Easy Indexing

Buy low and sell high

1
 Easy Indexing
Buy low and sell high

Abstract

In this paper, a rule-based strategy that systematically identifies attractive stock

markets is examined. Markets are ranked on a relative value basis and targeted
investments in the three most attractive stock markets are made. When relative
valuations change the strategy switches to more attractive indices. By including a
200-day Moving Average as a Trend Indicator, the strategy is able to adapt to a
change in the market environment. The basic strategy set-up works according to the
fundamental principle: invest in the three most attractive indices of your universe
according to traditional value ratios. Respectively, switch to new attractive indices
when relative valuations change. When more than 50% of the investment universe
break their 200-day Moving Average, a change in market environment must be in
place. As a consequence, the strategy switches to a long/short approach: short only
the three least attractive markets on a relative value basis. A targeted short in the
most expensive markets profits from a bear market. The strategy turns bullish
again, and invests in the three most attractive indices of the investment universe,
when more than 50% of the 200-day Moving Averages cross the underlying indices
from below. A combination of Behavioural Finance approaches, as well as structural
construction inefficiencies of major country indices, allow the strategies to
consistently outperform its benchmark.

2
Behavioural Finance – A Paradigm Shift in Financial Academia

Human behaviour has always had a role in financial markets. Yet, it is only in the last
years that the study of human behaviour has achieved acceptance as a distinct academic
field in finance 1 . Behavioural Finance, Behavioural Economics or Open-minded
Finance 2 are just a few of the many names of the search to identify the habitual cognitive
errors of investors and their effects on financial markets.

The Nobel Prize in economics in 2002 went to a psychologist, Daniel Kahneman, who
helped pioneer the field of Behavioural Finance 3 . Kahneman basically shows that
investors are predictably irrational. Investors continue to make the same mistakes over
and over.

Understanding the habitual and often predictable errors of human beings is both the pith
of Behavioural Finance and the optimum research modality for understanding the market
and profiting from it.

Behavioural Finance on the Level of the Individual

Both an enormous amount of evidence and anecdotal experience suggests that people are
very bad at predicting the markets 4 . This is often because we all tend to be massively
overconfident. The two most common biases are “Over-optimism” and
“Overconfidence” 5 .

Perhaps Over-optimism is the best comprehensible of all psychological errors. People

tend to exaggerate their own abilities. Overconfidence refers to a situation whereby
people are surprised more often than they expect to be. Effectively people are generally
much too sure about their ability to predict. This tendency is particularly pronounced
amongst experts. That is to say, experts are more overconfident than lay people. This is
consistent with the illusion of knowledge driving overconfidence.

Several studies confirm professional investors to be particularly overconfident 6 . For

instance, one study found that 68% of analysts thought they were above average at
forecasting earnings; 75% of fund managers think they are above average at their jobs. In
fact the appalling performance statistics of the active fund management industry tell a
different story, with an average of between 75 and 90% of fund managers
underperforming a benchmark index 7 .

1
There were many pioneers before that such as Granger and Morgenstern (1970)
2
Thaler (1993)
3
It is also thanks to the efforts of economists and psychologists such as Amos Tversky, Richard Thaler,
Meir Statman and Hersh Shefrin.
4
DeBondt and Thaler (1985 and 1987), Schachter et al. (1986)
5
DeBondt and Thaler (1990
6
Montier (2002)
7
A large body of empirical work, starting with Jensen (1969), finds that actively managed funds, on
average, underperform the market index.

3
However there are plenty of investment strategies that don't need forecasts as inputs such
as value strategies based on trailing earnings, or momentum strategies 8 based on past
prices. Easy Indexing is one of them.

Behavioural Finance on the Aggregate Level

According to Kahneman and Tversky the “Availability Bias” is a rule of thumb by which
decision makers reassess the frequency of class or the probability of an event by the ease
with which instances or occurrences can be brought to mind 9 . All else being equal, it isn't
a bad rule of thumb - common events come to mind easier than rare events. People are
exceptionally afraid of financial situations involving ambiguity 10 . This translates into
extreme caution on the part of investors with regard to stocks they think they don't know.
The flip side of the bias is a preference for the known or the familiar or the “Home Bias”
leading to investments in the local investors market 11 . However empirical studies 12 show
a significant risk reduction by considering markets on a global perspective.

Buy low and sell high

Price-earnings ratio (P/E) tests indicate that low P/E ratio stocks experienced superior
results relative to the market, while high P/E ratio stocks have significantly inferior
results 13 . The size effect indicates that small firms consistently experienced significantly
larger risk-adjusted returns than larger firms 14 . This is called the “Small Firm Effect”.
Tests of the small firm effect also found that firms that have only a small number of
analysts following them (thus, they are neglected firms) have abnormally high returns.
These excess returns appear to be caused by the lack of institutional interest in the firms.
The “Neglected Firm Effect” applies to all sizes of firms 15 . A huge Eurostoxx 50
company is usually widely followed by market participants while some index members of
the Danish OMX Index are hardly in the spotlight.

Easy Indexing profits from the market inefficiencies mentioned above. Easy Indexing
does not rely on the experience of a seasoned market pro. Neither Overconfidence nor
Home Bias hinders the performance of Easy Indexing. An unemotional P/E ratio based
trading signal could be blind to any market fads 16 . Easy Indexing supports the financial
community P/E ratio debate arguing for predictive power of the P/E ratio.

8
Kaufman (1998a), Jegadeesh and Titman (2005)
9
Kahneman and Tversky (1973)
10
Benartzi (2001)
11
Kenneth Froot et al. (1999)
12
Dimson et al. (2002)
13
DeBondt and Thaler (1985 and 1987), Keppler (1991), Lakonishok et al. (1993), Schachter et al. (1985
and 1986), Shleifer (1998), Hong and Stein (1999), Cutler et al. (1989), O’Shaughnessy (2005a)
14
Keim (1983)
15
Elfakhani and Zaher (1998)
16
Although one could argue that the P/E ratio is mostly driven by price changes or in other words market
fads.

4
Indexation & Allocation of Capital

The phenomenon of indexing portfolios to capture efficiently and cheaply the long-term
return of the stock market is gathering momentum. However there is a significant
underperformance against the index by many professional money managers.

The consensus for indexing portfolios is that an indexed fund owns a diversified strategy.
In fact most major country indices are very concentrated amongst a few sectors and
stocks and do not offer appropriate diversification.

As of June 21st 2006, the financial sector represents 33 % of the European Eurostoxx 50
index. For an investor it is extremely unwise to invest one third of the money that he has
allocated for Europe in one sector. Another example: the 15 biggest stocks in the UK
stock market (FTSE 100) represent 58% of the index. By buying the UK FTSE 100
index, an investor is buying a concentrated portfolio of big stocks. And since this
movement towards big market capitalisations has taken place all over the world, a major
country index will be overweight in "big caps". Still one has to keep in mind, not all
country indices are structurally flawed Capital Weighted indices but the majority of them
are.

Easy Indexing uses the 16 largest and most liquid Western European indices as an
investment universe. The total sum of 16 indices are 650 stocks, i.e. an investment in the
three “smallest by number of members” Western European indices still represents a
portfolio of 59 stocks, while an investment in the three “largest by number of members”
Western European indices represents a portfolio of 215 stocks, a much better diversified
portfolio.

How do you make money in financial markets 17 ?

The money management community is using mainly three techniques to reach investment
decisions:

1. Momentum Based Strategies: one of the best ways to make money in the financial
markets is to identify a trend and get in (and out) at the right time. Most money
managers try to invest following momentum.
2. Return to the Mean Strategies: the second way to make money in the financial
markets is to buy what is undervalued/oversold and to sell what is
overvalued/overbought and wait for the asset price in question to return to its
historical mean. This is the strategy adopted by most “value” managers.
3. Carry Trade Strategies: the third and final way to make money in the financial
markets is to play intelligently the yield curve (i.e. borrow at low rates and lend at
higher rates).

17
Gave et al. (2005)

5
A combination of two empirical supported strategies

Empirical studies 18 have shown that undervalued stocks outperform their overvalued
peers. Buy stocks that are out of favour and sell them when they are back en vogue.

What works for stocks, should also work for indices: just buying the index can be a cost
cautious but efficient investment strategy. Due to the principle of Mean Reversion,
inexpensive indices achieve an above-average performance over the long term.

Therefore, a successful strategy should invest in only most attractive indices according to
traditional value ratios. Then switch to the new attractive indices when relative valuations
change.

How does it work?

Easy Indexing is a simple 19 , rule-based strategy that systematically identifies attractive

stock markets. With Easy Indexing, the 16 largest and most liquid Western European
markets are analyzed according to two traditional value ratios only: P/E and P/BV 20 . The
markets are ranked on a relative basis, and targeted investments in the three most
attractive stock markets are made. Easy Indexing switches to new attractive indices when
relative valuations change.

The Easy Indexing strategy was implemented to a set of 16 Western European Country
Indices. The indices used are shown in Table 1:

18
DeBondt and Thaler (1985 and 1987), Keppler (1991), Lakonishok et al. (1993), Schachter et al.
(1985 and 1986), Shleifer (1998), Hong and Stein (1999), Cutler et al. (1989), O’Shaughnessy (2005b)
19
Gigerenzer & Goldstein (1996), Czerlinski et al. (1999)
20
Using 12 months-Trailing Multiples of MSCI Country Indices

6
Table 1: 16 Western European Country Indices
Country Index Name Bloomberg Number Type of Index
Ticker of Index
Members
1 United
Kingdom FTSE 100 ukx index 101 Capitalization -Weighted 21
2 Switzerland Swiss Market Index smi index 27 Capitalization -Weighted
3 Sweden OMX Stockholm omx index 30 Capitalization -Weighted
4 Spain IBEX 35 ibex index 35 Capitalization -Weighted
5 Portugal Lisbon PSI-20 psi20 index 20 Capitalization -Weighted
6 Norway Oslo OBX obx index 25 Capitalization -Weighted TR 22
7 Netherlands Amsterdam - AEX aex index 24 Capitalization -Weighted
8 Italy Milan – MIB30 mib30 index 30 Capitalization -Weighted
9 Ireland Irish Stock Exchange iseq index 54 Capitalization -Weighted
10 Greece Athens General ase index 60 Capitalization -Weighted
11 Germany DAX dax index 30 Total Return Index 23
12 France CAC 40 cac index 39 Modified Capitalization Weighted 24
13 Finland OMX Helsinki hex index 25 Capitalization -Weighted
14 Denmark OMX Copenhagen kfx index 20 Capitalization -Weighted
15 Belgium Brussels – BEL 20 bel20 index 19 Modified Capitalization Weighted
16 Austria Vienna – ATX atx index 20 Capitalization -Weighted

Historical Simulations

The Easy Indexing strategy was simulated from January 1994 until February 2006, with
the strategy’s decision rule applied on a monthly basis. Even profitable trading strategies
could lose money when commissions and slippage are added, therefore all simulations
were conducted including 1.5% management fee and 5 bps per trade:

21
A Capitalization Weighted Index measures the change in the market value of the index components.
In this type of index the sum of all market values (market value = price*outstanding shares) is divided by
the index divisor.
22
Note that effective April 21st 2006, OBX Stock Index became a total return index and had price history
split by a factor of 4.
23
A Total Return Index reflects the total value of a stock portfolio in the index because it incorporates
the dividends paid by index constituents as part of the calculation process. Total Return Indices are day-
end only and are calculated after dividends for the constituent stocks have been analyzed after the close
of trade.
24
In a Modified Capitalization Index, the weightings of large index members are capped in order to reduce
the impact on the index performance by a small number of large capitalization stocks. The constituent
stocks in this index are weighted according to the total market value of their outstanding shares. In this
way, the impact of a component’s price change on the Index is generally proportional to the issue’s total
market value. The Index value is calculated by summing up the weight-adjusted market capitalizations
for all constituent stocks and dividing that sum by a predetermined base value. The value of the Index is
adjusted to reflect changes in capitalization resulting from mergers, acquisitions, stock rights,
substitutions and other capital events.

7
Assuming a 3-year holding period for the investment, Easy Indexing would have
outperformed the Eurostoxx 50 25 in 70.3% of all observations. Average outperformance
against the Eurostoxx would have been 6.24% p.a. based on the Internal Rate of Return
(“IRR”) for weekly launches. Graph 1 illustrates the development of the strategy:

Graph 1: Internal Rate of Return for Easy Indexing for 3-year holding period

Investment Horizon: 3 Years

50%
Easy Indexing

40% Eurostoxx 50

30%

20%
IRR (% p.a.)

10%

0%

94 94 95 95 96 96 97 97 98 98 99 99 00 00 01 01 02 02 03
-10%n - Ju l- n - Jul- an - Ju l- n- Ju l- n - Ju l- n - Ju l- an - Ju l- n - Ju l- n - Ju l- n-
Ja Ja J Ja Ja Ja J Ja Ja Ja

-20%

-30%

Launch Date

Assuming a 3-year holding period for the investment, Easy Indexing (the blue square-
dotted line) would have had an average standard deviation of 11.46% p.a. vs. the
Eurostoxx 50 (the orange triangular-dotted line) with an average standard deviation of
19.36% p.a. based on weekly launches. Easy Indexing would have been about 40% less
volatile than an Eurostoxx 50 investment. The maximum drawdown of Easy Indexing
would have been -4.34% while the maximum drawdown for the Eurostoxx 50 was -
28.39%. Easy Indexing would have demonstrated an improved risk/return profile
compared to the Eurostoxx 50. Table 2 compares the average/maximum/minimum
annualized percentage return of the strategy versus the Eurostoxx 50:

Table 2: Easy Indexing vs. the Eurostoxx 50 Index for 3-year holding period
Easy Indexing Eurostoxx 50
Average annualized return (%) 15.64% 9.40%
Maximum annualized return (%) 43.87% 38.48%
Minimum annualized return (%) -4.34% -28.39%
Average standard deviation (%p.a.) 11.46% 19.36%

25
Indices aren’t directly investible. It is assumed to use the underlying index futures which can have a
slightly different performance than the spot index. Furthermore in the past some indices such as the
Grecian ASE Index would have been very difficult to invest with the underlying futures when costs and
liquidity would have been considered. The Eurostoxx 50 was selected due to its publicity. Benchmarks
such as the MSCI Europe or the Dow Jones Europe Index have performed very similar to the Eurostoxx
50 despite the fact that these indices have more index members as the Eurostoxx 50.

8
Assuming a 5-year holding period for the investment, Easy Indexing would have
outperformed the Eurostoxx 50 in 70.05% of all observations. Average outperformance
against the Eurostoxx would have been 6.53% p.a. based on the IRR for weekly launches.
Graph 2 illustrates the development of the strategy:

Graph 2: Internal Rate of Return for Easy Indexing for 5-year holding period

Investment Horizon 5 years

40%
Easy Indexing
35% Eurostoxx 50
30%

25%

20%
IRR (% p.a.)

15%

10%

5%

0%

-5%
98

99

00
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-10%

-15%
Launch Date

Assuming a 5-year holding period for the investment, Easy Indexing (the blue square-
dotted line) would have had an average standard deviation of 7.65% p.a. vs. the
Eurostoxx 50 (the orange triangular-dotted line) with an average standard deviation of
14.70% p.a. based on weekly launches. The maximum drawdown of Easy Indexing
would have only been -0.81% while the maximum drawdown for the Eurostoxx 50 was -
11.50%. Easy Indexing would have increased the average annualized return by 80% with
only half of the volatility and almost no negative drawdown. Table 3 compares the
average/maximum/minimum annualized percentage return of the strategy versus the
Eurostoxx 50:

Table 3: Easy Indexing vs. the Eurostoxx 50 Index for 5-year holding period
Easy Indexing Eurostoxx 50
Average annualized return (%) 14.60% 8.07%
Maximum annualized return (%) 26.27% 33.33%
Minimum annualized return (%) -0.81% -11.50%
Average standard deviation (%p.a.) 7.65% 14.70%

9
Easy Indexing for all Market Environments

How long can a bull market last? Markets do not always rise, so market performance is
not a one-way street. Most big bear markets have taken place because of a massive
misallocation of capital, the classical example being the bear markets in Asia, 1997-1998
as well as the global Internet bubble, 2000-2003 26 .

Easy Indexing should be able to adapt to a change in the market environment.

How will we know we are entering a Bear Market?

Stock prices move in trends. However, random fluctuations in prices mask these trends.
By using Moving Averages, once can eliminate the minor blips from graphs but retain the
overall long-run trend in prices 27 . Although, focussing on only one Moving Average is
doomed to give false signals. However, when more than the half of all underlying equity
markets turn and cross their Moving Average respectively, a change in market
environment must be in place 28 . Easy Indexing Long Short can adapt to this market trend.

Buy low, sell high and identify a trend and get in (and out) at the right time

Easy Indexing Long Short invests in the three most attractive indices of the index
universe according to traditional value ratios. Respectively, it switches to more attractive
indices when relative valuations change.

A Moving Average can track a trending market, but can also generate wrong signals.
However, when more than 50% of the investment universe break their 200-day Moving
Average, a change in market environment must be in place. Easy Indexing Long Short
switches to a long/short approach.

Easy Indexing Long Short shorts only the three least attractive markets. A targeted short
in the most expensive markets profits from a bear market.

When more than 50% of the 200-day Moving Averages cross the underlying indices from
below, Easy Indexing Long Short turns bullish again and invests in the three most
attractive indices of your universe.

26
Campbell and Shiller (2004), Shiller (2000)
27
Kaufman (1998b)
28
The Dow Theory argues that related Averages discount everything and must confirm each other.
For a Long/Short-signal averages must move into the same direction. One could argue that what works
well for the Dow Jones Industrial and Rail averages should also work for country indices of one
geographical area.

10
Historical Simulations

Easy Indexing Long Short was simulated for the period January 1994 until February
2006, with the strategy’s decision rule applied on a monthly basis. Even profitable
trading strategies could lose money when commissions and slippage are added, therefore
all simulations were conducted including 1.5% management fee and 5 bps per trade:

Assuming a 3-year holding period for the investment, Easy Indexing Long Short would
have outperformed the Eurostoxx 50 in 63.6% of all observations. Average
outperformance against the Eurostoxx would have been 9.81% p.a. based on the IRR for
launches occurring every 2 weeks. Graph 3 illustrates the development of the strategy:

Graph 3: Internal Rate of Return for Easy Indexing Long Short for 3-year holding period

Investment Horizon: 3 Years

50% Easy Indexing

Easy Indexing Long Short
40%
Eurostoxx 50
30%

20%
IRR (% p.a.)

10%

0%
Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03
-10%

-20%

-30%
Launch Date

Assuming a 3-year holding period for the investment, Easy Indexing Long Short (the grey
diamond-dotted line) would have had an average standard deviation of 7.96% p.a. vs. the
Eurostoxx 50 (the orange triangular-dotted line) with an average standard deviation of
19.36% p.a. based on weekly launches. The maximum drawdown of Easy Indexing
would have been still positive with 0.33% while the maximum drawdown for the
Eurostoxx 50 was -28.39%. The significant outperformance of the Eurostoxx 50 of 104%
combined with no negative performance would have made Easy Indexing Long Short the
superior investment approach to a long only Eurostoxx 50 investment. Table 4 compares
the average/maximum/minimum annualized percentage return of the strategy versus the
Eurostoxx 50:

Table 4: Easy Indexing Long Short vs. the Eurostoxx 50 Index for 3-year holding period
Easy Indexing Eurostoxx 50
Average annualized return (%) 19.21% 9.40%
Maximum annualized return (%) 42.14% 38.48%
Minimum annualized return (%) 0.33% -28.39%
Average standard deviation (%p.a.) 7.96% 19.36%

11
Assuming a 5-year holding period for the investment, Easy Indexing Long Short would
have outperformed the Eurostoxx 50 in 63.63% of all observations. Average
outperformance against the Eurostoxx would have been 9.42% p.a. based on the IRR for
launches occurring every 2 weeks. Graph 4 illustrates the development of the strategy:

Graph 4: Internal Rate of Return for Easy Indexing Long Short for 5-year holding period

Investment Horizon 5 years

Easy Indexing Long-Short
40%
Easy Indexing
35%
Eurostoxx 50
30%
25%
20%
IRR (% p.a.)

15%
10%
5%
0%
-5%
94

95

96

97

98

99

00
4

M 5

M 6

M 7

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M

-10%
-15%
Launch Date

Assuming a 5-year holding period for the investment, Easy Indexing Long Short (the grey
diamond-dotted line) would have had an average standard deviation of 3.35% p.a. vs. the
Eurostoxx 50 (the orange triangular-dotted line) with an average standard deviation of
14.70% p.a. based on weekly launches – an impressive volatility reduction of 77%. The
maximum drawdown of Easy Indexing would still have been positive with 7.47% while
the maximum drawdown for the Eurostoxx 50 was -11.50%. The performance figures
speak for themselves. Although the average annualized return of the 5-year holding
period would have been smaller then for the 3-year holding period the risk/return profile
would have been enhanced with a convincing minimum return with still only half of the
volatility compared to the 3-year holding period. Table 5 compares the
average/maximum/minimum annualized percentage return of the strategy versus the
Eurostoxx 50:

Table 5: Easy Indexing Long Short vs. the Eurostoxx 50 Index for 5-year holding period
Easy Indexing Eurostoxx 50
Average annualized return (%) 17.50% 8.07%
Maximum annualized return (%) 24.21% 33.33%
Minimum annualized return (%) 7.47% -11.50%
Average standard deviation (%p.a.) 3.35% 14.70%

12
Comparative Performance vs. Hedge Fund Indices

Hedge funds invest in a wide variety of public and private markets. However, the term
“hedge fund” simply refers to investment vehicles with a similar legal structure.
Consequently, generalizations about hedge funds are problematic and often contain more
sensationalism than sound understanding.

Inflows into hedge funds totalled over USD123 billion during 2004 29 . While increasing
asset flows will dilute investor returns in many areas, the impact will differ depending on
the supply/demand balance within the area in question. With barriers to entry low and
investor interest high, many low-quality hedge funds have entered the business. These
new launches are likely to provide disappointing results. In addition, many hedge funds
charge unjustifiably high fees. Most investors would balk if one of their traditional
managers asked for a 1% to 2% management fee plus 20% of profits, yet this is exactly
what many so-called “hedge funds” represent: market-oriented managers charging
exorbitant hedge fund fees. In comparison Easy Indexing and Easy Indexing Long Short
historical simulations were conducted including management fee of just 1.5% and 5 bps
per trade. Hedge fund indices provide a rough gauge of the diverse hedge fund group and
its dedicated strategies, such as Merger Arbitrage or Distressed Trading.

Graph 5 below shows the comparative performance of Easy Indexing (the blue square-
dotted line) and Easy Indexing Long Short (the grey diamond-dotted line) versus the
Eurostoxx 50(the orange triangular-dotted line), the CS Tremont Long Short Equity
Index (the puce dotted line) and the CISDM Equity Long-Short Europe Index (the sky-
blue cross-dotted line), with the strategy’s decision rule applied on a monthly basis for an
open-ended investment observed during the period January 2001 until February 2006 30 .
Easy Indexing and Easy Indexing Long Short even outperform the CS Tremont Long
Short Equity Index as well as the CISDM Equity Long-Short Europe Index.

Taking the high hedge fund fee structure and the comparative performance chart from
above into account, the results of the simple and cost conscious Easy Indexing and Easy
Indexing Long Short strategies are quite staggering. Especially Easy Indexing Long Short
would have beaten even Hedge Fund indices by a wide margin. While particularly skilful
practitioners offer compelling value as concentrated or activist managers, many products
offer nothing more than periodic exposure to market beta. Hedge fund fees are justifiable
only for those managers possessing extraordinarily specialized expertise.

29
Fortmiller et al. (2005)
30
The shorter observation period was due to the limited data availability of the ISDM Equity Long-Short
Europe Index.

13
Graph 5: Comparative Performance of Easy Indexing and Easy Indexing Long Short versus the
Eurostoxx 50, the CS Tremont Long Short Equity Index and the CISDM Equity Long-Short Europe
Index
Easy Indexing Comparative Performance
300
Easy Indexing Long Short

250 Eurostoxx 50

CS Tremont Long Short Equity

200
CISDM Equity Long/Short Europe
Index Level

Index
150

100

50

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Summary

Easy Indexing and Easy Indexing Long Short are strictly defined, scientifically proven
trading strategies. Both systematic strategies incorporate psychological as well as
economic reasons and have clear and objective “Buy” and “Sell” signals. Easy Indexing
and Easy Indexing Long Short invest in the 16 most liquid European indices. The 16
indices offer a well diversified portfolio with an universe of 650 stocks. Hence Easy
Indexing and Easy Indexing Long Short are transparent strategies using transparent index
underlyings. Easy Indexing and Easy Indexing Long Short offer outperformance in rising
but also in falling markets. According to historical simulations the long term
outperformance of the strategies vs. EuroStoxx 50 is about 8-10% p.a. with on average
only half the annual volatility of the EuroStoxx 50.

Conclusion

The conclusion that can be drawn from the paper is thus fairly simple: there are simple,
mechanical strategies that can give a risk/reward ratio greater than that of buying and
holding the market index. The strategy can earn large returns without taking on additional
risk Easy Indexing is an easy and simple to understand Trading Strategy, with superior
and stable returns based on buying value. Active (buying value) and passive (just indices)
fund management techniques are incorporated in one strategy. By following a set of
predetermined rules for managing Easy Indexing, costs can be reduced, and on an after-
fee basis Easy Indexing should have a significant advantage if it can deliver returns
similar to passive index and active fund strategies. Easy Indexing was able to even
outperform major hedge fund benchmarks based purely on the merits of the investment.
The fact Easy Indexing can be delivered at lower cost is an added benefit. Because Easy
Indexing is rules-based, it can also offer greater transparency compared with traditional
hedge funds and depending on the investments they make, better levels of liquidity.

14
Easy Indexing Long Short is designed to do the following:

• Provide diversification benefits when combined with traditional portfolio

investments;
• Enhance liquidity and transparency compared with the average hedge fund;
• Elimination of single-manager risk;
• Ability to scale investments to a larger size due to the liquidity of the underlying
assets;
• Provide meaningful protection in declining markets; and
• Enhance overall portfolio results.

Outlook

Easy Indexing could become the platform for more diverse underlyings and other easy to
gasp trading concepts such as:

• Easy Indexing Emerging Markets

• Easy Sector Indexing

Appendix: Backtest Summary

Table 6: Backtest Summary for Easy Indexing and Easy Indexing Long Short
Backtesting summary* Easy Indexing Easy Indexing Long-Short**
1. # Observation points 147 147
2. # SIGNALS 63 66
3. Occurrence 42.30% 44.30%
4. AVERAGE #days between signals 68.9 (2.3months) 65.8 (2.2months)
5. Rolling backtests launches every week launches every 2 weeks
3-year holding period 477 products examined 238 products examined
5-year holding period 372 products examined 186 products examined
* Easy Indexing and Easy Indexing Long Short were tested over a 12-year period since 1994.
**Long short with MAs was implemented using a 200-Day Moving Average and a "bear"
signal was generated if more than half of the indices (i.e. 9 out of 16) had a price lower than
the MA at the observation date, and vice versa for a “bull” signal.

15
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