Value's Comeback?

The Value factor has had a rough few years, ok...maybe more like a decade. As shown below (click to enlarge chart) Value massively underperformed Growth, particularly in the second half of the last decade with interest rates continuing to remaining near zero; 2020 was just brutal.   

New decade, new hope? With the threat of inflation and rising rates on the horizon as President Biden's plans for up to $6 trillion of fiscal spending gets underway, Value made a strong comeback in Q1 2021. In fact, it was the second best quarter of Value outperformance in nearly a 100 years (click chart below to enlarge). But will it last? After hitting a high of 1.74% on March 31, the yield on the benchmark 10-year Treasury Note has steadily fallen to 1.6% as of May 7. So, don't count the FAANGMs out just yet, they continue to be, we think, investors' best bet (except for maybe Netflix :().

Hedge Funds Have Decent January, Despite GME

GameStop was one of the most shorted hedge funds names coming into January. And last month's epic short squeeze that we wrote about (here, here and here) cost a number of big-name funds, like Melvin Capital, D1 and Point72, bigly--as they say. 

The S&P 500 was flying high up to the week of the squeeze. The equity benchmark was up 2.6% through Jan 25, before closing the month down 1.1%. So, we figured the pain would be felt broadly across hedge fund land...but, so far, Jan HFRI hedge fund returns suggests the damage was limited to a select group of funds with the HFRI Fund Weighted Composite Index, the widely cited hedge fund benchmark, up 0.78%. 

So, most hedge funds did well last month, at least the ones reporting early! Perhaps because it wasn't just WSB driving up the GME price, other hedge funds were in it too, amplifying the rally. (And, of course, Robinhood's liquidity issues shut out retail investors for a time which helped hedge funds.) True, the HFRI Equity Market Neutral Index was down 0.53%, but given this leveraged strategy is one of the most vulnerable to short squeezes, we're surprised (shocked even!) that losses were so...umm, pedestrian. Well, in any case, good for you hedge funds! You came out of a difficult month in good shape. 

Venn has a good recap of the factors that drove equity returns and, of course, Crowding was the biggest driver (click to enlarger).

As shown, the Equity factor was down 0.17% on the month. It was actually up 3.5% through Jan 25 on good vaccine news, but gave all of that back and more in the last week. And there was a LOT that went on within the Equity factor. First, Crowding had its worst month on record--of course! Hedge funds often herd into the same names on both the long and short sides...because differentiated strategies are,  well, rare...and there was broad degrossing in the last week of January. 

In a short squeeze, some things have to go up...and the Small Cap factor had one it best months ever (94th percentile) gaining 3.4%. Small Cap and lower quality/ higher risk stocks are often the most shorted, so makes total sense. Conversely, Low Risk stocks on the long side would have been sold in a short squeeze (because you know, (i) margin calls, and (ii) "hedge" funds...need to be hedged) and that factor had a big down month (11th percentile).

Separately, Macro factors related to inflation-expectations, also had a great month. The Inflation factor rose 2.1% (90th percentile) and the related Commodities factor gained 1.8% (84th percentile) on rising energy and agriculture prices. Interestingly, Macro hedge funds had a mundane Jan, the HFRI Macro Index was up 0.23%--either funds were split on inflation expectations or just hadn't put on a lot of risk for some reason. 

All in all, a good start to 2021 for most hedge funds.  

Momentum Wins Big in 2020

Venn has a nice recap of 2020 factor performances...and it's no contest. Momentum smoked all other factors and its own historical averages. Not a surprise when the market falls 34% in 30 days and then roars back 68% in the next 280. There were a couple of hiccups in June and November, but Momentum was up pretty much the whole year. (Click chart to enlarge) 

What didn't work? Value! And really badly...again! Just ask Cliff Asness. But the worst factor performance (relative to its own history) was Low Risk. Low beta stocks dropped 31%. As Venn notes, the factor "relies on trusting your risk model, and knowing which stocks are low or high beta. Severe and sudden regime changes can upend risk models and beta estimates, perhaps leading investors to unwind large positions in stocks that they previously viewed as low risk." 

The below chart from Acadian provides a nice illustration of "beta compression:"

Beta compression hit some big-name quant funds, hard, in 2020. No name bigger than Renaissance Technologies. Oh, its vaunted and closed Medallion fund did just fine, gaining 76% (its best year since 2008's 84%). No, it was Renaissance's other funds open to outside investors (with longer trading horizons) that tanked. REIF was down 22% and RIDA 34%! Both are structurally long the low beta factor...because over time there is a demonstrable premia there. But sometimes s**t happens!

November Factor Upheaval: Top Quant Funds Caught in Epic Rotation

Some of the industry's biggest quant names, including AQR, Renaissance and Two Sigma dropped sharply in November after the positive news from Pfizer's vaccine trial spurred a violent rotation out of high-flying tech stocks (Growth, Momentum factors) into cyclical, beaten-down Value stocks. The below chart from GS shows the reaction of various sectors (H/T HumbleStudentoftheMarkets):

Two Sigma's Venn platform provides further details on the the performance of different factors in November (click to enlarge):

Momentum had one of its worst month in history. Other factors with notable pullbacks were Low Risk and Quality. Low-leveraged and highly profitable companies underperformed more indebted and less profitable companies. Not surprsing as Low Risk and Momentum have been quite correlated in recent months (think FAAMG stocks).

Here's another look at Value and Momentum performances relative to history from JPM:

Additionally, much of the damage was done Nov 6-Nov 10. The Value-Momentum spread was relatively stable the rest of the month:

Hidden Figures: Unexpected Manager Exposures

Two Sigma's Venn platform has a very interesting analysis on the hidden exposures of fund managers. They analyzed the factor exposures of funds in four Morningstar catetgories: Large Growth, Large Value, Small Growth and Small Value. 

First up Large Growth Funds, which according to Morningstar: Invest primarily in large US companies that are expected to grow faster than other large-cap companies. Growth describes companies with high earnings and sales growth rates and high valuations. These funds are expected to exhibit negative exposure to Value factors (like low price-to-book) and zero to negative exposure to the Small Cap factor (market capitalization).

The analysis found that average exposure to Venn's Value factor was indeed negative among funds, though some funds in the category did exhibit some positive exposure to the factor. But surprisingly, the average Large fund displayed a fairly positive exposure to Venn's Small Cap factor! (Click on chart to enlarge)

Next to be analyzed were Large Value Funds.  The average positive exposure to Venn's Value facor was as expected. However, once again, the Size exposure was surprising. The majority of Large Growth funds exhibited positive Small Cap exposure.

Moving to Small Cap Growth Funds,  the analysis found that, on average, funds exhibited a negative exposure to Venn's Value factor--as expected (though a surprising number of funds did display positive exposures). There was little suprise in the Size exposure, with the vast majority of funds exhibiting positive exposure to the Small Cap factor.

The last category was Small Cap Value Funds. The results of here were in line with expectations for both Value and Size factors. The average exposures to both factors were positive and no funds exhibited negative exposures to either factor. Well done Small Cap Value managers, you do as you say!

Note: The time period of the analyes was Oct 29, 2016 - Oct 28, 2019

Size Doesn't Matter, Does It?

The 'size' factor has been a popular, longstanding risk premia, first identified by Rolf Banz in 1981. The factor is simple to follow: mid- and small-cap stocks (<$10B market cap) generally outperform large-cap stocks (>$10B market cap). The thesis seems to be borne out by empirical evidence: 

Or does it? There have been criticism of the size factor in the past, but research from AQR shows convincingly the real dynamic at play: Quality (consistency of earnings, low debt/equity ratio,higher margins, etc.). 

AQR provides a lot of evidence that after you adjust for their higher market beta, small-caps stocks do not outperform large-cap stocks. Shown below from monthly regression (1990-2020) on market factor plus lag (to take into account greater illiquidity of small cap stocks): 

The smallest stocks have an average beta of 1.35 and negative alpha! No statistically significant SMB premia. 

But if you take into account quality (in a separate study)...higher quality small cap stocks do outperforms large cap stocks. Adjust for quality, then you'll reap the size premium.