For many reasons, 2020 is already an exceptional year. Above all, the COVID-19 virus has shown how vulnerable the world is to a pandemic. To prevent a potential economic slump, the ‘whatever-it-takes’ response from central banks has been the fastest ever seen. Stock markets have rallied in reaction to the liquidity injections. While the major equity indices are now back, or close, to their levels at the start of 2020, the rally has raised questions about this exceptional drawdown and rebound.
Since the start of 2020, investors exposed to multi-factor equity strategies have suffered some underperformance. Investors with a long-term investment horizon can view this as a ‘short-term’ event.
When researching, designing and implementing systematic and factor investing strategies, we always consider short-term events as exceptional and non-predictable. Nonetheless, the COVID-19 crisis is an opportunity to review, confirm and, if necessary, improve the factor investing strategies we manage.
In recent years, multi-factor equity strategies have suffered from poor performance relative to cap-weighted indices. The market turbulence of 2020 has exacerbated this. In explaining this underperformance, we see a number of contributory factors:
Our multi-factor equity strategy seeks to tilt portfolios towards the cheapest (Value), the most profitable and best-managed companies (Quality) with the lowest risk (Low Volatility) and strongest trend (Momentum).
Recently, exposures to these factors did not generate the expected performance. Short-term outperformance was concentrated in specific stocks and sectors which were not well ranked from a factor perspective.
Our multi-factor equity strategies have been designed to improve the long-term risk/return profile of investments previously managed against traditional market indices. In the research phase, we carefully selected factors with the characteristics described in Exhibit 1.
We believe that market inefficiencies explain the existence and persistence of factor premiums in financial markets. Determining the exact reasons for their existence is not straightforward as there are a number of plausible explanations. These include:
Exhibit 2 shows periods of underperformance for each single factor, especially Value, in recent years. These are mitigated through their risk-weighted combination in a multi-factor framework. Clearly, factors may be subject to short-term disturbance, but in the long run, the combination of factors such as Quality, Low Volatility, Momentum and Value does deliver sustainable outperformance, especially when they are blended in an efficient portfolio construction framework.
As such, we reaffirm our conviction that our multi-factor strategies have the potential to deliver long-term sustainable outperformance while at the same time controlling investment risk and integrating sustainability and carbon reduction objectives.
Our quantitative equity investment team works closely with our Quantitative Research Group to constantly review, affirm and improve our factor investing strategies. A strict governance is applied based on three-year research cycles.
The current research cycle (the fourth of its kind) was launched in 2018, meaning that as of today we are in the middle of this new cycle. This current cycle is expected to lead to a number of improvements to the methodology. The investment philosophy will of course be maintained. We remain highly confident in our ability to deliver positive alpha over the medium to long term.
Under the current research project, we are reviewing the investment process, breaking it down into four main areas:
We will continue to refine and develop our multi-factor equity strategies over the coming years to deliver their three investment objectives:
As such, while 2020 will go down in history as the year of the COVID-19 pandemic, it will also be the year in which we further developed our research efforts in these key investment strategies.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.