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4. Methodology

4.4. Data collection method

Although the MSCI Emerging Market Index mainly includes the large and mid-cap

segment and a size analysis thus is hard to perform, there might still be a size effect, which is why we start our analysis by examining the difference between the returns of an equal- and a value-weighting of the portfolios of value, momentum and combination strategies in the emerging equity markets.

The above figure might indicate that the MSCI emerging equity market index is affected by the market movements in some countries more than the market movements of other countries. Although some findings show that there might be a country affect in regards to examining value, momentum and combination strategies across markets, other researchers find that this country effect is diminishing (Baca et. al 2000). Also, Rouwenhorst (1999) finds that there are no country affect on the returns obtained in the emerging markets. This might be due to the general co-movements of the emerging markets relative to the more developed markets.

The MSCI Emerging Market Index is calculated by the free-float adjusted market capitalization (MSCI, 2011). The purpose of using a free-float adjusted market capitalization measure, rather than using a market-capitalization measure, is to only include outstanding shares that are available for investors. Specifically, in the emerging markets, there might be some restrictions for foreign investors. Thus, the MSCI calculates the equities’ measurement in the index based on the outstanding shares that are available for foreign investors to invest in. Firstly, equities that are restricted from foreign investors and equities held by employees, banks or the company itself are excluded from the index.

Based on this, the MSCI determines a foreign inclusion factor, FIF. Second, the full market capitalizations of equities/firms are determined by multiplying the equity prices by the outstanding shares. Finally, the foreign inclusion factor is then multiplied with the full market capitalization of the equities, arriving at the free float-adjusted market

capitalization of each equity:

(MSCI Global Market Indices Methodology, May 2011)

The index is reviewed and rebalanced semi-annually, and the large, mid and small-capitalization cut off points are recalculated (MSCI Global Market Indices Methodology, May 2011). As we want to obtain a real world picture of the index and its constituents, we choose not to adjust for share classes as a firm with two outstanding share classes will account for two equities in the real world.

4.4.2 Size and industry distribution

As mentioned, we construct both equal- and value-weighted portfolios as we try to capture some of the size effect on the performances of value, momentum and combination

strategies. Additionally, we analyze the effect of industry performance on the returns of the strategies. Thus, the following will provide an overview of the average size and industry distributions of the MSCI emerging market index during the period 2003-2018.

Figure 4.2 present the weights of the different market segments in the MSCI Emerging Market Index from 31/03/2003 to 31/03/2018.

Figure 4.2 Based on data from Bloomberg (MXEF, 2003-2018)

As mentioned, the MSCI emerging market index is a value-weighted index and we see from figure 4.2 that it has an overhang of large-cap equities. This makes it difficult for us to examine the size effect, as the availability of small-cap equities are not proportional with the availability of large-cap equities. As mentioned in the literature review, value and momentum perform best within the small cap segment. Thus, this limitation makes our study more conservative, as research suggests that the strategies do not perform as well in the mid- and large-cap market segment. In the same vein, Asness et al. (2013) limit the equities into very liquid securities and rank them based on their beginning-of-month market capitalization in descending order, which makes their results more conservative, as the trading strategies works best among small, illiquid securities. Similarly, Blitz and Vliet (2008) eliminated limited market capitalization asset classes, micro-cap equities, to reduce

Figure 4.3 presents the average industry distribution in the MSCI emerging market index during 31/03/2003-31/03/2018.

Figure 4.3 Based on data from Bloomberg (MXEF, 2003-2018)

As can be seen from figure 4.3, the financial industry accounts for 26 percent of the MXEF, which is the biggest industry weight. This might suggest that the performance of the industry has a relatively big influence on the performance of the index. Conversely, health care and utilities have the smallest weights in the index, which might suggest that these industries do not have a predominant influence on the performance of the index.

As our strategies invest in the equities of the MSCI Emerging Market Index, this provides an understanding of the predominate market cap segments and industries, that might be influential when considering size and industry performance.

4.4.3 Database

The Bloomberg terminal is a globally recognized platform that provides real-time data on every market as well as powerful analytics (Bloomberg.com). The terminal is perceived as a reliable source, and is among others used by Asness et al. (2013) and Fama and French (1998) to obtain accounting information. The Bloomberg terminal caters to investors and other finance professionals, and has evolved tremendously since its release in the early 1980’s. Today, the terminal has become a very important source of information in the area of finance.

As previously mentioned, we create our models by using the Factor Backtester in the Bloomberg terminal and thus, we backtest the trading strategies based on the previous mentioned factor signals of the various strategies in the MXEF index in the period

31/03/2003 to 31/03/2018. We realize that our study might involve some biases, which will be reviewed in the following.