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Covid winners, losers of factor investing

Nicki Bourlioufas  |  13 Jul 2020Text size  Decrease  Increase  |  
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Factor investing is an investment approach that involves targeting assets with specific characteristics or attributes, which can help improve portfolio outcomes over the longer term and in some cases, protect against downside risk.

There are several different factors. ‘Value’ stocks are those that have low prices relative to their financial fundamentals such as earnings while ‘quality’ companies are those with financially healthy balance sheets including strong earnings and low debt.

‘Momentum’ investing refers to buying companies with strong performance trends. Stocks with low volatility historically have achieved higher risk-adjusted returns than those with higher volatility, while size refers to buying companies which are either large or small.

Exposure to factors can be achieved through a variety of investment products, including actively managed funds and exchange traded funds.

Different factors will behave in distinct ways during the various stages of an economic cycle, which is why the approach requires a long-term mindset, says Vanguard Australia’s Alla Kolganova.

Though each factor will experience periods of both under-performance and out-performance, over the longer-term, “we expect them to beat market benchmarks by between 1.5 and 2.5 per cent annually,” says Kolganova, who heads up Vanguard’s quantitative equity operations in Asia-Pacific.

“In recent years, with a high degree of economic uncertainty, people have been investing in companies with higher growth potential, so we have seen the outperformance of the momentum factor,” she says.

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Conversely, value stocks have underperformed since the GFC — and their valuations are now at their lowest levels in years.

“At some point, we would expect to see flows back into value funds,” Kolganova says.

“The value factor typically outperforms after a recession.”

Global asset markets comprise dozens of asset classes and millions of individual securities, but even across such wide variations there are a few factors that can help explain returns. These factors are driven by different economic rationales, and have tended to outperform at different times, says According to Andrew Ang, head of factor-based strategies at BlackRock.

“This cyclicality presents an opportunity to tilt portfolios toward some factors and away from others in pursuit of incremental returns,” says Ang.

Momentum, quality in the limelight

Momentum and quality have been the best performing factors in recent years, while value has delivered negative returns over the past five and 10 years, says Simon Lansdorp, portfolio manager, factor investing equities at asset manager Robeco.

The below graph shows global factor returns relative to the broad equity market for various periods up to December 2019. While the chart does not cover the past six-months, “the impact on five and 10-year performance would be relatively low,” says Lansdorp.

Generic factor returns over different timeframes

factor returns 1

Source: Robeco

Market sell-offs are often accompanied by a “flight-to-quality” which means size and value factors tend to underperform, explains Lansdorp. But they also tend to rebound most strongly as markets emerge from recession.

The low-volatility factor offers downside protection as low-risk stocks tend to decline less in such market environments.

The quality factor also often offers some downside protection, though to a lesser degree than low-volatility factors.

But as in investing generally, timing is crucial — and it’s also incredibly difficult. For this reason, Lansdorp believes a “diversified multi-factor approach often results in more stable performance.”

Factor performance in 2020
The COVID-19 pandemic has not changed the story too much. The best performing factor in the first half of 2020 has been the momentum factor and, to a lesser extent, the quality factor.

The following chart from index provider MSCI lists the top-performing factors over the first four months of this year. Value is represented by the book-to-price ratio. The chart includes environmental, social or governance investing, which is also considered a factor.

MSCI Global Equity Model year-to-date factor returns

factor returns 2

Source: Morgan Stanley, as of 30 April 2020.

Vanguard’s Kolganova says that high performing technology stocks have driven a lot of the gains within the momentum factor, which has been the best performer between mid-February and the end of June.

“Momentum has been pushed up by technology stocks since the coronavirus pandemic and it has also been pushed up by healthcare stocks to a lesser extent.

“The technology sector seems to be quite unstoppable at the moment and has been for many years given there have been such low interest rates and high economic uncertainty.

On the other hand, value has been underperforming but has been getting progressively cheaper.

“We are starting to see flows back into value funds,” says Kolganova, who echoes the view of Robeco’s Lansdorp.

“Timing factors is extremely difficult. A multi-factor approach cushions the ups and downs.”


is a Morningstar contributor.

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