RESEARCH: FACTOR FOCUS

TACTICAL STATISTICAL ARBITRAGE

  • Statistical arbitrage behaves similarly across markets
  • Volatility is the main performance driver
  • Attractive strategy for diversifying an equity portfolio

THE ODD FACTORS: PROFITABILITY & INVESTMENT

  • The Profitability factor generated attractive returns in the US and Europe since 1990
  • It is difficult to explain why investors should be compensated for holding highly profitable companies
  • The Investment factor was less attractive and is unusual from a financial analyst’s perspective

THE DARK SIDE OF LOW VOLATILITY-STOCKS

  • Low-volatility stocks have outperformed the market over the last 25 years
  • The strategy has reduced equity drawdowns in the US, Europe, and Japan
  • However, low-volatility stocks have been bond-proxies, which poses risk when rates rise

STATISTICAL ARBITRAGE

  • Statistical arbitrage has attractive strategy characteristics
  • However, the returns are highly dependent on transaction costs
  • Best used as a tactical strategy when volatility is high

IMPROVING THE ODDS OF VALUE

  • Value investors earn a premium for holding undesirable stocks
  • Market skewness may identify periods where the premium is more attractive
  • The returns from the Value factor since 1926 were zero when market skewness was negative

FACTOR MOMENTUM

  • The Momentum strategy can be applied to stocks, sectors, countries and factors
  • Factor momentum shows positive excess returns across regions
  • However, single-stock Momentum performance is comparable and less complex to implement

LOW VOLATILITY, LOW BETA & LOW CORRELATION

  • The Low Volatility, Low Beta and Low Correlation factors are interrelated
  • Low-risk factors generate attractive risk-adjusted returns, but require beta-neutrality
  • Currently they feature moderate to high interest-rate sensitivity

MOMENTUM VARIATIONS

  • The simplicity of the Momentum factor can be intellectually challenging
  • Various alternative Momentum versions highlight remarkable similar return profiles
  • The robustness is an attractive characteristic of the investment strategy

SECTOR VERSUS COUNTRY MOMENTUM

  • The Momentum strategy can be applied to stocks, sectors and countries
  • Sector and country Momentum portfolios generate positive excess returns
  • However, cross sector & country and single stock Momentum portfolios generate higher risk-return ratios

TACTICAL MEAN-REVERSION

  • The Mean-Reversion factor is driven by volatility
  • Allocating tactically when volatility is high generates an attractive payoff profile
  • The strategy can be considered as a tail risk hedge for equity portfolios

MEAN-REVERSION ACROSS MARKETS

  • The Mean-Reversion factor shows the same trends across markets
  • The strategy differentiates itself from other factors by exhibiting strong positive skewness
  • Mean-Reversion is an attractive diversifier for an equity-centric portfolio

ALPHA MOMENTUM

  • Stocks can be ranked by alpha instead of stock returns
  • Alpha Momentum generates a higher and more consistent performance than Price Momentum
  • Momentum crashes are reduced significantly and risk-return ratios increase

VALUE FACTOR: COMPARISON OF VALUATION METRICS

  • Price-to-book is not an effective valuation metric
  • There is not one valuation metric that is superior across markets
  • Combining multiple metrics generates the highest risk-adjusted returns

VALUE FACTOR: IMPROVING THE TAX EFFICIENCY

  • The tax efficiency of the Value factor can be improved by reducing exposure to dividend-yielding stocks
  • Improving the tax efficiency reduces the performance in Europe and Japan, but not in the US
  • Reducing turnover can be considered for minimising capital gains and stamp duty taxes

LOW VOLATILITY FACTOR: INTEREST RATE-SENSITIVITY & SECTOR-NEUTRALITY

  • The interest rate-sensitivity of the Low Volatility factor has increased in recent years
  • Mainly due to the sectoral biases from the long portfolio
  • Sector-neutrality reduces the interest rate-sensitivity, albeit at the cost of performance

VALUE FACTOR: INTRA VS CROSS-SECTOR

  • Intra versus cross-sector Value portfolios share the major trends
  • Neutralising the sector exposure increases the risk-return ratio of the Value factor
  • However, the benefits are marginal and come with higher operational complexity

WHAT’S IN A FACTOR? BREAKDOWN BY SECTORS

  • Some factors show structural sector exposure while others rotate sectors frequently
  • Sector concentrations explain factor performance and may represent concentration risks
  • Value is currently long Financials, Low Volatility is short Health Care, and Growth is short Energy

RESIST THE SIREN CALL OF HIGH DIVIDENDS

  • Buying high yielding and selling low yielding stocks has been an attractive strategy since 2000
  • However, it has been a highly unattractive strategy over the last century
  • Investors should resist the Siren call of high yielding stocks and focus on other factors

DEATH, TAXES, AND MEAN-REVERSION?

  • Mean-reversion has not performed well over the last few years
  • Highly sensitive to model assumptions
  • The strategy is an attractive addition for an equity-centric portfolio

QUALITY FACTOR: ZERO ALPHA FOR MOST INVESTORS?

  • It’s difficult to rationalise why there should be excess returns from high quality stocks
  • The Quality factor needs to be constructed beta-neutral to achieve positive returns
  • Exposure to the Quality factor is an attractive hedge for an equity-centric portfolio

THERE IS VALUE IN THE VALUE FACTOR

  • Equity factors can be valued using fundamental metrics
  • Value and Size are cheap while Low Volatility and Growth are expensive
  • Likely more meaningful for medium- to long-term than short-term investors

QUALITY FACTOR: HOW TO DEFINE IT? 

  • Different Quality definitions result in dramatically different return profiles
  • Questionable if there is structural alpha in the Quality factor
  • Investors would not have benefited significantly from exposure to Quality in the GFC

LOW VOLATILITY FACTOR: HIGH VALUATION 

  • The Low Volatility factor has generated stellar abnormal returns over the last decades
  • Current factor valuations are expensive compared to historical valuations
  • Factor volatility is at record lows and will likely surprise investors going forward

MOMENTUM FACTOR: INTRA VS CROSS-SECTOR 

  • Intra vs cross-sector Momentum factor profiles look remarkable similar
  • Momentum is like a force that permeates sectors and countries
  • Sector analysts need to pay attention to cross-sector Momentum

VALUE US SECTORAL ANALYSIS

  • Using price-to-book (PB) or price-to-earnings (PE) results in similar Value factor performance
  • Some sectors are perpetually expensive while others are always cheap
  • Sector rotation is higher with PE than with PB

SIZE FACTOR

  • Size as a factor shows little consistency in generating positive returns over time
  • Investors do not seem to get compensated for the higher risks of holding small caps
  • If small cap exposure is still desired, best to implement via a small cap ETF

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