Chris Muller

Style-based effects on the Johannesburg Stock Exchange: A graphical time-series approach

ABSTRACT Fama and French (1992), in a controversial paper at the time, noted strong associations between cross-sectional equity returns and so-called style variables including size, the price to earnings (P/E) ratio, gearing and the book to market (B/M) ratio. Other researchers have subsequently identified further priced effects relating to (inter-alia): dividends, momentum, cash-flow and a January effect. Many of these have been identified on the Johannesburg Stock Exchange (JSE), (see: Page & Palmer 1991, Page 1996), Plaistowe & Knight 1987, Fraser and Page 2000, van Rensburg 2001, Mutooni and Muller 2007 and Hoffman 2012). We re-examine many of these styles using an improved methodology and data set. We find that portfolios constructed on the basis of univariate ranked style characteristics exhibit significant effects over the period 1985 to 2011. Most notably, we find significant and persistent excess returns in the following variables: momentum, earnings yield, dividend yield, price to book, cash-flow to price, liquidity, return on capital, return on equity and interest cover. Furthermore, we find no evidence of a size effect, except for fledgling companies.

Empirical testing of the CAPM on the JSE

ABSTRACT Famas (1970) efficient market hypothesis (EMH) and the capital asset pricing model (CAPM), jointly ascribed to Markowitz (1952), Treynor (1961), Sharpe (1964), Lintner (1965) and Mossin (1966), remain the foundation of most finance and investment courses. This is surprising, given the sustained criticism of the model and its assumptions, and is a reflection of the elegance and parsimony of the theory over the empirical evidence. On the Johannesburg Stock Exchange (JSE), several authors have examined and noted significant inadequacies relating to the single factor CAPM, particularly with regard to the dual nature (resources versus industrial shares) which characterise this bourse. Van Rensburg and Slaney (1997) advocate the use of a two factor arbitrage pricing theory (APT) model, but show that (at least for industrial shares), additional parameters are required (Van Rensburg, 2001). We revisit this ground using an improved methodology and data set over the period 31 December 1986 to 31 December 2011. We find that portfolios constructed on the basis of ranked beta exhibit a monotonic, inverse relationship to what the CAPM prescribes for most of the time-series. The use of the single beta CAPM is therefore inappropriate.

The long-term share price reaction to Black Economic Empowerment announcements on the JSE

ABSTRACT Black Economic Empowerment has been one of the South African governments primary mechanisms for addressing the economic imbalances of the apartheid era. Voluntary sector “charters”, and more recently legislation, have required largely white owned business enterprises to become more inclusive across key areas of economic empowerment, including the provision of minimum levels of ownership for black shareholders. This research employs event study methodology to examine the long-term impact on the share prices of listed companies after announcements are made relating to black empowerment deals which impact equity ownership. The research examines 118 announcements and finds a positive cumulative abnormal return of around 10% after the first year. The positive result is confined to smaller companies, with market capitalisation of less than R3, 5bn, whilst large companies experience a marginally negative cumulative abnormal return. The results also show that those companies which made BEE announcements prior to May 2005 (‘first-movers’) did somewhat worse than those who followed. Finally, the results were found to be consistent for companies making further BEE related announcements, although the cumulative abnormal returns were lower at around 6%.

Active share on the JSE

ABSTRACT Fund managers earn a portion of their fees by out-performing a benchmark, typically an index. To out-perform, they may leverage the fund or engage in scrip lending, but usually they “stock-pick“, taking positions in the market which differ from those of the benchmark, namely: “active share”. Several factors in the funds mandate may constrain the level of active share in a fund, inter-alia: limits on specific equities or sectors, tracking error constraints around the benchmark or limits on short-selling. We find that the percentage of active share on the JSE has declined from around 50% to 15% over the last 20 years, which is consistent with research elsewhere. This indicates that fund managers are unable or unwilling to take active positions. In contrast to other studies, we find no relationship between the level of active share and a funds return, raising doubts about the stock picking ability of fund managers. Finally, we observe that some index-tracking funds (with low active share) consistently out-perform around 80% of domestic general equity funds on the JSE over five-year holding periods. These findings challenge the high fees charged by many fund managers.

Empirical Testing of the CAPM on the Johannesburg Stock Exchange

Fama’s (1970) efficient market hypothesis (EMH) and the capital asset pricing model (CAPM) jointly ascribed to Markowitz (1952), Treynor (1961), Sharpe (1964), Lintner (1965) and Mossin (1966) remain the foundation of most finance and investment courses. This is surprising, given the sustained criticism of the model and its assumptions, and is a reflection of the elegance and parsimony of the theory over the empirical evidence.On the Johannesburg Stock Exchange (JSE), several authors have examined and noted significant inadequacies relating to the single factor CAPM, particularly with regard to the dual nature (resources versus industrial shares) which characterises this bourse. Van Rensburg and Slaney (1997) advocate the use of a two factor arbitrage pricing theory (APT) model, but show that (at least for industrial shares) additional parameters are required (van Rensburg, 2001).We revisit this ground using an improved methodology and data set over the period 31 December 1986 to 31 December 2011. We find that portfolios constructed on the basis of ranked beta exhibit a monotonic, inverse relationship to what the CAPM prescribes, for most of the time-series. The use of the single beta CAPM is therefore inappropriate in the context of asset pricing.

Fund size and returns on the JSE

ABSTRACT Market sentiment, the popular press and academia are divided on the question of whether the size of a fund affects its performance. This study examines the issue by constructing hypothetical portfolios of varying sizes, using historical data for each of the years 1991 to 2008. Each portfolio consisted of 40 randomly selected stocks, chosen from an investment universe of the top 160 JSE listed shares in terms of market capitalisation. Rules were applied to limit the concentration of any particular share and to ensure that trading volumes were practical. Simulation was then used to explore the boundaries of possible returns for each portfolio. The results of the simulation indicate that a funds size is a contributing factor to its performance; liquidity being the underlying reason for this relationship. Performance was found to be affected for fund sizes greater than about R5bn. Large funds are increasingly forced towards market-cap weightings with a resulting concentration in resource stocks. The relevance of these findings to the South African fund management industry is that large funds should switch to passive investment strategies. Small to medium sized portfolio managers must be aware of the size effect and ensure that their funds are ‘capped’.

The Relationship between the Management of Payables and the Return to Investors

Effective working capital management assists a firm in achieving improved liquidity through the management of the components of receivables, inventory, and payables. Previous studies have established that changes in working capital have a strong positive correlation to profitability and that whilst changes to receivables and inventory have a positive correlation to profitability, changes in payables have an inverse relationship. The inverse correlation between payables and profitability is contrary to the theory that advocates extending payment terms as a means of managing working capital and improving liquidity. We apply a buy-and-hold portfolio methodology to an extensive database of Johannesburg Stock Exchange (JSE) listed South African companies over the period 1986 to 2014. We find that for those companies in industries that have a significant investment in payables, there is a significant positive association between changes in payable days and shareholder return, which supports the general theory o...

The impact of reference-day risk on beta estimation and a proposed solution

ABSTRACT The ability to accurately estimate systematic risk (or beta) when reference-day risk is considered, is an ineluctable requirement for all applications of the capital asset pricing model (CAPM). This research documents evidence of reference-day risk for shares on the Johannesburg All Share Index. In response to the need for greater accuracy when estimating systematic risk, this paper contributes a volume-weighted-average-price (VWAP) method for estimating beta which may be employed when reference-day risk is considered. Furthermore, this research applies a graphical time-series approach to test the underlying risk-reward tenet postulated by the CAPM. Using beta as a measure of systematic risk, this research finds that the CAPM appears to imperfectly specify the risk-reward trade-off.

The investment return puzzle on the Johannesburg Stock Exchange

ABSTRACT Firms that invest into positive net present value projects should outperform firms that do not invest. Surprisingly, several studies on United States data have found a negative relationship between capital investment and subsequent shareholder return. There are conflicting explanations for this negative relationship. The present study also confirmed a significant negative relationship between capital investment and subsequent shareholder returns in the South African developing market conditions. Over the period from 1992 to 2017, shares on the Johannesburg Stock Exchange with lower investment rates consistently outperformed shares with higher investment rates, exhibiting similar behaviour to the US. We find that the negative investment return is significantly associated to the firm’s book-to-market value consistent to the rational-based q-theory of investment with real options explanation.

The Applicability of Black's Variation of the Capital Asset Pricing Model (CAPM) in the South African Context

The ability to accurately price equity is an ineluctable requirement within businesses where decisions need to be taken daily that impact upon the future viability of that business. The Capital asset pricing model (CAPM) is the preeminent tool, that has become entrenched within academia and business, for estimating the cost of equity capital. This study aimed to prove whether the application of the CAPM, in various forms, including the Black’s CAPM, was merely a myopic inculcation of the academic and business spheres, or whether it truly reflected the empirical reality of South African markets. The research discredits eight variations of the CAPM through a quantitative causal design, which employed t-tests and ANOVAs, tested upon a sample of the largest 160 shares on the JSE.