Dog of Dow Strategy

Question: Discuss about the Dog of Dow Strategy. Answer: Introduction: The current research examines the popular Dog of the Dow strategy by evaluating the risk and return. This is made through application of the principles behind the strategy to the Hang Seng Index (HSI) and Hang Seng China Enterprises Index (HSCEI) from the years 2003-2012. The back-testing outcome signifies that this particular strategy has been conventionally famous amongst the community of investment by outperforming the benchmark successfully, which is the Dow Jones Industrial Average. The outperformance in Dogs of HIS has been only observed. By comparison, the Dogs of HSCEI have failed to overrun the standard in the previously mentioned time horizon. The discrepancy of outcome has been attributed to the fact that the mainland counterparts (A-shares) highly affect the constituents of HSCEI. It is observed that the mainland market of China is a growth play, which has restricted the progress of the principle of value investment underlying the strategy of Dogs. History of Dogs of the Dow: The Dogs of the Dow has gained the polarity among the investment community because of its straightforward, understandable and prudent performance (He 2014). In addition, the long outperformance in comparison to the index of benchmark, The Dow Jones Industrial Average (DJIA) is another reason behind the growing popularity of the Dogs strategy. Dogs strategy is an application of investment value, which criticises that the undervalued stocks have purchasing opportunities, which are probable to bring back to their fair prices. This provides the investors with an opportunity of earning favourable returns. However, hrberg, Schnknecht and sterberg (2014) argued that using dividend yield is an efficient measure to track the undervalued securities among the constituents of DJIA instead of price/earnings and price-to-book ratios. This is primarily because of the following three reasons: A high stock of dividend yield is probably to be a dawdler with a depressed share price over the last year and it is more likely in contrast low dividend yield shares for regaining value and catches the peers, which has outperformed DJIA. The investors tend to select defensive shares, which are relatively less subject to the poor economic cycle and fetch stable income for the investors in a struggling market. A cushion effect could be developed with the help of dividend, which receives greater appreciation from the investors in a sluggish market. During the time of economy recovery, the investors could make both gain in dividends and appreciation of capital. The other multiples of trading could not provide any protection level, which indicates the superiority of dividend yield in choosing undervalued stocks. Price/earnings and price-to-book ratios are highly subject to accounting manipulating and short-term profit fluctuations. On the contrary, dividend data avoids accounting manipulation, since it is more predictable. The concept Dogs imply that these securities have underperformed considerably and therefore, they could be termed as unfavourable investments. Coming to construction of portfolio, the advocator of Dogs strategy chooses the beginning ten largest stocks in terms of dividend yield. These stocks are selected on the final trading day of each accounting year to construct a uniformly weighted portfolio for the purpose of simplicity. The developed portfolio is kept for a year until the last day of the upcoming accounting year. During that time, the investors need to select the same criteria for reassessment of new Dogs securities in order to rebalance the portfolio. Henceforth, the portfolio is comprised of ten securities, which is overhauled yearly to consist of the current greater dividend yield securities amongst the constituents of DJIA. With the help of such portfolio construction, the investors do not need to invest all funds on a specific security; however, they could invest in a diverse group of stocks from DJIA. These are some of the securities of reputed organisations, which are large and liquid in nature. In addition, these securities have undergone many economic crises and managed to survive over the years. Thus, the Dogs portfolio could be considered as conservative investment due to flourishing operating history. In the words of Qiu, Song and Hasama (2013), despite the undervaluation of some firms due to complicated business issues like the oil spill of Exxons Valdez in 1984, they have overcome the situation to maintain business sustainability. However, there is an exception, in which Manville Corporation has become insolvent in 1984 due to legal suits, which has resulted in elimination from DJIA. Dogs strategy is planned for making long-term investments and ample time horizon is needed for accomplishing the desired outcome. After investigating the Dogs portfolio and the performances of DJIA for 17 years from 1973-1989, it has been found that the portfolio has made an annual return of 17.9%, while the figure is 11% for DJIA constituents. However, review of the current performance is necessary to assess the effectiveness of the Dogs portfolio. The below-mentioned chart supports the efficiency of the strategy, since it has outrun the market by 17.74% starting from 2010 to 2013. In case, the risk is high to beat the market, the strategy might not be convincing for the investors. Hence, it is feasible to contrast the outcomes relative to both risk and return. According to the research results of Tissayakorn et al. (2013) from 1928 to 2001, it has been found that the Dogs have outperformed DJIA, since the return achieved is 12.9% with a standard deviation of 12.8%. On the contrary, the return of DJIA is 11.4% having standard deviation of 22.4% based on risk adjustment. Therefore, it could be inferred that the strategy of Dogs have outrun the market with a lower level of risk, as laid out by the values of standard deviation. In simple words, it could be inferred that the Dogs strategy has a greater Sharpe ratio in contrast to the set benchmark. The investors planning to invest for longer periods prefer steady growth instead of changed dividend payout. In addition, the firm maintaining the growth in its dividend policy could achieve certain requirements to increase the value of the shareholders. Based on this viewpoint, Ghouse, Nadrah and Ahmad (2014) named ten securities, which have the greatesr dividend yield with never reduced dividends from 1998 to 2003. These have been categorized as the Dow Core 10. The portfolio has an average half-yearly return of 14.9%, which is 0.47% more in contrast to the Dogs portfolio. This is because of the lower rebalancing need, which minimises the requirement of realisation arising from capital gains tax. Hence, it could be inferred that the fall in transaction cost makes the portfolio of Dow Core 10 highly cost-effective for the investors. References: Ghouse, M., Nadrah, S.H. and Ahmad, N., 2014. Conceptual Paper of the Trading Strategy: Dogs of the Dow Theory (DoD).Noryati, Conceptual Paper of the Trading Strategy: Dogs of the Dow Theory (Dod)(June 4, 2014). He, J.J., 2014.Can Alternative Dogs of the Dow Beat Hedge Funds?(Doctoral dissertation, Princeton University). hrberg, T., Schnknecht, P. and sterberg, E., 2014. Dogs of the Dow. Olsson, D. and Necander, A., 2016. Beating the market through dividend yields: Dogs of the Dow in the Swedish context. Qiu, M., Song, Y. and Hasama, M., 2013. Empirical Analyses of the/dogs of the Dow Strategy: Japanese Evidence.International Journal of Innovative Computing, Information and Control,9(9), pp.3677-3684. Tissayakorn, K., Song, Y., Qiu, M. and Akagi, F., 2013. A Study on Effectiveness of the" Dogs of the Dow" Strategy for the Thai Stock Investment.International Journal of Innovation, Management and Technology,4(2), p.277. Yan, H., Song, Y., Qiu, M. and Akagi, F., 2015. An empirical analysis of the dog of the dow strategy for the Taiwan stock market.Journal of Economics, Business and Management,3(4), pp.435-439.