Swinging Factors Shake Core Performance

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Core equity managers have struggled to deliver this year in a rapidly changing market environment. We think exposure to volatile equity factors—which is often unintended—may be the culprit.

Equity factors can be oh so fickle. Research shows that exposure to features of stocks known as factors—such as attractive valuations or strong momentum or profitability—can help portfolios outperform the market over time. But over short periods, factor performance can be very volatile.

This year’s patterns are a case in point. In the first half of 2016, global stocks considered to be safer, such as those 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 (Display, left chart). Stocks with high momentum also trailed the benchmark in the third quarter after a solid second quarter.

The rapidly changing environment may have created headwinds for core equity portfolios, which often have biases toward different factors. Less than half of the 234 strategies in the eVestment Global All Cap Core Equity universe outperformed the MSCI ACWI in each individual quarter (Display, right chart). Less than a third beat the market in both of the first two quarters. And only 6% outperformed the market in all three quarters this year.

There’s an important lesson here for investors. Core equity portfolios may be more vulnerable to volatile factor returns than expected. With more market uncertainty on the horizon from the Italian referendum, French election and Donald Trump’s new administration plotting its policy course, we expect factor return turbulence to continue in the coming quarters. In this environment, it’s especially important to make sure that a core equity portfolio derives its returns from fundamental stock selection and doesn’t have unintended factor biases—which can lead to unpleasant return patterns.

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.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

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