Sunday, 28 August 2011

Fund Managers use SPSS to Select Stocks

Business analytics (BA) refers to the skills, technologies, applications and practices for continuous iterative exploration and investigation of past business performance to gain insight and drive business planning.BA makes extensive use of data, statistical and quantitative analysis, explanatory and predictive modeling, and fact-based management to drive decision making.

SPSS is a tool that is commonly used to drill down into various details of the business. It makes use of functions like “Frequency” and “Cross tab bivariate analysis” to dig deep into the various aspects of the business. This simplifies the decision making process by focusing on the key aspects which otherwise may not be very visible.

The Process starts with the Hypothesis where you want to find whether a relationship exists between two variables or not. As a finance person, I can think of innumerable possibilities of its applications.

SPSS uses different variables in the Data View tab. These are shown as columns. The cases exist in the rows. The values of different variable of a particular case are entered in the Data view tab. The different attributes of these variables can be changed in the Variable view tab.

Let us assume that we want to establish a relation between “Returns given by the stocks and its PE ratio over a long period of time (say 5years)”

Our Hypothesis will be “There is no significant relation between the Low P/E stocks (also called Value stocks) and the Returns given over a 5 year horizon”

The Cases will be its details including the name & the variable values. These variables will be the Returns, P/E ratio, Market capitalization, Book value-to-Price ratio.

We can select the range of P/E using the function “Recode into same Variable”. Here we can define a range for P/E and thus create a new variable. Each range is given some value while its labels can be changed to Value Stocks (Low PE) and Growth Stocks (High PE). Similarly, using the same function range can be given to the Returns. The labels can be- Very high returns, high returns, moderate returns, low returns and negative returns. PE values shall be in the rows while the Return labels should be in the columns. We should use the percentages to see what percentage of low PE stocks have Very high returns (or high returns) over the last 5 years.

Using Cross tab we can create further layers based on the Market Capitalization and the Book to Price Value ratio of the stock. These two layers will give us better understanding. Using the Chi-Square value (more or less than 5%) we can accept or reject our Null hypothesis. Suppose it is less than 5%, we reject our Null Hypothesis and there is a significant relationship with Low PE stock and high returns over a period of 5 years when say the Book-to-Price value ratio is high (the third variable introduced as Layer)

Therefore, a Smart Fund manager uses SPSS to pick up the stocks where he should invest (given his time horizon for investment is large enough). This way SPSS can prove to be extremely useful in stock picking. Such FUNDS give much superior returns than the Market returns.

Now we know the secret why some fund managers outperform the rest….!!!


Vyom Saini

Finance Grp-6 (13114)

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