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Phil Dabo: Welcome to Quant Concepts' working from home edition. We've seen the value style of investment management underperform in the recent past, but it's an area that people are really starting to warm up to. The economic backdrop is improving along with corporate earnings and value still has incredible catch-up potential. However, markets are very uncertain, so it can be a good idea to diversify into more growth-oriented stocks that have the ability to grow organically. In addition to that, we know that investors are becoming increasingly interested in ESG, which can increase the quality of stocks in your portfolio.
Today, let's take a look at a strategy that looks for decently priced growth stocks and incorporates ESG research. Let's start by selecting our universe of stocks, which includes all of the stocks in our Canadian database. We're going to rank those stocks from 1 to 700 according to seven key factors. The first factor is our forward reinvestment rate because we would like to see companies that are expected to successfully reinvest their earnings and grow organically. The next factor is our 180-day standard deviation to reduce volatility. And the next factor is our ESG controversy level. Sustainalytics provides an assessment of controversies using news screens of over 35,000 sources. The ESG factor amalgamates all of this research into a single score. The next two factors are our earning surprise and quarterly earnings momentum. We would like to see companies that are consistently increasing their earnings and beating analyst expectations. The next two factors are the industry relative price to book and price to earnings. The two factors can be drastically different between sectors, so we would like to see companies that are less expensive than their peer group.
Now, let's take a look at our buy rules. We're only going to buy stocks that are in the top 15th percentile of our list. We're only going to buy stocks if the quarterly earnings momentum is greater than negative 1, and if their debt to EBITDA is better than one-third of our list. We also want stocks that have good momentum and are trading at less than 14% from their 12-month high because stocks trading close to their 12-month high tend to perform well. Our last buy rule excludes stocks that are less than 1 billion in market cap, so that we get a good mix of mid and large cap stocks. Mid-cap stocks tend to perform quite well at the beginning of an economic recovery.
Now, onto our sell rules. We have three key sell rules. The first is to sell stocks that fall out of the top 45th percentile of our list. Our second sell rule is to sell stocks that don't have good earnings momentum. And our third sell rule is to sell stocks if their debt to EBITDA deteriorates and falls to the bottom third of our list.
Now, let's take a look at performance. The benchmark that we used is the S&P/TSX Total Return Index, and we ran the strategy from April 2003 to December 2020. Over that time period, the strategy returned 14.9%, which is 6.3% higher than the benchmark, with slightly higher annualized turnover of 71%. We can see that this strategy has generated a superior return compared to the benchmark over each and every significant time period, and it's done so with slightly higher standard deviation, but it's also generated higher risk-adjusted returns as measured by the Sharpe Ratio.
Now, although the market risk of the strategy is slightly higher, the strategy does perform well during down markets as you can see by the downside deviation. When looking at this chart, we can see very good performance since inception. And when looking at the up and downside capture ratios, the overall market capture ratio is quite strong, showing that this is a strategy that can perform well throughout different market cycles. This is a great strategy to consider if you're looking for stocks that have a mix of value and growth characteristics. It can also provide some really good ideas to invest in mid-cap stocks which typically perform well when the economy is being driven by expansionary policies. In addition to these corporate fundamentals, the portfolio incorporates some of our exclusive Sustainalytics research. You can find the buy list along with the transcript of this video.
From Morningstar, I'm Phil Dabo.
For a larger image of the buy list, click here.
