The Main Reason Quants Have Performed Badly? Value

2020 was yet another bad year for value stocks, causing factor-based strategies to underperform.

Illustration by II

Illustration by II

Systematic investment strategies are failing to outperform — and one particular investment style is to blame, according to quantitative researchers at BNP Paribas Asset Management.

Value investing — allocating to stocks that are seen as cheap relative to the company’s underlying financial position — has yielded poor returns for over a decade, while the valuations of high-flying technology companies and other growth stocks have soared. This has proven to be a problem for many systematic investors, who build portfolios that target risk factors and investment styles — including value.

“Over the last 50 years of factor investing, we have witnessed a number of love and fear cycles for the use of factors to select stocks for portfolios,” BNP Paribas researchers wrote in a recent paper. “At present, 2019-2020 seems likely to go down in history as a period of fear, much like 2009-2011 and 1998-2000. These were periods when the most traditional factor combinations used by portfolio managers did not deliver.”

For example, the authors reported that a simple multi-factor portfolio investing in U.S. stocks delivered negative excess returns of 1.3 percent per month over the one-year period ending on August 31, 2020. Global multi-factor portfolios performed only slightly better, with monthly premiums of negative 1.1 percent.

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In past periods of underperformance, like during the tech bubble and the great financial crisis, poor returns could be attributed to the “choppy performances” of multiple factors, according to the BNP Paribas quants. This time, however, “the main culprit was without doubt the value factor,” they wrote.

“2020 was different as the poor performance was driven mainly by value, which strongly underperformed even by historical standards,” the authors said. “In fact, the performance of value factors was still within bounds by March 2020, but was sent into disarray by the Covid-19 crisis and the unusual stock performances that followed from the impact of lockdowns imposed around the world.”

Based on their analysis, U.S. value delivered negative excess returns of 6.7 percent monthly for the one year through August. Other factors did much better: Momentum, for example, generated a monthly premium of 2.1 percent in the U.S., according to the report.

These divergent performances persisted through the end of 2020. Two Sigma’s Venn, which provides risk analytics for investors, said in a January 13 report that the value factor was down 31.11 percent last year while momentum jumped 20.98 percent.

“Value was 2020’s worst-performing factor, marking its fourth consecutive down year,” Two Sigma vice president Alex Botte wrote in the report. “The poor performance was due in part to the factor’s short positioning in ‘work-from-home’ tech names that outperformed in 2020.”

This underperformance dragged down multi-factor portfolios, with higher exposure to value tied to worse results, according to the BNP Paribas paper. This underperformance was exacerbated by the size factor, which favors small companies over large-cap stocks. Like value, this factor has underperformed as large-cap tech stocks have dominated.

“Managers voluntarily allocating to the size factor, creating a preference to smaller-capitalization stocks in their portfolios, would have likely increased the extent of their recent underperformance,” the researchers wrote.

Despite the past underperformance of both value and size, the BNP Paribas quants were optimistic about the future for the systematic strategies that target these exposures.

“The valuation gap between the cheap and expensive stocks in sectors is at historically high levels, and the level of concentration in the market capitalization benchmark indices has also reached historical highs,” they concluded. “We would find it surprising should the trends seen in both value and size continue much further.”