Long/Short Sector-based Trading Strategy

Emergent Asset Management, LLC

Konstantin Savov Scott Smith

Pin-Yew WongVaswar Mitra

Vinaya Jain

February 27, 2006

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Agenda Establishing the Long/Short Trading Strategy Description of Factors Scoring Methodology Sectors Chosen for Analysis Sector Analysis

Average Top and Bottom Quintile Returns for all Considered Factors

Factors Chosen and Calculated Scores In Sample Analysis 1996-2003 Out of Sample Analysis 2004-2005

Imperfections in the Analysis

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Establishing Long/Short Trading Strategy Overview

Limit universe of stocks to firms with market capitalization > $500M Stocks selected from the S&P 1500 Index (US large, mid and small cap

stocks). Sectors were defined using S&P’s GICS classification system We feel these stocks will have sufficient liquidity and historical data

Establish long / short sector based portfolios using quantitative stock selection. Equal weight strategy Rebalance portfolios monthly In Sample: 1996-2003, Out of Sample: 2004-2005

Quantitative stock screen Thirteen factors considered initially Find predictive powers on positive and negative returns

Select factors with strong predictive power for sector returns Go long stocks in top quintile Go short stocks in bottom quintile

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Description of factorsFundamentalFundamental1. Book to Price: book value per share / price per share2. Dividend Yield: dividends per share / price per share3. CFO Yield: cash flow from operations / price per share4. Earnings Yield: LTM earnings / price per share5. Return on Assets: annual net earnings / total assets6. % Change in ROA: % change in ROA over previous month7. Return on Equity: annual net earnings / total shareholder equity8. % Change in ROE: % change in ROE over previous month

ExpectationalExpectational1. Revision Ratio: (Upward revisions – downward revisions) / total revisions2. SUE Score: standard unexpected earnings (Earnings surprise / std deviation)3. Mean FY1 to Actual % Change: (FY1 Estimate – Current Actual) Current Actual4. LT Projected Growth – Historical Growth: Next 5 year annualized estimate – previous

5 year annualized actual

MomentumMomentum1. 12-Month Lagged Monthly Price Growth: Eg: (Jan’06 Price – Jan’05 Price) / Jan’05 P

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Scoring methodology

Each month the quintiles are ranked based on returns

Assign points from highest to lowest rank (+2,+1,0, -1, -2)

Sum points for quintiles 1 and 5

Scale points across factors from +10 to -10

We tried using an objective scoring methodologyParameter 1

Date F1 F2 F3 F4 F5 F1 F55/1/2003 7.83 2.89 5.23 4.92 3.90 2 -1

5/30/2003 3.55 1.10 1.34 1.23 3.89 1 27/1/2003 7.82 7.98 6.42 5.87 6.92 1 08/1/2003 7.33 4.52 4.78 5.76 4.79 2 0

8/29/2003 -4.57 -2.76 -5.58 -4.42 -5.88 0 -210/1/2003 8.29 9.07 7.08 8.35 6.59 0 -2

10/31/2003 5.11 4.13 3.46 2.69 3.88 2 012/1/2003 6.25 4.03 5.12 5.17 5.75 2 1

10 -2

Points Summary for all selected ParametersF1 F5 F1 F5

Parameter 1 10 -2 2.86 -5.71Parameter 2 12 -8 4.29 -10.00Parameter 3 20 -1 10.00 -5.00Parameter 4 10 -4 2.86 -7.14Parameter 5 8 -2 1.43 -5.71

Max 20Min -8Range 28

Points

Assigned Scores

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Sector choice

Considerations in choosing sectors: Sufficient number of companies in the defined

universe Maturity of sector

Final Choice Financials Industrials Healthcare

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Financials

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Average Annual Factor Returns for top and bottom quintiles

Financials

0.00

0.50

1.00

1.50

2.00

2.50

Change inROE

Change inROA

Book toPrice

DividendYield

EarningsYield

Momentum ROE ROA CFO Yield RevisionRatio

Sue Score EPS FY1to Actual

Rate ofChange of

Growth

Long TermGrowth -HistoricalGrowth

Ret

urn

1st Fractile 5th Fractile

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Factors chosen & calculated scores

Financials

Factors 1 5Earnings Yield 10.00 CFO Yield 1.33 ROE Change 1.86 (10.00) Book to PriceEPS FY1-to-Actual (5.58) ROE 2.92 (8.58)

Quintile Scores

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In sample analysis 1996-2003

Financials

Cumulative annual returns - (index = 100 each year)

Year F1 F2 F3 F4 F5

1996 152.5 122.7 133.9 118.4 124.4

1997 168.8 142.3 159.0 156.2 133.8

1998 110.4 118.6 106.1 101.3 96.1

1999 90.4 101.6 96.6 93.8 88.1

2000 166.9 148.4 138.7 135.2 125.3

2001 126.4 107.8 102.5 100.2 102.8

2002 105.6 100.8 95.9 104.9 80.6

2003 148.8 136.3 133.5 138.6 135.7

Average relative performance

1.5 2.5 3.1 3.5 4.4

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Out of sample analysis 2004-2005

Financials

Cumulative annual returns - (index = 100 each year)

Year F1 F2 F3 F4 F5

2004 133.6 123.8 117.2 122.8 118.8

2005 118.1 114.9 103.3 107.0 103.0Average relative performance

1.0 2.0 4.5 3.0 4.5

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Healthcare

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Average Annual Factor Returns for top and bottom quintiles

Healthcare

0.00

0.50

1.00

1.50

2.00

2.50

Change inROE

Change inROA

Book toPrice

DividendYield

EarningsYield

Momentum ROE ROA CFO Yield RevisionRatio

Sue Score EPS FY1to Actual

Rate ofChange of

Growth

Long TermGrowth -HistoricalGrowth

Ret

urn

1st Fractile 5th Fractile

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Factors chosen & calculated scores

Healthcare

Factors 1 5Earnings Yield 10.00 (10.00) Book to Price 7.74 ROE change (5.16) Revision Ratio 2.26 SUE Score 9.35

Quintile Scores

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In sample analysis 1996-2003

Healthcare

Cumulative annual returns - (index = 100 each year)

Year F1 F2 F3 F4 F5

1996 112.2 110.1 105.1 106.1 84.4

1997 153.8 115.9 125.5 124.8 112.4

1998 112.3 140.6 149.0 134.3 100.1

1999 109.4 92.8 101.1 91.2 164.8

2000 236.1 176.4 144.7 172.7 142.0

2001 117.6 115.2 104.1 94.3 85.7

2002 97.1 87.0 84.4 80.8 63.4

2003 160.4 138.2 124.7 138.5 138.2

Average relative performance

1.5 2.6 3.1 3.4 4.4

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Out of sample analysis 2004-2005

Healthcare

Cumulative annual returns - (index = 100 each year)

Year F1 F2 F3 F4 F5

2004 121.6 106.4 116.3 108.4 119.1

2005 128.5 104.3 112.9 111.8 110.3

Average relative performance

1.0 5.0 2.5 3.5 3.0

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Industrials

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Average Annual Factor Returns for top and bottom quintiles

Industrials

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

Change inROE

Change inROA

Book toPrice

DividendYield

EarningsYield

Momentum ROE ROA CFO Yield RevisionRatio

Sue Score EPS FY1to Actual

Rate ofChange of

Growth

Long TermGrowth -HistoricalGrowth

Ret

urn

1st Fractile 5th Fractile

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Factors chosen & calculated scores

Factors 1 5Earnings Yield 10.00 CFO Yield 4.70 (10.00) ROE 2.77 Revision Ratio (3.25) ROA Change 3.49

Quintiles

Industrials

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In sample analysis 1996-2003

Industrials

Year F1 F2 F3 F4 F5

1996 134.8 117.3 121.2 113.3 115.2

1997 142.0 135.7 132.2 123.4 119.3

1998 93.2 108.8 100.3 98.1 106.1

1999 113.4 90.6 111.2 88.4 110.1

2000 116.7 110.1 126.4 104.6 118.7

2001 135.4 107.9 108.1 108.5 83.6

2002 96.1 99.4 107.3 88.5 76.0

2003 152.1 141.4 131.1 124.9 136.6

Average relative performance

2.0 2.8 2.4 4.3 3.6

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Out of sample analysis 2004-2005

Industrials

Cumulative annual returns - (index = 100 each year)

Year F1 F2 F3 F4 F5

2004 136.2 125.1 125.3 119.5 125.9

2005 106.0 117.9 111.2 110.7 110.6

Average relative performance

1.5 1.4 1.4 1.8 1.5

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Imperfections in analysis

Monthly rebalancing – trading costs not taken into consideration

Migration tracking could potentially reduce turnover and trading costs

Need a more exact estimation of the impact of turnover and short sale restrictions

Use of static scores