Feature | Value vs momentum


faced a challenging time for at least a dec- ade and investment in value is usually asso- ciated with investors sharing an upbeat out- look on economic growth. A shift on such a scale could have potential ramifications for the portfolios


of long-term institutional


investors. Factor investing has become increasingly important for pension schemes. Examples include HSBC’s DC schemes, which has a factor investing fund as its equity default option and the BT Pension Scheme, which until recently had more than half of its listed equity portfolio invested in factor weighted strategies. While not all schemes are directly invested in factor funds, about 75% of DB schemes globally are employing one or more factors in their investment strategy, according to BlackRock’s Global DB Pensions Report. In other words, a fac- tor perspective has increasingly shaped the way institutional investors analyse equity markets. A change in factor trends could potentially affect their equity portfolios. Should pension fund investors start to increase their exposure to value stocks?


BOND MARKET BETS Traditionally, value stocks are understood to be stocks that are not necessarily cheap but are trading at a lower price than their fundamentals, while momentum investors focus on stocks that displayed high returns in the recent past. These approaches to sourcing potential profits in equity invest- ments are based on fundamental data which is unlikely to change in the short term. In the past couple of years, value stocks have consistently underperformed while investors crowded their money in already expensive momentum stocks. How does this definition of value investing explain the sudden shift? The short answer is,


it doesn’t. Looking


back at the “momentum massacre” that took place in September, a consensus between equity analysts and investors emerged that the sudden turnaround had nothing to do with changing fundamentals and was instead a bet on bond markets. September saw the US yield curve normal- ising. Having inverted earlier that month,


the trajectory for US treasuries appeared to calm down with yields on 10-year treasuries being again higher than those of 2-year treasuries, helped by a Fed rate cut. For many equity investors, that was reason to be more bullish. Wyn Francis, deputy CIO at BT Pension Scheme, sees this as a key reason for the change in investor demand: “Going into mid-September, the yield curve steepened largely as a result in the move of 10 year rate, but the curve remained broadly flat/ inverted (and has been again bull flattening since mid-September.) Equity and bond investors most likely responded to similar information, in the context of heightened uncertainty around US monetary policy and economic growth.” This view is also backed by Jan de Koning, portfolio manager Core Quant Equities at Robeco. “We have conducted extensive research into the behavior of the value fac- tor given different interest rate scenarios since


the financial crisis of 2008. We


observe a positive correlation between the direction of interest rates and the perfor- mance of the value factor over the past 10 years. If rates rise, value tends to perform positively and when they decline value underperforms the market. Also, when the interest rate steepens,


value does well, whereas if the curve flattens it tends to lag.”


DIGGING DEEPER – A SECTOR PERSPECTIVE But there are other factors complicating the picture, most importantly the performance of individual sectors in the value segment, who have contributed heavily to the tilt, as Thomas Stork, a specialist in equity manager research at Aon highlights: “There can be a couple of drivers for the trend, it is important to look at the sectors where value has congregated more recently. From con- versations with managers, the most obvi- ous sectors are financials autos, some areas in healthcare. What happened in Q3 is most pertinent for financials rather than energy. We saw a short rally in the financial sector while we saw geopolitical tensions in Saudi Arabia and a bump in energy prices so some of the energy stocks did well, those


48 | portfolio institutional | November 2019 | issue 88


are the kind of sectors and stocks you would see in a value portfolio so for that reason value has done quite well.” He also acknowledges that the reasons for the momentum sell-off are a bit harder to identify. “There is certainly a technical aspect to it. Growth and momentum factors have obviously done quite well but the bump in value stocks has put a technical selling pressure on the momentum side. Based on the conversations I had with quant managers, it is important not to over- state the extent of the rotation. Yes, value did well at the start of September but it is still very much an underperforming factor and the extent of the sell-off in momentum has not been huge. So looking at the overall performance in Q3, momentum isn’t a standout underperformer because it did so well in July and August.” But there is also another side to the sectoral argument. Advocates of value investing argue that the current underperformance of value stocks bears resemblance to the period of the tech bubble in the 1990s. Andrew Dyson, CEO at quant firm QMA, believes the recent turnaround is indicative of investors losing faith in overpriced growth stocks.


“The value environment is extreme, but it is not unique. We have every reason to believe


that outperformance will follow.


After the tech bubble and the GFC, correc- tions to value more than eclipsed their prior losses.” Academic research also points to structural factors which explain the long-term demise of value stocks. One important aspect is the growing importance of investments in intangible assets such as R&D, branding or business processes for the traditional value sectors, according to an article by Baruch Lev and Anup Srivastarva. The researchers point out that intangible assets have become an increasingly important factor to the gross value added, but these invest- ments have not been factored in to their book values, making firms appear to be overvalued. These accounting mismeasure- ments have made it harder for value inves- tors to source potential investments, the authors argue.


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