, we
have monthly installments. In this chapter it has been exploited the market down turns
in order to make investment at lower price. It has been computed a certain percentage of
down turns for each market and then it has been designed the entire strategy according
to this.
Once it has been outlined all the 75 plans, it has been made the same analysis as before.
In the end it has been compared the two strategies trying to identify the best one.
1. Investment Companies
The term Investment Company has started to be used more frequently with the enacting
of the Security Act in 1933 and the Security Exchange Act of 1934. Those have been
created to protect investment of securities “issued by commercial and industrial
corporations and sold to the public and traded on exchanges”
1. All those rules were
necessary in order to protect investors after the stock market crash of 1929 and the
following Great Depression. Moreover with the development of the Investment
Company Act, in 1940, it has been established a series of rules for the investment
industry.
In Europe collective investment company scheme is regulated by the Directive
2014/91/EU, that amends the current directive also known as UCITS IV, based on the
original Directive 85/611/EC, whose aim was to give a uniformity among the European
markets, setting rules for the creation of an internal market in order to exploit
economies of scale, for example to reduce investment costs.
UCITS stands for Undertakings for the Collective Investment in Transferable Securities
accounting for around 75% of all collective investments by small investors in Europe
2.
On the Italian side, investment companies are called “Organismi di Investimento
Collettivo del Risparmio” and regulated by the “Decreto legislativo 24 febbraio 1998, n.
58: Testo unico delle disposizioni in materia di intermediazione finanziaria”,
making a
distinction between
Societa di Gestione del Risparmio (SGR), more oriented toward the
management of the investment, and
Società D'investimento A Capitale Variabile
(SICAV), that is defined as an investment company, since investors subscribe shares of
it.
According to the definition given by the U.S. Securities and Exchange Commission, an
investment company is a “company (corporation, business trust, partnership, or limited
liability company) that issues securities and is primarily engaged in the business of
investing in securities.”
3Based on the classification described into the Investment Company Act of 1940, it is
possible to divide those companies into three categories: Unit Investment Trusts,
Closed-End Funds and Open-End Funds
4.
1.1.1 Unit Investment Trusts
This kind of companies offer a portfolio of securities fixed for the entire life of the fund.
Those have been created in the middle if the 1920s as “fixed trust”. Generally they
make a one-time “public offering”
5with a precise number of redeemable securities (also
called “units”) to be issued. Once the units have been issued there is no an active
management on the investment portfolio, so also the fees associated with it are not
unaffordable. UITs keep the funds until their termination date, when they will be sold
and paid back to the investors. Moreover there exist other intermediaries working as
UITs sponsors, who act in a secondary market where units can be bought back from
investors and sold to new investors.
1.1.2 Closed-End Funds
Differently these investment companies enter into the category of managed funds,
together with opened end funds. As it happens for the UITs, they release a certain
amount of shares at one time, in an Initial Public Offering (known as IPO); shares are
then traded in a secondary market where the price is determined. The following issue of
right offering or dividend reinvestment
1.1.3 Open-End Funds
These kinds of companies collect, from each individual, a certain amount of money that
will be pooled into funds and reinvested into securities or different kind of assets, as the
other investment companies do. The difference consists in the fact that shares are
bought by individuals directly from the fund and not from other investors on the
secondary market. Moreover their shares are redeemable at any time with no
restrictions, since the investor can sell them back to the fund.
The price paid by the investor to buy a share is the so-called Net Asset Value, NAV. It
is the total assets’ value minus the total liabilities’ value. Dividing this difference by the
total amount of outstanding shares leads to the NAV per share
6.
Open-end Funds as well as Unit Investment Trusts have to compute the NAV for every
single day, right after the U.S. exchange close. To the contrary, Closed-end Funds are
not required to compute every day the Net Asset Value, due to the fact that their shares
are not redeemable.
Before going on with an in-depth analysis of investment companies through the
description of mutual funds, it can be appropriate to present some other kinds of
intermediaries, whose function is very analogous to the one of investment companies:
Commingled Funds. They are defined as partnership of investors pooling their
funds. Very close to Open-end Funds, they offer units (not shares), that have
been traded at the NAV and managed by a bank or an insurance company.
Real Estate Investment Trust. On the other hand, these kinds of fund have
feature in common with Closed-end Funds. The investment is done in real
estate.
Hedge Funds. The mechanism is the same as for the other types of funds: private
investors pool assets into a basket to be invested all at once by a fund manager.
Since those organizations are not subject to SEC regulation, funds’ managers
using doing arbitrages with derivatives, short sales
7and leverage.
1.2 Mutual Funds
In 2014 the U.S. mutual fund industry remained the largest in the world.
8Figure 0.1 - Source www.icifactbook.org
Mutual Funds are open-end companies that collect money from several investors and
invest that money in other securities.
They offer the advantage of a greater liquidity, a reduction of investment costs, due to
scale economies associated to the dimension of the fund, and diversification with
respect to investments in single stocks or in other single financial instruments. Indeed
mutual funds are composed by a wide variety of companies and industry sectors:
diversification is useful in order to reduce volatility, spreading risk among different
assets. Moreover, one feature of Open-end Funds is the opportunity to redeem shares
anytime, evaluated at their current NAV, plus the associated fees. In this way the mutual
funds is presented as a very liquid financial tool.
money from investors to create a trust named “Eendragt Maakt Magt”
9. This provided,
for small investors, the opportunity to decrease the risk associated to an investment, by
means of the diversification, and to facilitate the access to credit, after the financial
crisis of 1772-1773 and the consequent lack of liquidity (Rouwenhorst, 2004).
There exist different kinds of mutual funds according to the investment policy they
pursue. Some examples could be found in:
Bond Funds. The portfolio is composed by corporate bonds, treasury bonds,
mortgage-backed securities, municipal bonds with a maturity longer than one
year;
Equity Funds. The investment is done mainly in stocks. Inside this category it
is possible to make a distinction between income funds (where the major part
of the firms are characterized by high dividend yields), growth funds and
sector funds (according to the industries in which they operate, for instance);
International Funds. It so called the investment located outside the residence
country of the investor and that can be traded outside the country where those
are located.
Money Market Fund. The portfolio is composed of bonds with a maturity
smaller than one year, also known as short term debt securities
Index Funds. Their aim is the replication of the performance of a market
index, such as the S&P500 or FTSE100. The replication consists into the
purchase of shares composing the index proportionally.
There are a lot of different features to be taken into account underwriting mutual funds,
e.g. their past performance, the investment policy, but also the expenses that could be
faced.
There could be several fees associated to mutual funds, such as
10:
Front-end loads, paid at the beginning when the investors subscribe the funds.
9
“unity creates strenght”
to decrease as much as the funds are left invested, probably due to encourage the
investors to keep their shares.
Management fees, such as management expenses, distribution costs. Those are
computed as a “percentage of the total asset under management” (Bodie et Al.,
2005). These fees are deduced periodically from the value of the individual
portfolio.
Total Expense Ratio. It is a measure of the trading cost of a fund, since it is
computed as the total amount of the fees over the total value of the fund. It is
generally employed for the evaluation of the fund’s expenses, even if it does not
always embody all the costs associated to an investment. For instance,
management costs are not included here.
1.3 Exchange Traded Funds
ETFs could be defined as an hybrid tools
11, since those combine some features of the
Open-End Funds and some of the Closed-End Funds. As Open-End Funds, specifically
as Mutual Funds, they aim to replicate the performance of a benchmark security, such
as a stock, a bond, a composite index, futures and other financial instruments. On the
contrary ETFs can be traded intraday, characteristics in common with Closed-Ends
Funds. Indeed investors can trade ETFs’ individual share in the secondary market
12intraday.
ETFs belong to the class of Exchange Traded Product, known as ETPs, together with
Exchange Traded Commodity, ETCs
13.
As for ETFs, the other two type of financial products’ object is the replication of an
underlying. For the ETCs the referring benchmark is a commodity
14.
1993. Nevertheless, the concept of an Exchange-Traded Fund is related to the market
crash of 1987 and to the scarcity of liquidity in the market. After two years, the idea of
exchange big amount of shares pooled into only one basket was found with Index
Participation Shares (IPS). It was a good proxy for the S&P500 and its volume started
to increase over time, until the Chicago federal court found the ISP illegal and forced
the investors to liquidate all their assets. (Gastineau, 2001).
The basic idea of Nathan Most consists in an in-kind creation and redemption process.
It is possible to separate the two markets where the ETFs are traded into a primary
market and a secondary market. The figure 1.1 can help to better understand the
creation process.
In the primary market, can operate only the fund and the authorized participants. The
fund issues creation units, i.e. funds units, to the authorized participants, making a
change for a basket of securities and cash. Then authorized participants trade on the
secondary market the funds units, keeping their price close as much as possible to fund
iNAV values (Drenovak and Urosevic, 2014).
In order to make better understand what ETFs are, it could be useful to recall the
example made by BlackRock investment company.
flower. The broker is the flower shop.
Let’s start from the secondary market. Investor goes to the flower shop (the secondary
market) and he or she chooses the bouquet (ETFs). The florist (broker or dealer) takes
the order and sends it to the porter (market maker).
The market maker goes in the market to find the flower composing the bouquet. If the
supply of flowers is smaller with respect to demand, market maker has to go to the
authorized participant (AP), who watches the market.
The market maker sends the order to the AP, who can work also inside the primary
market. Market maker gives to AP the stocks necessary to replicate the index. The AP
so goes to the fund and exchanges stocks with ETFs. Then he goes back to the market
maker and sells him the ETFs. Market maker gives the ETFs to the broker who sells it
to the investor. This process is called creation. The price does not change even if the
demand of the ETFs increases, since it always possible to create new ETFs.
As the investor wants to sell its ETFs in the market, there happens the inverse process.
The market maker brings back the ETFs to the AP, who gives them back to the fund in
the primary market. The inverse process is called redemption.
The particular in kind creation/redemption allow to have a performance close to the one
of the underlying the ETFs try to replicate.
The importance and the presence of ETFs in the market are quite considerable. Just
looking at figure 1.4 it is possible to have an idea of how much are increased in value
since the first ETFs entered in the European market in 2002
The success of these investment vehicles is due to many factors.
Since those can be traded as mere securities inside the market, ETFs are very accessible
for even a private investor: he or she can buy or sell ETFs just sending the order through
a bank.
As already said, ETFs ensure a certain level of diversification, decreasing the risk
associated to the investment. As much the securities inside funds are diversified as
much is reduced the possibility to be affected by unsystematic risk. This is the risk
associated to unexpected events. Investing in just one company, for instance that could
be affected by negative events, means to lose the amount invested. On the contrary, if
the investment is well diversified among companies, possibly with lower correlation
between them, the negative event would less affect the overall investment.
Since ETFs are characterized by a passive management, there are no front end loads and
back end loads to be paid. It is applied a management fee (generally in between the
0.30% and the 0.50% on the total investment).
Furthermore ETFs distribute dividends paid by its components, generally once per year,
even if there are some ETFs distributing also several times per year, as it will be
possible to see in the empirical case.
Transparency is another key for their success
15. For each ETF it is possible to have the
NAV updated all over the day, as it would be for the price of a stock, the composition
(i.e. the list and the weights of the stocks included in the basket), the composition of the
underlying. This information could better guide a potential investor into choosing the
right ETF.
2. Periodic Payment Plans
The timing problem always represents a big issue for a potential investor. The problem
arises since it is not possible to foresee the market price, so an investor might be
worried to buy at higher price or sell at lower price.
There exists an investment methodology that tries to elude the timing problem, this is
called in italian “Piano di Accumulo del Capitale”, or Periodic Payment Plans.
Based on the principle of the Dollar Cost Averaging, it consists in the underwriting of
an Undertakings For The Collective Investment Of Transferable Securities (UCITS),
such as Mutual Funds or ETFs. Investing a definite amount of money for a certain
period of time constantly, for instance quarterly, allows the investor to minimize the
downside risk
16, since the average cost of the overall investment is rebalanced at each
new payment.
2.1 Investing Strategies
There exist several investment strategies advisors offer to their clients in order to
purchase assets (Leggio and Lien, 2001). We can find some examples of those in the
Lump Sum Investment, in the Buy and Hold, in the Value Averaging and in the Dollar
Cost Average.
2.1.1 Lump Sum Investing
An individual decides to allocate an amount of money into assets, purchasing those
up-front. She or he invests all the capital once, so the investor owns the entire capital at the
beginning and then computes profits or losses deriving from this investment. The main
advantage characterizing this strategy is the possibility to earn equity excess returns on
the portfolio from the beginning, but the disadvantage derives from the fact that the
investment could be done in an inopportune instant, leading to have losses at the end.
2.1.2 Buy And Hold Strategy
This strategy is very close to the lump sum since the investor owns the total amount of
capital from the beginning and she or he invests once. The difference consists in the fact
that investor selects a portfolio composed by a risky asset, where to invest half of the
capital, and a risk free asset (such as a Treasury Bill) where to invest the remaining part
of the available money. At each period of time, for instance one year, it is computed an
“overall return for the investment strategy” (Thorley, 1994) without any rebalancing in
the portfolio
17.
2.1.3 Value Averaging
Value averaging is a strategy characterized by the fact that the investor takes advantage
from the fluctuation of the price. She or He decides the value of the portfolio for each
period and will buy or sell sufficient “shares” or units of the investment as to reach the
predetermined portfolio worth (Marshall, 2000). Indeed at each revaluation point the
amount of money invested is changed according to the requisite to reach the quantity
established.
2.1.4 Dollar Cost Averaging
“Periodic investments of equal dollar amounts in common stock can substantially
reduce (but not avoid) the risk of equity investment by insuring that the entire portfolio
of stocks will not be purchased at temporarily inflated prices” (Malkiel,1975).
The last strategy and the most important for this analysis is the Dollar Cost Averaging.
The basic idea is that the individual invests the same amount of money at each interval
17
Differently from the Optimally Balanced Strategy where at each subsequent period the investment composition is rebalanced, in order to reach an optimal balanced investment. In this way the investor buys greater quantity of the risky
that could be each month, each quarter, each semester. As for the value averaging the
investor will buy more shares when the price is lower and less shares when it is higher.
Let’s see an example to better understand the dynamics regulating those strategies. We
will compare the Buy and Hold, the Value Averaging and the Dollar Cost Averaging
over three different market trends: increasing trend, constant trend and decreasing trend,
along four period of time.
Let’s suppose to invest in a market characterized by a positive trend. The price is
increasing through time, from €8 to 16€. (Table 2.1) The investor owns from the
beginning, the total amount of capital needed, €8000. According to Buy and Hold
strategy, the investor will buy shares with his or her capital and hold those as long as he
or she wants. Buying at €8 in the first period the investor will hold until the price has
reached €16. In this way he or she gains €8000, having a returns of 100%.
Buy and Hold Price Invested
Capital
Shares Owned
Terminal Value Gain (or Loss) Cost per share 1 € 8 € 8,000 1000 € 8 2 € 10 3 € 12 4 € 16 € 8,000 1000 € 16,000 € 8,000
Table 2.1 Buy and Hold example: increasing trend
Value Averaging consists to fix up front the amount of shares we should have with the
amount of money we would invest. Let’s see from the example how it works.
The investor aim is to fix an amount of capital per month and to buy shares according to
the value of his or her portfolio. The investor has a capital of €8000 (Table 2.2). He or
she wants to make periodic investments in order to have a portfolio whose value is
predetermined by the investor himself. In our example there are four period of time.
€8000. In order to do so, the first year the investor will purchase as much more shares
he or she can with the capital available, i.e. €2000. The shares owned by the end of the
first year will be 250. The second year the price increases at €10,00. The portfolio’s
value will be €4000, that means to own an amount of shares equals to 400. Since
investor owns 250 shares yet, we should buy 150 shares to have 400 shares. The same
happens in the third period. With the new price, €12,00, the investor should has inside
his/her portfolio 500 shares. Since he or she already holds 400 shares, investor will buy
just 100 of them. Indeed is the difference between the number of shares owned and the
number needed to reach the portfolio’s value. In the fourth year investor will not buy
anything, even if price increases. Indeed he or she owns the shares needed to cover the
entire amount yet.
Value Averaging Price Theoretical Capital Shares Owned Shares Invested Capital Terminal Value Gain (or Loss) Cost per share 1 € 8 € 2,000 250 250 € 2,000 € 8 2 € 10 € 4,000 400 150 € 1,500 € 10 3 € 12 € 6,000 500 100 € 1,200 € 12 4 € 16 € 8,000 500 0 € 0 € 0 € 8,000 500 € 4,700 € 8,000 € 3,300
Table 2.2 Value Averaging example: increasing trend
Let’s move to the DCA strategy. Investor has again an overall capital of €8000,
distributed among four years (Table 2.3). On each year he or she has available €2000
to invest in the market. In the first period, price per share is €8, so the amount of
shares will be the 250. In the second year the price per share goes up, so the number of
share to be bought will be smaller. Indeed as we can see from the table it will be 200.
And so on until the last year, when the amount of shares will be 125. Differently from
Value Averaging strategy, we do not compute the amount of shares on the theoretical
capital we would invest. We decide, a priori, to invest a specific amount of money and
then we compute the amount of shares. So, by the end of the investment plan, the
investor will have 742 shares in his or her portfolio. Since the price per share has
increased, the investment has produced positive returns.
Before to make a comparison between the returns of those strategies, we can have a
look at another feature of the DCA. One can see that cost per share of the former two
strategies corresponds with the price itself of the security. On the contrary, the cost per
share of the DCA is decreasing over time. Indeed one main feature of this strategy is
the reduction of the cost per share among the entire period of time
18. Return for this
strategy is 48% of the invested capital, more than value averaging.
Dollar Cost Averaging Price Th. Capital Th. Shares Acc. Shares Acc. Capital Terminal Value Gain (or Loss) Cost per share 1 € 8 € 2,000 250 250 € 2,000 € 8.00 2 € 10 € 2,000 200 450 € 4,000 € 8.89 3 € 12 € 2,000 167 617 € 6,000 € 9.73 4 € 16 € 2,000 125 742 € 8,000 € 10.79 € 8,000 742 € 8,000 € 11,866.67 € 3,866.67
Table 2.3 Dollar Cost Averaging example: increasing trend
Supposing now to have constant market trend. We can make the computations for the
three strategies again and we get the following results.
Buy and Hold Price Invested Capital Shares Owned Terminal Value Gain (or Loss) Cost per share 1 € 8 € 8.000 1000 € 8 2 € 12 3 € 10 4 € 8 € 8.000 1000 € 8.000 € 0 € 8
Table 2.4 Buy and Hold example: constant trend
Since the initial price is the same of the final price, investor does not have any gain or
loss (Table 2.4).
Value Averaging Price Theoretical Capital Shares Owned Shares Invested Capital Terminal Value Gain (or Loss) Cost per share 1 € 8 € 2.000 250 250 € 2.000 € 8 2 € 12 € 4.000 333 83 € 1.000 € 12 3 € 10 € 6.000 600 267 € 2.666 € 10 4 € 8 € 8.000 1000 400 € 3.200 € 8 € 8.000 1000 € 8.866,67 € 8.000,00 -€ 866,67
Table 2.5 Value Averaging example: constant trend
For this strategy, instead, investor has bought more capital than the value of the shares
he or she owns. So there will be a loss, and a negative return (Table 2.5).
Dollar Cost Averaging Pric e Theoretical Capital Theoretical Shares Accumulated Shares Accumulated Capital Termina l Value Gain (or Loss) Cost per share 1 € 8 € 2.000 250 250 € 2.000 € 8,00 2 € 12 € 2.000 167 417 € 4.000 € 9,60 3 € 10 € 2.000 200 617 € 6.000 € 9,73 4 € 8 € 2.000 250 867 € 8.000 € 9,23 € 8.000 867 € 8.000 € 6.936 -€ 1.064
Table 2.6 Dollar Cost Averaging example: constant trend
The terminal value is smaller than the invested capital, having a loss even in this
strategy (Table 2.6).
Without going deeper again in the analysis, since the computation are the same of the
previous example, we get that B&H strategy does not produce any return. On the
contrary both VA and DCA make a loss, since returns are negative, respectively -11%
and -13%. Furthermore, the price per share is increasing in the DCA strategy.
The last example
19takes into consideration a decreasing trend. It has been supposed
price turns down from €16 to €8. Let’s see how the strategy works in this situation.
B&H presents the worse results (Table 2.7). Investor bought 500 shares paying €16, so
now the investment plan has made a loss equal to 50% of the invested capital. Even if
also the other two strategies present negative returns, DCA (Table 2.9) allows investor
to lose less amount of money.
Buy and Hold Price Invested Capital Shares Owned Terminal Value
Gain (or Loss) Cost per share 1 € 16,00 € 8.000,00 500 € 16,00 2 € 12,00 3 € 10,00 4 € 8,00 € 8.000,00 500 € 4.000,00 -€ 4.000,00 € 16,00
Table 2.7 Buy and Hold example: decreasing trend
Value Averaging Price Th. Capital Shares Owned Shares Invested Capital Terminal Value Gain (or Loss) Cost per share 1 € 16 € 2.000 125 125 € 2.000 € 16,00 2 € 12 € 4.000 333 208 € 2.500 € 12,00 3 € 10 € 6.000 600 267 € 2.666 € 10,00 4 € 8 € 8.000 1000 400 € 3.200 € 8,00 € 8.000 1000 € 10.366,67 € 8.000 -€ 2.366,67
Table 2.8 Value Averaging example: decreasing trend
Dollar Cost Averaging Price Theoretical Capital Theoretical Shares Accumulated Shares Accumulated Capital Terminal Value Gain (or Loss) Cost per share 1 € 16 € 2.000 125 125 € 2.000 € 16,00 2 € 12 € 2.000 167 292 € 4.000 € 13,71 3 € 10 € 2.000 200 492 € 6.000 € 12,20 4 € 8 € 2.000 250 742 € 8.000 € 10,79 € 8.000 € 8.000 € 5.933,33 -€ 2.066,67
From Figure 2.1, we can see the comparison between returns of those strategy. B&H is
the better one with increasing trend, but it produces greater loss with decreasing trend.
DCA seems to work better than VA except with constant trend. Again this is just an
example to see how strategies work, we cannot prove that one is better than the other
just through this.
Figure 2.1 Comparison between Returns
2.2 The Dollar Cost Averaging in the literature
The literature about the dollar cost averaging is very wide.
Starting from the 1940s it is already possible to read about the formula plan as a
solution for the investment timing’s problem. Solomon (1948) presents a personal plan
in order to increase the value of the portfolio invested “by the time the market returns to
the point-of beginning, irrespective of what fluctuations occur in the intervening
period”, based on “an equalizing plan” created by Carpenter (1945).
Francis (1980) describes the Dollar Cost Averaging a “simple investment plan which
helps […] investors with the timing of their investment”
20; Latane, Tuttle and Jones
(1975) define this as a way to take “advantage of the stock market ups and downs”
21since the cost of each single share will be smaller than the average of the market prices.
20 p. 706 Francis (1980) -60% -40% -20% 0% 20% 40% 60% 80% 100% 120%
Increasing Constant Decreasing
B&H VA DCA
(Bierman et al., 2004); Fisher and Jordan (1995) suggest the Dollar Cost Averaging as
investment strategy since it “relieves the pressures on the investor to forecast fluctuation
in stock prices”
22. This is just to have an initial idea of how timeless is, the problem of
timing, since the prices’ forecast is still impossible.
According to Brennan et al. (2005) the academic view on the formula plans for
investing has changed as the random walk theory became an approximation of the
stock market behavior.
23Indeed both Ketchum (1947) and Weston (1949) have
analyzed different formula plan as a function of the cyclical fluctuation finding that a
timing plan strategy is always superior, for instance as in Ketchum’ work, to an equity
strategy.
With the replacing of prices based on cyclical trend, in favor of the random walk, the
academic articles about formula plans started to present negative view on the argument,
above all in the comparison between dollar cost averaging and other investment
techniques.
The first example can be found in Edleson (1988) who compare the Value Averaging
methods with the Dollar Cost Averaging, finding better results for the former
investment strategy. Another example is offered by Harrington (2001), who, in
addition to Edleson work, compares also the performance of Lump Sum investing
strategy, finding this the best out of the three, even if the Value Averaging is
outperformed by the Dollar Cost Averaging.
An alternative survey has been made by Braselton et Al. (1999), who compare the
Lump Sum strategy with the DCA through a simulation of the S&P500 for 54 months.
Their results show that the Lump Sum has higher returns on average, but it is more
volatile with respect to the DCA strategy.
Another academic article based on simulation methods of the DCA strategy is
represented by Scherer (1998), whose work shows a constant underperformance of the
DCA. Again through the employment of a simulation, the Monte Carlo method,
could lead to charge the investor of higher risks.
The literature presents also some positive comments to the Dollar Cost Averaging,
above all in the last two decades. Israelsen (1999) makes a study on 35 of the largest
equity funds in a period of 10 years, from September 30, 1998. He ignored taxes and
other loads. Furthermore he reinvested dividends and capital gain. The results shows a
better performance of the DCA with respect to the Value Averaging more than half of
the time for those funds with lower volatility. On the contrary Milevsky and Posner
(1999) in the same year present a study where the DCA outperforms the Lump Sum for
funds with higher volatility too.
It is possible to find in many articles the correspondence between DCA and other
investment strategies. Knight and Mandell (1993), for instance, compare the strategy
with Buys and Holds (hereinafter as B&H) and Optimal Rebalancing (hereinafter as
OR). Through the utility function concept they compare the investor’ utility functions
associated to the optimal rebalancing strategy with DCA, supposing he or she invests
half of his/her capital on a risky asset and half on a riskless asset. Then through the
MonteCarlo simulation with NYSE data they make a comparison between certainty
equivalent. The results say DCA has the smallest return and mean utility. Moreover the
costs associated to DCA investment strategy are bigger than the other two strategies,
since a bigger number of installments, even if the amount of money is small, involves
more costs with respect to a single installment bigger on size. Those are the reason why
the authors present the DCA as underperforming.
According to this view, Rozeff (1994) objects to the fact that DCA reduce variance
without reducing also returns. His analysis takes into consideration a market with
upward trend and it compares lump sum (LS) strategy with DCA. He makes a
simulation on the S&P500 monthly data, from 1926 to 1990. The results founded show
DCA underperforms the LS, even if DCA has lower standard deviation.
Thorley (1994) defines DCA even “harmful as an investment strategy”. Again, through
the analysis on S&P500 and Treasury Bill in the period 1926-1991, he makes a
comparison of DCA and Value Averaging (VA) strategy with Buy and Hold. Both DCA
and VA exhibit higher risks and lower returns. Furthermore, he illustrated the fallacy of
another advantages associated to the DCA, that is lower average costs of shares, since
this can be likely but not always true.
The analysis is not made only on stock exchange market. Bacon, Williams and Ainina
(1997) examine the bond market. As Rozeff did, they compare DCA with LS. Providing
the same results as for stock market: investing once gives more returns than splitting the
investment over time. This also justified that DCA with lower installments generates
more returns. So again LS is considered a better strategy with respect to DCA, also in
different markets, such as for bond markets. The only positive effect seems to be the
psychological advantage derived from period payments. This feature will be deepen
explained along the chapter.
In another article it has been highlighted that efficient market hypothesis, explained by
Fama (1960), do not work with DCA or other investment strategies. In order to prove
the supremacy of VA with respect with both DCA and Random Investment (RI),
Marshall (2000) tests data regarding S&P500, from 1966 to 1989, without considering
any additional costs, such commissions or taxes. He finds out that VA is the best
strategy for all the tests he have done, while DCA performs almost as RI.
Vora and McGinnis (2000) suggest the dollar cost investing as a retirees plan. Chen
and Estes (2007) also study the strategies as applied to a retirement plans. They
analyzed the performances of DCA and VA based on a Monte Carlo simulation. They
considered, as most of the authors did, the S&P500 and Treasury bills over 70 years.
The results shows that DCA strategy underperformed VA strategy in term of
risk/returns trade-off.
Scherer and Ebertz (2003) propose a dynamic DCA, remodeling between equity and
cash. They asserted the inefficiency of DCA, claiming that is not possible to take
advantages from it in a volatile market.
excludes dividends and also the costs associated to the application of the strategy. The
analysis highlighted one more time that timing the market is almost not possible with
the dollar cost averaging.
Atra e Mann measure the performances of LS and DCA over different periods. They
set a self financing portfolio borrowing funds at risk free rate and investing into risky
securities. They ignored costs, such as transaction costs and taxes. They focused on the
seasonality, showing that for certain period of the year could be better one strategy, and
viceversa. So the choice between one instead of the other strategy should embodied the
timing pattern of stock market.
Bierman and Hass (2004) critized the diversifications, claiming that it decreases the
advantages of the DCA. Greenhut (2006) asserted DCA advantage, with respect to LS,
for the trade-off between reward and risk.
Most of the authors did not take into consider transaction costs for the evaluation of a
strategy. Khouja and Lamb (1999) did, since the evaluation should be more realistic as
possible. They tried to maximize the returns of the DCA finding the best time interval
between each purchases and the best amount of equity to be bought.
2.3 Description of Periodic Payment Plan
Let us better understand how the Periodic Payment Plan
24works. First of all it is
regulated, for what regards the Italian Legislation, by the “Regolamento della Banca
d’Italia, sezione IV, comma 8”, declaring that “La partecipazione al fondo comune si
realizza tramite sottoscrizione delle quote del fondo ovvero acquisto a qualsiasi titolo
del certificato rappresentativo delle stesse”.
Since it is based on the Dollar Cost Averaging, the CAP is not a financial product but an
investment strategy. It consists in a periodic payment of a fixed installment in order to
purchase some shares of an OICR
25.
The main aim of the CAP is to invest small quantity of money each period of time
buying different numbers of shares according to the market price. In fact the investor
decides a priori the value of the installment, the frequency of the investment, the funds
where to invest but not how many shares to buy. This because this strategy exploits the
market movement, buying more shares when the market price decreases and buying less
shares when the market price increases. The capital accumulated increases as the
number of payments does. So this strategy can be seen under a double point of view:
both as an investment plan and as a saving plan.
It can be seen as an investment plan, if the investor is interested only into the excess
returns generated by the plan. Generally the individual owns the entire capital at the
beginning of the investment period and uses this strategy mainly for its principal
feature: avoid the timing problem associated to other methods, such as lump sum
investing strategy.
On the other hand, the capital accumulation plan can be thought as a saving plan. Indeed
an investor can employ this strategy in order to create a personal capital for the future,
gradually feasible in time. The investor can set aside part of its wage each month, for
example, to be invested in a specific portfolio. In this way she or he could hold a
significant amount of money by the end of the plan for an additive pension.
In doing this is not necessary to hold from the beginning the entire capital to be
invested. It is enough to have at each period the correspondent amount for each
payment. For this motivation even small investors can subscribe this strategy.
2.4 Advantages and Disadvantages of Periodic Payment Plans
the main results regard the Italian market, since, as also Merlone and Pilotto(2014)
pointed out, it is a phenomena in great expansion in the Italian area, but not so exploit in
the Anglo-Saxons countries.
It is not so easy to find a specific literature about this
26. And it is not so easy to
determine the pros and cons of implementing this investment, among all these
advertising.
Anyhow it is easy to see that one of its main advantages is the management of the
timing in the investment. The possibility to invest partial amount of the capital step by
step allows the investor to bypass the problem of choosing the best initial day for the
investment: indeed what counts is not each single payment but the average weighted
price
27paid. Furthermore at the evaluation day the average book value should be
smaller than the price of a single unit purchased in order to have some profits at the end
of the plan.
There is not only the fear associated to the wrong initial day, but also there exists an
emotional component that could compromise the investment. This is a problem when an
individual tends to sell all its investment as things go wrong in the market. The Capital
Accumulation Plan captures the negative market movements. But at the same time it
captures the positive movements, creating as said before an average price.
Another advantage, associated to those kinds of investment plans, is related to the
duration of the plan itself. It is the investor who decides the duration of the plan,
eventually to interrupt for a given period of time or to interrupt it permanently.
Generally, also in order to have better returns, DCA should last more than 5 years.
Definitely, if the investment plan lasts for a period of time smaller than one year, the
DCA will lose its feature of constant period payments, and it will seems to assume the
features of a buy and hold investment.
Another advantage is the diversification, both under the timing point of view, as just
explained, and under the assets point of view. One feature of the CAP is that the
investment can be done underwriting Mutual Funds or ETFs or other financial tools.
Thinking about, for instance, to what is a mutual fund: this collection of money has
been invested into different securities pooled in a single basket. This allows a complete
diversification of the investment and consequently a decrease of the market risks
associated.
The investor can choose also the amount to be invested and she or he can change the
amount anytime she or he wants. Each individual indeed can decide if to set aside a big
quantity of capital or a small one, such as €25 per month
28. This could be thinking one
of the reasons why the strategy is so attractive for any kind of investors. It is not
necessary to hold the entire amount at the initial day of the plan. The strategy could be
interesting for an individual who wants to create a personal pension fund, or to fund the
studies of the children into the future, or to make an investment in the future, for
instance a car. The reasons why people would want to collect money in the future could
be countless.
As well as there exist many advantages subscribing the Periodic Payment Plan, there
also exist many disadvantages. Those mainly regard the fees associated with this
investment strategy
The first disadvantage is represented by the Front-End Load. When an investor
subscribes this plan with a financial intermediary, such as a bank, she or he has to pay
some initial fees. For instance, who manages the funds can ask for a payment of the
30% of the overall commissions up-front
29and to divide the remaining amount for the
entire period of the investment. The disadvantage actually arises if the investor will
decide to withdraw the investment before the maturity. This will lead to have higher
commission costs on average, since those are not split for the entire accumulation plan.
There could be other commissions, for instance, such as fixed fees on the single
installment. Even if those are quite small
30, fees affect more individual who have chosen
to invest small quantity of money. Since fees are not variable according to the amount
of capital used but fees are fixed, those will weigh more on smaller investors with
The last disadvantage is not related to the cost itself. But regards the returns of the
investment. It is not possible to be sure to have always positive returns. What if the
price of the underlying (e.g. mutual funds or ETF), at the end of the last period of time,
will be smaller than the average weighted costs? The plan will be sold at a lower price
with respect to the amount of money the investor has paid the shares. So the possibility
to rebalance the average weighted cost per share every time there is a new payment,
leading the average weighted cost per share toward a stable value. Again, this will not
imply that the capital accumulation plan will generate profits every time, just that it
embodied every movement of the market, balancing the average cost of the investment.
3. Standard
Dollar Cost Averaging
Let’s suppose to be a private investor, who wants to accumulate a certain amount of
money over a period of 10 years, in a portfolio composed by ETFs, in order to exploit
the diversification given by their composition.
As explained in the second chapter, the DCA can have high fees when she or he entrusts
the management to an external intermediary. So the investor will create by himself the
entire plan, purchasing the ETFs trough an online bank, since in this way she or he has
the possibility to pay a smaller amount of fees. This is one of the reasons why we have
chosen ETFs, instead of mutual funds, for instance.
Another assumption regards the capital owned by the individual. The investor does not
handle the entire capital at the starting day but she or he sets aside the necessary
quantity on each month.
3.1 The ETFs’ choice
The reason why it can be better to choose ETFs apart from the lower fees associated
with, it is the diversification they offer. This can be done both on a sectorial level (e.g.
financial, industry, energetic, utility, consumption goods, pharmaceutics) or on a
geographical level, diversifying by country or region (e.g. developed market and
emerging market).
For this analysis it has been decided to choose four ETFs, replicating stock indexes. In
this way it is possible to reach both sector and area diversifications. Indeed, stock
indexes embodied several kinds of sectors within. Moreover, indexes belonging to
The decision to create a portfolio of ETFs, diversified by geographical area, has led to
the choice of picking at least one ETF representative of the emerging markets, i.e. the
CECE Composite Index, and to choose the other three ETFs out of the major stock
exchanges
31in the developed markets, that are the S&P500, the FTSE100 and the
NIKKEI225.
The S&P500 Index. It is a capitalization-weighted index of 500 stocks
32traded on the
New York Stock Exchange, NYSE, and on the National Association of Securities
Dealers Automated, NASDAQ. It is composed by 500 of the most capitalized
companies listed in these market. It has been launched in the market in 1957 by
Standard & Poor’s.
Figure 3.1 S&P500 Last Price from January 1999 to March 2015
The FTSE100 Index. It is the most representative index at the London Stock
Exchange. One hundred of the most capitalized companies compose the index since
1984.
Figure 3.2 FTSE100 Last Price from January 1999 to March 2015
The NIKKEI225 Index. As for the other two indexes, it represents the most capitalized
225 companies in the Japan market since 1950.
Figure 3.3 NIKKEI225 Last Price from January 1999 to March 2015
Figure 3.4 CECE Last Price from January 1999 to March 2015
Data series for the last 16 years of these indexes have been downloaded from
Bloomberg. Means and standard deviations of returns for each index have then be
computed on a monthly basis. Most importantly, the correlation between the indexes
has been computed, as shown in table 3.1.
Table 3.1 Correlation between Stock Exchange Indexes
