E Practical Applications Of The Devil In HML’s Details


This article has a catchy title. Its findings are equally catchy for quantitative portfolio managers who want to pick up an extra 300 to 400 basis points of annual performance on their high-minus-low (HML) investment strategies. Do I have your attention yet?

Practical Applications

  • The calculation. HML portfolios—or those that are long value stocks/short growth stocks—are constructed using the book-to-price ratio (B/P), the academic-favored flip of the price-to-book ratio (P/B).

  • The rub. Traditionally, value strategy construction relies on lagged data for both book value and share price. The data lag is anywhere between 6 and 18 months.

  • The tweak. Use current price data to construct valuation ratios. Beyond improving the ability to identify cheap stocks, it unveils the level of correlation between value and momentum strategies—thereby enhancing the construction of HML portfolios, which in essence blend the two.

  • The caveat. The tweak doesn’t improve the performance of a stand-alone value strategy. Its efficacy lies in portfolios combining value and momentum strategies.

Key Definitions

High-minus-low (HML) - A quantitative investment strategy that aims to exploit the performance differential between value (cheap) and growth (expensive) stocks, by using B/P as the measure.

Price-to-Book (P/B) - A ratio used to compare a stock’s share price to its book value. If a stock has a low P/B, it may be considered cheap. You may be paying very little for the fundamentals. It is calculated by dividing the current closing price of the stock by the latest fiscal year’s book value per share.

Book-to-Price (B/P) - A ratio used to compare a stock’s book value to its market price. It is the academic-favored flip of P/B. A stock may be considered cheap if its book value is high versus its share price. It is calculated by dividing the latest fiscal year’s book value per share by the current closing price of the stock.

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