Investment diversification with momentum hybrid performance

By Riya Jain & Priya Chetty on April 14, 2021

The rational linkage between risk and return in the stock market motivates investors to assess risks and estimate returns on investment. Due to stock market uncertainties, they prefer to invest in a mix of different financial instruments. This investment portfolio with different investment options is referred to as investment diversification (Leković, 2018). This reduces their chances of loss. Momentum hybrid performance helps an investor assess how to combine different types of stocks to optimise their return on investment.

EXAMPLE

In the case of high variability, a mix of growth and income stocks can provide an assured return to investors as the latter is a low-risk investment.

This article compares the returns on each category of stock i.e. growth, income and value with hybrid stock which is a mix of all three. Such a comparison gives investors more clarity regarding the ideal investment instrument whether they should invest in a particular type of stock or diversify their portfolio to maximise returns. The comparison is drawn for the period April 1, 2000, to March 31, 2020, by dividing the entire dataset into five groups:

  1. April 1, 2000 – March 31, 2005
  2. April 1, 2005 – March 31, 2010
  3. April 1, 2010 – March 31, 2015
  4. April 1, 2015 – March 31, 2020
  5. April 1, 2000 – March 31, 2020

The following hypothesis is tested using paired t-test method at a 5% or 10% level of significance to determine whether the performance of stocks is different from the momentum hybrid performance.

H03: There is no significant difference in the momentum hybrid performance

HA3: There is a significant difference in the momentum hybrid performance

Momentum hybrid performance for the period April 1, 2000, to March 31, 2005

The below table depicts the risk and returns of growth, income, value and hybrid stock for the period 1 April 2000 to 31 March 2005.

VariablesMeanStandard Errort-statp-value
Growth stock return0.280.272.400.07
Hybrid Return0.160.23
Income stock return0.250.350.590.59
Hybrid return0.160.23
Value stock return0.460.351.610.18
Hybrid return0.160.23
Table 1: Growth momentum hybrid for April 1, 2000, to March 31, 2005

Growth stock versus hybrid stock (2000-2005)

The mean value of growth stock is higher than hybrid stock, which shows it provides better returns to investors. However, the standard error is also more in growth stock, which shows more variability i.e. higher risk. The P-value is 0.07 which is less than 0.10, the significance level of the study. Thus, the null hypothesis of no significant difference in the momentum hybrid performance is rejected. Hence, the growth stock performance and momentum hybrid performance are different. Although there is a high risk, the opportunity of earning is even more in growth stocks.

Income stock versus hybrid stock (2000-2005)

The mean value for income stocks is higher than for hybrid stocks, indicating higher returns. The standard error value of stocks is also higher, indicating high volatility and therefore higher risk than hybrid stocks. The P-value of the paired t-test is 0.59 which is greater than the required value of 0.05 or 0.10. Thus, the null hypothesis of having no significant difference in the momentum hybrid performance is not rejected. Hence, despite the more earning possibility for investors in comparison to hybrid investment, there is not much difference in the performance of income and hybrid stocks.

Value stock versus hybrid stock (2000-2005)

The mean value of value stocks is higher than hybrid stocks, indicating higher returns, however, the standard error values show that volatility and risk are also higher in value stocks. P-value is 0.09 which is less than the required significance value of 0.10. Thus, the null hypothesis of having no significant difference in the momentum hybrid performance is rejected. Hence, value stock investment provides better returns but hybrid investment has lesser risk.

Momentum hybrid performance for the period April 1, 2005, to March 31, 2010

The below table depicts the risk and returns of growth, income, value and hybrid stock for the period 1 April 2005 to 31 March 2010.

VariablesMeanStandard Errort-statp-value
Growth Stock Return0.470.281.610.18
Hybrid Return0.340.25
Income stock return0.360.340.190.86
Hybrid return0.340.25
Value stock return0.370.320.310.77
Hybrid return0.340.25
Table 2: Growth momentum hybrid for April 1, 2005, to March 31, 2010

Growth stock versus hybrid stock (2005-2010)

The mean value of growth stock return is higher than hybrid stock’s, indicating better returns. However standard error is also higher, making it a higher-risk instrument but by a marginal degree. A P-value of 0.18 is greater than the significance value of 0.05 or 0.10. Thus, the null hypothesis of no significant difference in the momentum hybrid performance is not rejected. Hence, though there is a difference in return and volatility between a single investment in growth and hybrid stock, the performance does not differ much.

Income stock versus hybrid stock (2005-2010)

The mean value and standard error of income stock are higher than hybrid stock, indicating slightly better returns and a much higher risk. This return is also significantly lesser than growth stocks’. P-value is 0.86 which is greater than the required value of 0.05 or 0.10. Thus, the null hypothesis of having no difference in the momentum hybrid performance is not rejected. Hence, the analysis shows that though the risk borne by the investor is high in the income stocks as compared to the hybrid investment but the actual performance doesn’t have any significant difference.

Value stock versus hybrid stock (2005-2010)

Mean value and standard error are slightly higher in the case of value stock as compared to a hybrid, indicating higher returns at a higher risk. This return is less than growth stocks’ but is similar to income stocks. The P-value is 0.77 which is less than the required value of 0.05 or 0.10. Thus, the null hypothesis of no difference in momentum hybrid performance is not rejected. Hence, the analysis shows that though there is a higher return provided by a single investment, the magnitude of risk is also very high. Thus there is not much difference in the performance of value stocks and hybrid investments.

Momentum hybrid performance for the period April 1, 2010, to March 31, 2015

The below table depicts the risk and returns of growth, income, value and hybrid stock for the period 1 April 2010 to 31 March 2015.

VariablesMeanStandard Errort-statp-value
Growth Stock Return0.280.191.720.16
Hybrid Return0.120.11
Income stock return0.180.180.670.54
Hybrid return0.120.11
Value stock return0.060.14-1.960.12
Hybrid return0.120.11
Table 3: Growth momentum hybrid for April 1, 2010, to March 31, 2015

Growth stock versus hybrid stock (2010- 2015)

For the period of 1st April 2010 to 31st March 2015, the mean value and standard error of growth stock are higher than the hybrid, indicating a much higher return for higher risk. The P-value is 0.16 which is greater than the required value of 0.05 or 0.10. Thus, the null hypothesis of no difference in the momentum hybrid performance is not rejected. Hence, although hybrid stock reduces the risk for the investors but returns possibility is also low.

Income stock versus hybrid stock (2010- 2015)

For income stock too, the mean value and standard error are higher than hybrid stock, indicating a higher return for a higher risk. However, this risk is lesser than growth stocks. The P-value is 0.54 which is greater than 0.05 or 0.10. Thus, the null hypothesis of no difference in the momentum hybrid performance is not rejected. Hence, the performance of stocks though is more than the hybrid investment but for this, investors must bear high risk. Thus there is not much difference in investing in hybrid or income stocks.

Value stock versus hybrid stock (2010- 2015)

The mean value and standard error of value stock and hybrid stock show that value stocks offer lesser returns at a higher risk than a hybrid. The P-value is 0.12 which is greater than 0.10 or 0.05. Thus, the null hypothesis of no significant difference in momentum hybrid performance is not rejected. Hence, the analysis states that though there are more returns and less risk in hybrid investment, this variation in performance does not have a significant difference.

Momentum hybrid performance for the period April 1, 2015, to March 31, 2020

The below table depicts the risk and returns of growth, income, value and hybrid stock for the period 1 April 2015 to 31 March 2020.

VariablesMeanStandard Errort-statp-value
Growth Stock Return0.120.120.500.64
Hybrid Return0.090.07
Income stock return0.220.280.630.56
Hybrid return0.090.07
Value stock return0.060.20-0.210.84
Hybrid return0.090.07
Table 4: Growth momentum hybrid for April 1, 2015, to March 31, 2020

Growth stock versus hybrid stock (2015- 2020)

A comparison of mean value and standard error of growth and hybrid stocks shows a higher return at higher risk for a growth stock. The P-value is 0.64 which is more than the required significance value of 0.05 or 0.10. Thus, the null hypothesis of having no significant difference in the momentum hybrid performance is not rejected. Hence, the analysis of the growth and income stocks depicts that the risk propensity is higher in growth stocks but there is not much difference in the future return possibility from both investments.

Income stock versus hybrid stock (2015- 2020)

For the income stocks, the mean value and standard error are much higher than hybrid stocks, indicating a much higher return at a significantly higher risk. P-value i.e. 0.56. As the value is more than the required significance level of 0.05 or 0.10, the null hypothesis of no significant difference in momentum hybrid performance is not rejected. Hence, income stock performance is similar to that of hybrid stock, and although there is more return possibility, the risk is also higher.

Value stock versus hybrid stock (2015- 2020)

For value stock, the mean value is lesser while standard error is higher than hybrid stock, showing that risk is much higher but returns are lower. P-value is 0.84 which is higher than the required value of 0.05 or 0.10. Thus, the null hypothesis of no significant difference in the momentum hybrid performance is not rejected. Hence, the analysis of value stocks for the period 1st April 2015 to 31st March 2020 shows that although there are more returns and less risk in hybrid investment, future earning possibility is not different for both investments.

Momentum hybrid performance for the period April 1, 2000, to March 31, 2020

The below table depicts the risk and return of growth, income, value and hybrid stock for the cumulative period, i.e. 1 April 2000 to 31 March 2020.

VariablesMeanStandard Errort-statp-value
Growth Stock Return0.290.113.080.01
Hybrid Return0.180.09
Income stock return0.250.141.080.29
Hybrid return0.180.09
Value stock return0.240.131.010.33
Hybrid return0.180.09
Table 5: Growth momentum hybrid for April 1, 2000, to March 31, 2020

Growth stock versus hybrid stock (2000- 2020)

The mean value and standard error of growth stock are higher than hybrid stock, therefore indicating a higher return at a higher risk. The P-value of investment is 0.01 which is less than the significance value of 0.05 or 0.10. The null hypothesis of no significant difference in the momentum hybrid performance is rejected. Hence, the analysis shows that growth stocks for the period 1st April 2000 to 31st March 2020 provided more opportunities to earn with less volatility, indicating a clear difference in the performance of both instruments.

Income stock versus hybrid stock (2000- 2020)

The mean value and standard error of income stock are higher than hybrid’s, indicating a higher return at a higher risk. P-value is 0.29 which is greater than the required value of 0.05 or 0.10. Thus, the null hypothesis of no significant difference is not rejected. Hence, the analysis shows that income stocks for the period 1st April 2000 to 31st March 2020 witnessed better-earning possibilities but at risk of higher risk. However, the benefit of having a different performance of hybrid investment and single stocks investment is absent.

Value stocks versus hybrid stock (2000- 2020)

For the value stocks, the mean value and standard error are much higher than hybrid stocks, indicating higher returns and a higher risk. P-value is 0.33 which is more than the significance value of 0.05 or 0.10. Thus, the null hypothesis of no significant difference in the momentum hybrid performance is not rejected. Hence, the analysis of the value for the overall period shows that a better-earning opportunity raises the probability of risk for single-stock investors. However, as there is not much difference in the performance of both stocks, investors could opt for any medium of stock for investment.

Risk diversification with a Hybrid investment portfolio

The existence of uncertainty and dynamism encourages investors to diversify their stock market portfolio. With the availability of different stocks, often these investment decisions of either choosing a single stock option or having a hybrid investment portfolio are based on performance. Herein, the analysis for the growth, income and value stocks was done by comparing their performance with the hybrid investment. The analysis shows that only for the period 1st April 2000 to 31st March 2005 in the first four sub-groups, there was a difference in the performance of growth and value stocks from the hybrid investment. Although volatility was high, the magnitude of the increase in return was also high in a single investment. But for the remaining periods, there was no difference in the performance of hybrid and single stocks investments.

Comparison for the period 1st April 2000 to 31st March 2020 depicts the difference in growth stocks and hybrid stocks’ performance. However, not much difference could be seen for value and income stocks. Hence, investors for growth stocks should make their decision based on their risk tolerance while income and value stock investors could be indifferent between single stock or hybrid investment.

References

  • CUMIS. (2009). The Benefits of Diversification. 1–2.
  • Leković, M. (2018). Investment diversification as a strategy for reducing investment risk. Ekonomski Horizonti, 20(2), 173–187. https://doi.org/10.5937/ekonhor1802173l.
NOTES

Priya is the co-founder and Managing Partner of Project Guru, a research and analytics firm based in Gurgaon. She is responsible for the human resource planning and operations functions. Her expertise in analytics has been used in a number of service-based industries like education and financial services.

Her foundational educational is from St. Xaviers High School (Mumbai). She also holds MBA degree in Marketing and Finance from the Indian Institute of Planning and Management, Delhi (2008).

Some of the notable projects she has worked on include:

  • Using systems thinking to improve sustainability in operations: A study carried out in Malaysia in partnership with Universiti Kuala Lumpur.
  • Assessing customer satisfaction with in-house doctors of Jiva Ayurveda (a project executed for the company)
  • Predicting the potential impact of green hydrogen microgirds (A project executed for the Government of South Africa)

She is a key contributor to the in-house research platform Knowledge Tank.

She currently holds over 300 citations from her contributions to the platform.

She has also been a guest speaker at various institutes such as JIMS (Delhi), BPIT (Delhi), and SVU (Tirupati).

 

I am a master's in Economics from Amity University. Having a keen interest in Econometrics and data analysis, I was a part of the Innovation Project of Daulat Ram College, Delhi University. My core expertise and interest are in environment-related issues. Apart from academics, I love music and exploring new places.

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