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Steering Equity Portfolios Through Stormy Style Seas

10 January 2019
4 min read
David Dalgas, CFA| Co-Chief Investment Officer—Global Core Equity
Klaus Ingemann, CFA| Co-Chief Investment Officer—Global Core Equity
Thomas Christensen, CAIA, CQF| Senior Quantitative Analyst—Global Core Equity

As volatility returned to global markets in 2018, return patterns for equity styles were very unstable. With more signs of turbulence ahead, investors should prepare to reduce the impact of short-term factor swings on portfolio performance.

Investors in global stocks are facing tough conditions. In 2018, the MSCI World Index fell by 8.7%, in US-dollar terms. The index rose or fell by more than 1% on 45 days during the year, compared with only three days in an unusually calm 2017. The performance of stocks with types of characteristics known as factors, or styles—such as value, growth and momentum—was particularly unruly.

Equity Factor Returns Shifted Sharply in 2018

On a monthly basis, the best and worst performing equity styles shifted dramatically as the year unfolded (Display). Based on our analysis of six different global equity factors, momentum stocks were the best performers in four separate months, but were also the worst performers during four other months. Value stocks were the poorest performers in three months. Growth stocks did relatively well in January and May, but ranked near the bottom of the list over the last four months of 2018.

Equity Style Patterns Swung Sharply in 2018

Global Equities: MSCI ACWI Month Factor Index Returns (USD, Percent)

Equity Style Patterns Swung Sharply in 2018

As of December 31, 2018
Historical and current analysis do not guarantee future results.
Returns based on MSCI ACWI indices for each factor shown.
Source: MSCI and AllianceBernstein (AB)

October was a particularly turbulent month. The collapse of growth stocks relative to the broader MSCI ACWI index in October ranked in the worst percentile of monthly returns recorded since 2003. In contrast, during the same month, value stocks’ relative returns were close to the best percentile of their history. During 2018, each factor index posted at least one month of relative returns in the top and bottom deciles of its performance record over the last 15 years.

Just how volatile was this compared with history? To check, we modelled a “panic portfolio” to buy the types of stocks that were sold down the most each month. It took the worst-performing style of stocks from the previous month based on MSCI ACWI style indices and rebalanced each month. In other words, this approach assumed that buying into an underperforming style segment would deliver results the next month—and would perform well if styles swung sharply. In 2018, this strategy would have outperformed the MSCI ACWI Index by 7.2%—the strongest relative performance in the 15-year period that we surveyed (Display).

“Panic Portfolio” Highlights Extreme Factor Rotations

Model Portfolio Investing in Worst-Performing Factor Every Month

“Panic Portfolio” Highlights Extreme Factor Rotations

As of December 31, 2018
Historical and current analysis do not guarantee future results.
The Panic Portfolio is created by rebalancing every month. Each month, it buys 100% of the style benchmark that has posted the worst returns during the previous month, and sells the position held. Benchmarks included in the model portfolio are the MSCI style indices: MSCI ACWI Quality, MSCI ACWI Growth, MSCI ACWI Value, MSCI ACWI High Dividend Yield, MSCI ACWI Minimum Vol, MSCI ASWI Risk Weighted and MSCI ASWI Momentum, all in US-dollar terms. Trading costs are not taken into account in this analysis.
Source: MSCI and AllianceBernstein (AB)

Protecting Portfolios from Style Rotations

So how can investors protect themselves from rapid style rotations? In our view, adopting three complementary principles can help address the challenge.

  1. When factors rotate, stay focused on long-term strategy—it’s a timeless investing lesson, yet one that deserves restating when volatility strikes. Sticking to an investing strategy is essential in turbulent conditions because it is almost impossible to time inflection points in the market. For example, in recent years, growth stocks performed strongly, driven by the rising popularity of technology and new media stocks. But in 2018, an investor who added more weight to growth stocks at the wrong time, and then pulled back as growth stocks fell, would have been hit hard. Robust risk models can help investors stay cool during tough times. Yet some risk-reducing trades that are designed for stable markets may not be effective during a correction. Increased vigilance toward valuations and other market forces that may influence trades is essential in order to stick with a strategy through volatility.
  2. Monitor style biases—a core equity approach is a good antidote to volatility, especially when factor returns are so unpredictable. By monitoring exposures to equity factors, a portfolio can be relatively insulated from sharp shifts in style performance. And a position that is broadly style neutral allows portfolio managers to exploit dips in certain areas to increase positions in stocks that have been hit by a style headwind. Portfolios with a built-in methodology to detect factor biases in an allocation may have an advantage in today’s market conditions, in our view.
  3. Pay attention to price—the sharp downturn in growth and quality stocks during the fourth quarter delivered a particularly painful blow to portfolios that held more expensive names. Valuations of growth stocks rose sharply through mid-2018, and investors who paid too much to gain or increase exposure would have been hurt during the fourth-quarter sell-off. Similarly, quality usually provides downside protection, but didn’t do the job in late 2018. We think that’s because many quality stocks traded at expensive prices, so investors who didn’t focus on valuation when buying quality got burned. When investing in stocks that fall into any factor category, it’s essential to check that the price is right before purchasing.

These three principles are a good starting point for today’s unpredictable market conditions, in our view. By combining this awareness with stock-picking skill focused on company fundamentals and cash-flow analysis, we think equity portfolios can be positioned to navigate stormy style seas.

Sources: MSCI and AllianceBernstein (AB)

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.


About the Authors

David Dalgas joined AB in 2014 and is Co-Chief Investment Officer of Global Core Equity. He previously served as head of equities and CIO at CPH Capital, which he cofounded in 2011. Prior to that, Dalgas was head of equities at BankInvest, where he was responsible for equity portfolios serving global institutional investors. He previously worked in portfolio management and equity research at LD Invest (now known as Maj Invest), WestLB, Amagerbanken and the Central Bank of Denmark. Dalgas holds a BSc in economics and business administration and an MSc in finance and accounting from the Copenhagen Business School, and is a CFA charterholder. Location: Copenhagen

Klaus Ingemann joined AB in 2014 as Portfolio Manager and Senior Research Analyst and was promoted to Co-Chief Investment Officer of Global Core Equity in 2018. He previously served as an executive member of the investment board at CPH Capital, which he cofounded in 2011. Prior to that, Ingemann was chief portfolio manager and a member of the investment board at BankInvest. He previously worked as a corporate finance advisor for Carnegie Bank, where he mainly advised on cross-border mergers and acquisitions. Before that, Ingemann spent four years in the finance department at Tele Danmark, where he was primarily involved with developing a value-at-risk management system. He holds a BSc in business administration and an MSc in finance and accounting from the Copenhagen Business School, and is a CFA charterholder. Location: Copenhagen

Thomas Christensen joined AB in 2014 as a Senior Quantitative Analyst for AB Global Core Equity. He previously served as senior risk and quant manager at CPH Capital. Prior to that, Christensen held a similar role at BankInvest. He holds both a BSc and an MSc in business administration and management science from the Copenhagen Business School, and is a Chartered Alternative Investment Analyst (CAIA) with a Certificate in Quantitative Finance (CQF). Location: Copenhagen