# RESEARCH: FACTOR FOCUS

**GARP INVESTING: GOLDEN OR GARBAGE? **

- GARP aims to combine Growth and Value investing
- GARP stocks have outperformed the market since 1989
- It is somewhat perplexing how well the strategy worked

**MINIMUM VARIANCE VERSUS LOW VOLATILITY**

- The largest smart beta Low Volatility ETF is technically a Minimum Variance strategy
- Low Volatility and Minimum Variance have comparable and attractive characteristics
- However, both currently feature a high sensitivity to interest rates

**VALUE, MOMENTUM & CARRY ACROSS ASSET-CLASSES**

- Cross-asset multi-factor exposure might be an attractive diversifier for an equity portfolio
- Factors share trends across asset classes, indicating common drivers
- However, relationships are time-varying, increasing complexity and risks

**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