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Factor performance in 1Q sees value outperform: MSCI research
MSCI has recently examined how different equity factors have performed since Russia’s invasion of Ukraine and found that stocks related to oil rallied alongside others that were metal-related. In terms of the broader economic environment, the value factor is expected to outperform in this period of rising inflation.
Russia’s invasion of Ukraine in the first quarter of 2022 was met with a bid drop in global equity markets, a sharp rise in energy prices and a rapid rise in the Cboe Volatility Index (VIX). MSCI’s research reveals that the MSCI Enhanced Value, MSCI High Dividend Yield and MSCI Minimum Volatility Indexes led during the quarter in terms of active performance among the MSCI Factor Indexes, as the chart below shows. The equity sell-off in high-valuation stocks had a negative effect on quality, despite its defensive characteristics.
Different factors drive equity returns depending on financial or economic fundamentals. Value stocks have low prices relative to their financial fundamentals such as earnings. Quality involves investing in companies with healthy balance sheets including strong earnings and low debt, while size refers to small or large companies. Momentum refers to investing in companies with strong price trends. Growth stocks have high price-earnings ratios such as technology companies. Exposure to factors can be achieved through a variety of investment products, including actively managed funds and exchange traded funds (ETFs).
Value outperforms when inflation rises
Damien Hennessy, head of asset allocation at Zenith, says that in periods of rising bond yields and the US Federal Reserve tightening interest rates, value, cyclicals and small cap stocks “have performed relatively well while momentum has endured some positive yet more mixed results. Quality has also had mixed results. Growth has underperformed as have defensive exposures and minimum volatility.”
When considering periods where US inflation is above target and rising (for example 1977 – 1980, 1987 -1991, 1999-2000, 2004-06 and the recent episode), value has generally outperformed growth, Mr Hennessy said. “The performance of momentum and small caps has been strong at times while quality and high dividends have been more mixed. Cyclical sectors have underperformed defensive sectors in the last three ‘rising inflation’ episodes,” he said.
The value factor may also push Australian shares to outperform the US market this year given the local market is heavier value shares then the US, which is dominated by technology companies. Russel Chesler, Head of Investments and Capital Markets, VanEck, made the following prediction following Russia’s invasion of Ukraine in February.
“Australian value shares are outperforming and we are also seeing the overall Australian share market outperform the US share market by a wide margin … largely thanks to value shares listed on the ASX, that is, the big miners and big banks,” Mr Chesler said.
“Australian shares could continue outperforming US and global share markets by a reasonable margin in 2022, after several years of underperformance.
“This inflationary environment is conducive to further gains by such value shares on the ASX. With long-term interest rates jumping higher, Australian companies that can maintain or increase their prices, and therefore margins, without turning away customers, will be the winners as inflation shoots higher. It is time for value companies to shine and investors who embrace their resilience are likely to see their portfolios benefit as growth shares suffer relatively more as interest rates rise,” he said.
