Equities Blog

Finding Consistency in Erratic Equity Markets

15 May 2017
3 min read
Finding Consistency in Erratic Equity Markets
David Dalgas, CFA| Co-Chief Investment Officer—Global Core Equity
Klaus Ingemann, CFA| Co-Chief Investment Officer—Global Core Equity

Why was it so hard for core equity managers to deliver consistent performance last year? Unpredictable market currents may have exposed the vulnerabilities of strategies that are meant to transcend volatile return patterns within stock markets.

Global equity market patterns shifted dramatically during 2016 (Display). Consider the returns of different equity factors—features of stocks such as attractive valuations, strong momentum, or profitability. In the first half of the year, stocks that were considered to be safer, with lower-volatility characteristics or higher dividend yields, outperformed the MSCI All Country World Index (ACWI) by a wide margin. But they underperformed sharply in the third quarter.

Equity Return Patterns Have Been Very Volatile
Relative Returns of MSCI Factor and Style Indices vs. the MSCI ACWI Cap-Weighted Index
Equity Return Patterns Have Been Very Volatile

As of March 31, 2017
Source: MSCI and AB

Momentum and Value Stocks Changed Direction

High-momentum stocks were also unpredictable. They surged in the second quarter, only to underperform in the third. And value stocks were just as fickle, staging a strong rally after the US presidential election in the fourth quarter.

These were challenging times for many equity managers. In particular, portfolios that are rooted in an investing style, which lean on equity factors in stock-selection processes, had a rough ride. For example, minimum-volatility and growth managers struggled to deliver annual outperformance in the rapidly changing environment.

Squeezing the Core

Core equity portfolios were also under pressure. Less than 50% of global core equity strategies outperformed the MSCI ACWI in either the first or second half of 2016 (Display). Only 13% outperformed in both the first and second half of 2016, and only 8% beat their benchmarks in all four quarters.

Core Equity Managers’ Performance Has Been Inconsistent
Percent of Managers Outperforming the MSCI ACWI Index, 2016
Core Equity Managers’ Performance Has Been Inconsistent

As of December 31, 2016
Manager returns represented by 245 strategies in the eVestment Global All Cap Core Equity universe relative to MSCI ACWI
Source: eVestment, MSCI and AB

Why the challenged performance? We think that many core equity managers have biases to different equity factors. While these equity factors can be good guides to sources of long-term returns, their performance can be very volatile over short periods, as we saw last year.

Of course, style-oriented portfolios are susceptible to factor-return volatility, but these hazards can be addressed through careful stock selection and diligent risk control. By definition, core equity portfolios aren’t meant to be heavily weighted toward specific style factors. Yet in practice, core managers may not be aware of how the group of stocks they have chosen has inadvertently created a bias toward a particular factor or style that can lead to unintended performance swings.

Irregular Return Patterns to Continue

Last year’s volatile return patterns may not be an anomaly. With more market uncertainty on the horizon, driven by political risk or changing monetary policy, we expect more irregular return patterns as the year unfolds. This could dilute or augment the effectiveness of stockpicking. Indeed, in the first quarter of 2017, growth, quality and momentum stocks were top performers, while value stocks decelerated.

In this environment, we believe it’s especially important for portfolio managers to focus on fundamentals. This means ensuring that the fundamental characteristics of the companies they research—such as cash-flow trends and business dynamics—will drive long-term stock returns. And portfolios must be constantly monitored to avoid unintended skews toward equity factors, in our view. By applying these two principles to core portfolios, investors can neutralize the impact of sharp shifts in factor performance and enjoy more consistent long-term return patterns in erratic equity markets.

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.

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

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein.

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.

Dalgas takes a long-term view and uses cash-flow-based analysis to construct portfolios. It's a process honed over years and underpinned with rigorous research. “The portfolio should grow faster, be of higher quality than the market, have a cleaner ESG profile and be cheaper,” he says. “That's the balance we try to strike.”

Dalgas relishes the intellectual challenge of finding companies that fit these criteria, and building conviction that they can outperform the market. “We do use some quant tools,” he says. “But we focus on bottom-up qualitative research to find these opportunities.”

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 co-founded in 2011. Prior to that, Ingemann was chief portfolio manager and a member of the investment board at BankInvest.

AB’s reputation for grit and loyalty to people, products and processes attracted Ingemann to the firm, and his investment philosophy seeks to align skill and proven processes with client demand. The funds he manages tap into all available sources of stock market returns, yielding high long-term returns potential while also offering a very diversified opportunity set with less risk relative to the benchmark and peers.

Ingemann has been investing in stocks since he was a child, and he has a particular fondness for the strategic aspect of building growing and sustainable business models. “We use qualitative measures to find great, sustainable companies, and we use quantitative models to select those offered at attractive prices,” he says.