Systematic investing, the value factor and Hong Kong swap rates

The week on Risk.net, October 12–18, 2019

7 days montage 211019

Research Affiliates expects 16% return from value repricing

New study shows “the engine for value performance is not broken”

Value: ‘Trade of the decade,’ says QMA

Quant firm predicts big revival for out-of-favour strategy

Hong Kong eyes SOFR solution for term fixing

New ‘proxy’ Honia could help change discount rate from Hibor to OIS for local swaps, says HKEX

 

COMMENTARY: Hidden value

Doomsayers predicting the death of the value factor as a driver for returns may have spoken too soon, if evidence from two big investors is to be believed.

Value stocks have lost 21% in 18 months and long/short value strategies have seen a 12-year drawdown, hurting factor investing funds and leaving quant investment gurus red-faced and grasping for reasons why. But Rob Arnott, founder of factor specialist Research Affiliates, which runs $180 billion in assets, is not deterred by the slump.

Arnott is doubling down on the underperformance, and insists value stocks are now so cheap that investors should expect at least 16% returns over the next three years on top of the alpha they would normally achieve. The firm reckons the value factor is as tempting now as at any point since the dotcom bubble.

Cynics may dismiss this as a face-saving attempt to justify a losing strategy, but Arnott is not alone. QMA, the quant investing arm of US insurance giant Prudential, is also backing value to rise, Lazarus-like, from its death bed.

QMA portfolio manager Gavin Smith says value stocks have accrued substantial latent upside during their prolonged spell in the doldrums. The gap between cheap and expensive names has widened over the past five years to hit historical extremes. The market dislocation gives Smith confidence that “the returns to value in the future are very significant, very much above average”.

Such optimistic talk will leave investors asking when the reversal of fortunes may start. On this, experts are predictably reticent to name a date. QMA has identified the macroeconomic forces it believes are depressing value stocks, and there is no guarantee they will end soon. The value factor may underwhelm for a while yet.

Another driver of value’s subpar returns is thought to be the near monopolies enjoyed by today’s high-flying tech firms, which have dominated stock markets and crowded out rivals. Despite a recent fall in the share price for some of the so-called FAANGS, who would bet on the kind of structural change required to topple them from their lofty perch?

That leaves even value’s fans having to proceed carefully. Nearly a year ago, a senior quant at SocGen was warning: “Global value stocks are looking pretty cheap. Can they get cheaper? Of course.” Investors would be well advised to remember these words today.

STAT OF THE WEEK

Technologists are looking to apply quantum computing to securities settlement. Given the large volumes of trades at clearing houses, quantum computers could transform how settlement runs are optimised. As IBM notes, a quantum computer with 100 qubits can simultaneously represent a quadrillion values squared.

QUOTE OF THE WEEK

“He looked at me and said: ‘I’ve got no idea what’s going on in this business. All I get is phone calls from people asking for more capital, and I don’t know why’” – MarketAxess chief risk officer Oliver Huggins explains how a director at previous employer Prudential plc demonstrated a surprising lack of understanding of how the company was run.

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