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Quantity again earns profits from factor trades, just as before

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In Science and Space: For a once-revolutionary breed of quant investor who took a heavy hit in the cheap-money era, the worst year for stocks since the financial crisis is bringing back the good times.

Pandemic-era excesses are reversing as rising interest rates combined with unprecedented inflation bring a sudden end to Big Tech’s reign. According to S&P Global statistics, mega-capitalized corporations are no longer devouring gains in stock benchmarks, and the performance gap in the S&P 500 between winners and losers has increased to its widest level in more than a decade.

This year, automated funds that analyse stocks based on characteristics like how cheap they appear to be or how quickly they have risen have consistently outperformed discretionary hedge funds and speculative day traders. This strategy is known as factor investing.

All of that only serves to energise rule-based managers who enjoy hedging their bets. Value shares, those with cheap prices relative to some fundamental indication like earnings, are extending their post-lockdown recovery. These strategies buy up low-volatility or high-momentum companies.

It’s still early. However, there are encouraging signs in the investment patterns for 2022 for those who are hoping that the conclusion of the low-rate era will herald the beginning of a protracted period of outperformance for the multi-trillion dollar factor sector.

The rate-driven selloff that has hit the most expensive equities is hitting megacaps like Meta Platforms Inc. and Alphabet Inc. the hardest, and the traditional cap-weighted S&P 500 is on track to have its worst year since 2013 compared to its equal-weighted cousin. Despite the fact that factor investors come in all shapes and sizes, the more diversified performance of the market is positive for quants as a whole because their entire investing ethos revolves around spreading their money across a wide range of shares as opposed to investing in a single stock or sector.

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According to Bruno Taillardat, head of smart beta and factor investing at Amundi SA, who helps manage 29 billion euros ($29 billion), “we have an equities market that is better diversified, which is less concentrated on a few companies.” “For us, conflict is a chance.” A Dow Jones market-neutral index reveals that these managers are often more exposed to the value approach than other categories of investors, which is currently up 48% from its low point in 2020. Shares with smaller multiples appear to have less room to fall when rates rise. Energy companies, which are frequently favoured by long-only value funds, have also benefited the most from inflationary markets.

The momentum trade, which entails buying recent winners and selling losers, has benefited from value’s outperformance by piggybacking on it after rotating into profitable cheap equities like Exxon Mobil Corp. Price changes for both factors are currently trading close to the tightest positive relationship in data dating back to 2002 after swinging in opposing directions for the majority of the last two decades. The least volatile stock-buying approach is also making a comeback as a shelter from the equity storm, and a market-neutral index for the trade is poised to have its best year since 2018. This is the strongest association between value and low volatility since 2006.

There is still more work to be done, she noted.

Stacie Mintz, head of quantitative equity at PGIM Quantitative Solutions, which oversees $91.5 billion, claims that following the factor’s spectacular recovery, the firm’s stock funds now have a reduced value bias. Despite this, she is still confident in an extended rebound because inexpensive shares are still trading at or close to the biggest discount to growth peers. The high degree of co-movement raises the possibility that these elements could collapse simultaneously in the event of another market regime upheaval. Sanford C. Bernstein strategist Mark Diver cautions that cheap equities often do poorly in a recession, which is increasingly likely. The business now advises investing in stocks with high dividend yields and free cash flow yields as a more protective version of the value play.

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