If you missed it, 2019 was a good year for a stock investor. When looking at market capitalization-weighted indices, the US stock market rose by ~ 30%, the Developed International Markets by ~ 22% and the emerging markets by ~ 18%.
But how did the factors develop in 2019?
In the following I update my contribution from last year and examine the performance of portfolios with simple factors. This year I’m making some small improvements to highlight performance while varying performance concentration to every factor.
Let us examine the results.
Factor investing data and results
Similar to last year, I examine the holdings of the IWB ETF (~ 1,000 largest US stocks). 1
The stocks are updated on the end-of-quarter dates (e.g. 31.12.18, 31.03.19, 30.06.19 and 30.09.19), whereby the factors are calculated on the same dates. Once the stocks and factors have been calculated, the stocks are divided into decile portfolios (as well as quintiles, terciles and halves) and held for 3 months. 2 All portfolios, including the universe and the factor deciles, are weighted equally. No transaction costs or other fees are charged for any of the portfolios.
I examine a number of common factors within the portfolios:
- Value investment factors (5):
- Enterprise Multiple (EBIT / TEV)
- Book-to-Market (B / M)
- Yield (inverse of P / E)
- Cash flow at the price (CF / P)
- Sales at price (S / P)
- Other investment factors (5):
- Momentum (12_2) 3
- ROA (quality) – return on assets
- FS Score – Our 10-point score for financial strength (very similar to the Piotroski F-Score!). 4
For all variables except size and beta, a higher value is considered “better” and the companies would therefore be in higher deciles.
The value factor results
First, let’s examine the results of the five “value” factors described above. Below you will find the annualized returns of the Long / short portfolios for the five respective value factors. The x-axis represents the 2019 compound annual growth rate (CAGR), with the y-axis representing (1) the various measures of value and (2) levels of concentration.
What you immediately notice is that none of the value factors generated a positive return in 2019. Regardless of which measure was used or in what concentration.
In other words, 2019 was another difficult year for value investors.
New in the analysis in 2019 are the different concentrations of the individual value factors. For example, the decile performance will be long / short at every bar than the upper / lower decile. If we assume that we have 1,000 companies, it means that we are long 100 companies and short 100 companies. Compare this to the “halves” portfolio, where the portfolio is long in the top half and short in the bottom half. In our example with 1,000 companies, the portfolio consists of long 500 shares and short 500 shares.
Looking at the results above, it is not surprising to find that performance is even worse if you place a more focused bet on a factor that is not working well.
If you simply look at the EBIT / TEV factor, the CAGRs with different levels of concentration are listed below:
- Half (least concentrated) = -3.40%
- Tercile (1 / 3s) = -6.62%
- Quintile (1 / 5s) = -8.41%
- Decile (most concentrated) = -13.74%
As mentioned earlier, a more “watered down” approach would have been better in 2019. These results underline one of the disadvantages of greater concentration; However, it should be noted that the concentration can be “good” if the factor “works”. These results are similar to the analysis I did in the middle of last year to examine value investing and concentration.
However, most factor investors use long-only funds for their investment portfolios as opposed to long / short funds. 5 In the following I show the results for each value measure in relation to the “upper” portfolio and the “lower” portfolio, while the degree of concentration is varied. 6
Here, the y-axis represents the average annual growth rate (CAGR) for each portfolio, while the x-axis (1) varies the measures of value and (2) the level of concentration.
Perhaps surprisingly, after looking at the long / short portfolio results above, all portfolios had a positive return in 2019!
What you can see is that the concentrated “top” portfolios underperformed the equally weighted universe return and were compared to their corresponding “bottom” portfolios. Unsurprisingly, as we move from left to right, returns increase as our portfolio becomes more similar to the market (that is, choosing top 500 value stocks versus top 100 value stocks) approach the market.
The above results therefore illustrate the effects of concentration within “value” portfolios.
Overall, Value had a bad year in the US, no matter how you pick cheap stocks. For long-only investors, however, it was at least a “positive” year of return. We congratulate everyone who recommends buying the decile from companies with the highest sales / price ratio (i.e. the most expensive for this measure) on the excellent performance of 2019!
But what about the other non-worth factors above? How did you play
Below I do a similar analysis of the other 5 factors: momentum, size, beta, ROA and FS score. Similar to the value portfolio analysis above, I vary the concentration levels for each factor.
What you notice is that except for the return on capital, all factors had a negative return. Along with the results for Value above, 2019 was a bad year for factor investors. 7
In general, the concentration results are similar to that given above for value – if the factor doesn’t work, more concentration increases the pain.
However, since most investors are invested in long-only funds, we should examine the returns on the “good” and “bad” portfolios, ie the “long” and “short” portfolios. In the following I show the results for each factor measure in relation to the “upper” portfolio and the “lower” portfolio, while the degree of concentration is varied. 8th
The long-only portfolios once again generated positive returns in 2019. However, most “good” portfolios returned below the equilibrium return of the universe of 29.80%. Similar to Value, the less concentrated the portfolios are (i.e. the closer the portfolio is to the market), the greater the convergence of annualized returns with the universe CAGR.
In 2019, all value measures and the saving of ROA failed, the other factors also failed. However, at least 2019 was a positive year for long-only factor investors from a yield perspective.
Examining how concentration affects factor return shows that it would have been painful to place a more focused bet on that factor if one factor didn’t work. While we have examined in the past the effects that concentration within both value and momentum can have (on paper portfolios), the results above demonstrate that concentrated value and momentum stakes may be preferred, but compared to Short can be painful – run.
It should be borne in mind that only stocks that were within the IWB ETF at a certain point in time (~ 1,000 largest companies) are examined here. In addition, managers and funds generally (1) hold more or fewer stocks, (2) use different weighting schemes, (3) use different rebalancing dates, (4) combine or use multiple signals, and (5) may invest in stocks outside of the company universe. Therefore, this may not fully explain all of the returns on factor portfolios, but it is a start.
I wish you a happy 2020! 9
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