June 17, 2020 -
Are Factors Helping in This Recovery?
Paul Davidson, Director of Product Management, speaks with special guest Dr. Eric Shirbini of Scientific Beta, the investment specialist responsible for the composition of the Canadian Equity mandate in IPC Private Wealth Fundamentals, and for the Counsel Canadian, U.S. and International Multifactor mandates.
In this audiocast, Dr. Shirbini explains which Factors have performed well in 2020, and how Factor investing is expected to add value with a fast recovery time coming out of the recent downturn.
Here are a few highlights:
- Why specific Factors performed well over the past couple of months
- Making investments based on quantitative data versus subjective and qualitative input in our current environment
- Stock selection attributed to challenges in the concentrated Canadian equity mandate
- Dr. Shirbini’s outlook on the staying power of the recent recovery and positioning to deliver consistent returns going forward
To access the full transcript, click here.
Paul Davidson (00:00):
Dr Eric Shirbini Global Research and Investment Solutions Director with Scientific Beta. Scientific Beta is responsible for the composition of the Canadian Equity mandate in IPC Private Wealth fundamentals, and for the Council of Canadian, U.S and international multifactor mandates. Eric, it's great to speak with you today.
Dr. Eric Shirbini (00:19):
Thank you very much Paul.
Paul Davidson (00:21):
Markets have been unusual, to say the least, in 2020. Do you think that because of this, that the strategy behind stock selection based on certain factors has been impacted in the short-term?
Dr. Eric Shirbini (00:35):
Absolutely. During the first quarter of 2020, factors have been very important, and you only need to look at the performance of the factors to see huge differences between the various factors. So looking at the first quarter, what we've seen is that the size factor performed poorly, the value factor performed poorly and also investment factor. But on the other hand, though-volatility companies, high momentum companies, and companies with high profitability, performed extremely well.
Dr. Eric Shirbini (01:11):
So this tells us that factors, or if you like the stock selection that leads to the factors, were very important drivers of performance over the quarter. Because, the performances across the factors was very different. So factors were an important driver of performance.
Dr. Eric Shirbini (01:30):
But if you actually look at the performance of all the six factors on average, you'll see that they averaged out to virtually zero. So even though yes, there were strong differences between factors, and therefore strong differences between stocks, if you average it out across the six well-rewarded factors, you'll see that the return was fairly flat.
Dr. Eric Shirbini (01:53):
Now, it's also very important to understand that we... I said that value performed poorly. Well, this is exactly what you would expect in a crisis. Because during a crisis, a value company tends to be a company with a very high fixed asset base, if you like, fixed costs, and therefore they tend to perform poorly. And also smaller companies also tend to perform poorly because they tend to be less profitable and more exposed to economic risks.
Dr. Eric Shirbini (02:22):
So, what we've actually seen over this quarter is exactly what we expect value and size to perform poorly, but profitability and something like a low volatility to perform well. But having said that, that if you look at those six factors, and the fact that the performance has been fairly flat across the six factors, it's also important to understand that when you invest in factors, it also exposes you to other risks as well. And it's the other risks that have actually been more important in terms of the final performance of multi-factor strategy.
Dr. Eric Shirbini (03:01):
Two other risks that were very important during this quarter are: Number one, the market beta. And number two, the concentration effect. So let's talk a little bit about the market beta first. Now, when you invest, in fact, you tend to have a different strategy. You tend to choose companies with a lower exposure to the market. Well, during this particular crisis, that low exposure to the market wasn't maintained. So stocks that have had a lower beta, that typically have a low exposure to the market, their risk increased. So it actually increased the exposure of a multifactor strategy to the market, normally, it would be defensive, well, in fact it wasn't very defensive at all this quarter.
Dr. Eric Shirbini (03:45):
Now, that's quite a rare and quite an unusual event. The only time that that happened was back in 1987. In other crisis, the strategy tends to benefit from the defensive property. So the market beta was an important driver of the performance of the strategy. That's the first driver.
Dr. Eric Shirbini (04:06):
The second driver is concentration. Now, we strongly believe that when you invest in a factor strategy, when you select companies, you need to use a very well-diversified approach. You don't want all the performance coming from a very small number of stocks. So scientific beta uses a well-diversified approach.
Dr. Eric Shirbini (04:26):
But if you actually look and see what happened during the first quarter of 2020, you had a massive flight to quality. So what happened is, the very small number of stores and it was the largest blue chip companies, did really well. Which by definition means that all the other stocks did poorly. A more diversified approach, that selects a broader range of companies will therefore tend to do more poorly. Because it's only a very small set of stocks that did well during this particular crisis.
Dr. Eric Shirbini (05:00):
So let me just sum up what happened over this quarter. There were very large differences in performance between the factors, the kind of differences you would expect to see. On average, the performance across all the factors was flat. But what really drove the performance of multifactor strategies was the fact that they weren't very defensive, their market beta increased during the quarter, number one. And number two, a diversified strategy has underperformed as well, because there was a flight to quality, and only a small handful of stocks did well. So that really sums up what happened during the quarter, Paul.
Paul Davidson (05:46):
When you look at some of the factors that did do well, for example, high profitability, that seems somewhat intuitive, but is there some background you can provide around why that particular performed well over the past couple of months?
Dr. Eric Shirbini (06:02):
That fact tends to perform well particularly when value is not performing well. Companies with a high profitability, a high margin, tend to do well when value doesn't do well, because of the high margin. So investors prefer stocks that have got high profitability during a crisis. And they shunned stocks, like value companies, like smaller companies that are less profitable.
Dr. Eric Shirbini (06:37):
So yes, you would expect companies with high profitability to perform well. Because during a crisis, investors will flock to those particular companies because they see that almost like as a safe haven.
Paul Davidson (06:54):
In an environment like we've seen over the past couple of months, and even moving forward from here, are there advantages to making investments based on quantitative data, as opposed to allowing for more subjective and qualitative input?
Dr. Eric Shirbini (07:13):
Subjective qualitative input is all very well. If you can look through the rear view mirror, but we don't have that benefit. So in terms of going forward, this is a piece of research that we are doing right now. And what this research shows is that when it comes to the recovery, after a crisis, factor strategies do particularly well. They get hit during a crisis, but in terms of recovery, if you look at the average recovery time, it tends to be half the average recovery time than you get from a straight [inaudible 00:00:07:51]. Or if, you like from the average market index. So recovery tends to be very strong for multi-factor type of products.
Paul Davidson (08:04):
Okay. And just switching over to take a closer look at the concentrated Canadian equity mandate, it has experienced some challenges in comparison to the broader market, the S&P/TSX, so far in 2020. Is that based on performance or certain sectors, or are there some unusual anomalies you may have noticed when looking at the broader Canadian index? I wonder if you could provide some insight on that?
Dr. Eric Shirbini (08:29):
Yes. We've had a look at that index, and we've looked at it from a sector perspective. So we've done a sector attribution analysis. And in sector attribution analysis, you can try to work out how much of the performance is coming from your over-weights and under-weight to certain sectors, and then the rest of the performance can be attributed to the companies you've selected, the you've under-weighted.
Dr. Eric Shirbini (08:57):
Now, in terms of the sectors, the profitability factor did over-weight and under-weight sectors, but that did not contribute to the overall performance of the index. It contributed negatively, but only slightly by around about half a percent. So really, the performance was very much driven by the individual companies and the individual stocks. So it's very much a stock-specific story.
Dr. Eric Shirbini (09:27):
Now, it's very difficult to work out exactly what happened with the factor over such a short period of time, given the number of companies in the Canadian market. So it's very difficult to work out what the factor performances were in Canada. But what this particular index was dominated by was a stock-specific effect, much more so than factors. The stock-specific effect accounted for something like 80% of the performance of the strategy. So it was entirely driven individual stock stories, as opposed to by factors.
Paul Davidson (10:10):
And I wonder, just looking forward, we're currently seeing a fairly significant rebound in the markets, at least for North America and even globally as well. Can you provide us with some thoughts on the staying power of the recent recovery that we're seeing? Do you feel that multi-factor strategies are positioned well to deliver consistent returns, going forward from here?
Dr. Eric Shirbini (10:34):
Yes. Well, certainly if you look at past crisis, as we've done, we see that the recovery time tends to be about half the recovery time of the overall market. So for factor-strategies, you do tend to get a very strong recovery. In terms of the individual factors, we've seen quite a strong recovery, from the size-factor, that has performed particularly well. But in general, yes, we do see a strong performance from factor strategies following your recovery.
Paul Davidson (11:07):
There's been some recent press and some conversations recently about equity style, and particularly, thinking about growth and value. I wonder if you had some thoughts on these two equity styles, and how they've performed recently?
Dr. Eric Shirbini (11:22):
Yes, absolutely. As we saw during this crisis, during the first quarter, value stocks, which are companies with a high book to market, are companies with very large fixed assets in place, and therefore are more exposed to economic shocks. Because those companies can't react as quickly. I'm thinking of things like in [interred 00:11:51] companies with industrial plants, with moneys and so on. So value stocks do tend to suffer during a crisis. But it's, precisely because of that, why you expect a premium in the longterm from investing in value stocks, is because value companies are less flexible, they are more risky, more exposed to economic shocks that you would expect to receive a premium for those kinds of stocks.
Dr. Eric Shirbini (12:20):
Now, on the other hand, a growth company, a company that grows and can cut back on growth during a crisis, it tends to do very well over a very short period of time during a crisis. But in a long-term that strategy doesn't pay. Because, essentially what you're doing is if you're buying growth companies during a crisis, you're kind of protecting yourself and protection is something that costs.
Dr. Eric Shirbini (12:47):
So over the long-term, a growth strategy tends to underperform. Because what you're doing, essentially, is buying safety during a crisis, and that's going to cost you over the long term. It's only buying the risky stocks, the ones that are exposed to the crisis, where you expect to be well rewarded. Which is the value companies. So over the long-term, we expect a positive return, positive premium, from value. Even though during a crisis, they will suffer more.
Dr. Eric Shirbini (13:19):
And for growth companies, you expect a negative return to growth companies, or if you like an under-performance to growth companies. Because what you're doing is buying safety, you're buying something that is less risky, and therefore you should expect lower returns from investing in growth companies. So it's an important point and to think about value and growth in this way, in terms of what happens during a crisis, and what happens over the long term.
Paul Davidson (13:48):
This is great information, Eric. Thank you so much for being with us today.
Dr. Eric Shirbini (13:52):
Thank you Paul.
Dr Eric Shirbini Global Research and Investment Solutions Director with Scientific Beta. Scientific Beta is responsible for the composition of the Canadian Equity mandate in IPC Private Wealth fundamentals, and for the Council of Canadian, U.S and international multifactor mandates. Eric, it's great to speak with you today.
Dr. Eric Shirbini (00:19):
Thank you very much Paul.
Paul Davidson (00:21):
Markets have been unusual, to say the least, in 2020. Do you think that because of this, that the strategy behind stock selection based on certain factors has been impacted in the short-term?
Dr. Eric Shirbini (00:35):
Absolutely. During the first quarter of 2020, factors have been very important, and you only need to look at the performance of the factors to see huge differences between the various factors. So looking at the first quarter, what we've seen is that the size factor performed poorly, the value factor performed poorly and also investment factor. But on the other hand, though-volatility companies, high momentum companies, and companies with high profitability, performed extremely well.
Dr. Eric Shirbini (01:11):
So this tells us that factors, or if you like the stock selection that leads to the factors, were very important drivers of performance over the quarter. Because, the performances across the factors was very different. So factors were an important driver of performance.
Dr. Eric Shirbini (01:30):
But if you actually look at the performance of all the six factors on average, you'll see that they averaged out to virtually zero. So even though yes, there were strong differences between factors, and therefore strong differences between stocks, if you average it out across the six well-rewarded factors, you'll see that the return was fairly flat.
Dr. Eric Shirbini (01:53):
Now, it's also very important to understand that we... I said that value performed poorly. Well, this is exactly what you would expect in a crisis. Because during a crisis, a value company tends to be a company with a very high fixed asset base, if you like, fixed costs, and therefore they tend to perform poorly. And also smaller companies also tend to perform poorly because they tend to be less profitable and more exposed to economic risks.
Dr. Eric Shirbini (02:22):
So, what we've actually seen over this quarter is exactly what we expect value and size to perform poorly, but profitability and something like a low volatility to perform well. But having said that, that if you look at those six factors, and the fact that the performance has been fairly flat across the six factors, it's also important to understand that when you invest in factors, it also exposes you to other risks as well. And it's the other risks that have actually been more important in terms of the final performance of multi-factor strategy.
Dr. Eric Shirbini (03:01):
Two other risks that were very important during this quarter are: Number one, the market beta. And number two, the concentration effect. So let's talk a little bit about the market beta first. Now, when you invest, in fact, you tend to have a different strategy. You tend to choose companies with a lower exposure to the market. Well, during this particular crisis, that low exposure to the market wasn't maintained. So stocks that have had a lower beta, that typically have a low exposure to the market, their risk increased. So it actually increased the exposure of a multifactor strategy to the market, normally, it would be defensive, well, in fact it wasn't very defensive at all this quarter.
Dr. Eric Shirbini (03:45):
Now, that's quite a rare and quite an unusual event. The only time that that happened was back in 1987. In other crisis, the strategy tends to benefit from the defensive property. So the market beta was an important driver of the performance of the strategy. That's the first driver.
Dr. Eric Shirbini (04:06):
The second driver is concentration. Now, we strongly believe that when you invest in a factor strategy, when you select companies, you need to use a very well-diversified approach. You don't want all the performance coming from a very small number of stocks. So scientific beta uses a well-diversified approach.
Dr. Eric Shirbini (04:26):
But if you actually look and see what happened during the first quarter of 2020, you had a massive flight to quality. So what happened is, the very small number of stores and it was the largest blue chip companies, did really well. Which by definition means that all the other stocks did poorly. A more diversified approach, that selects a broader range of companies will therefore tend to do more poorly. Because it's only a very small set of stocks that did well during this particular crisis.
Dr. Eric Shirbini (05:00):
So let me just sum up what happened over this quarter. There were very large differences in performance between the factors, the kind of differences you would expect to see. On average, the performance across all the factors was flat. But what really drove the performance of multifactor strategies was the fact that they weren't very defensive, their market beta increased during the quarter, number one. And number two, a diversified strategy has underperformed as well, because there was a flight to quality, and only a small handful of stocks did well. So that really sums up what happened during the quarter, Paul.
Paul Davidson (05:46):
When you look at some of the factors that did do well, for example, high profitability, that seems somewhat intuitive, but is there some background you can provide around why that particular performed well over the past couple of months?
Dr. Eric Shirbini (06:02):
That fact tends to perform well particularly when value is not performing well. Companies with a high profitability, a high margin, tend to do well when value doesn't do well, because of the high margin. So investors prefer stocks that have got high profitability during a crisis. And they shunned stocks, like value companies, like smaller companies that are less profitable.
Dr. Eric Shirbini (06:37):
So yes, you would expect companies with high profitability to perform well. Because during a crisis, investors will flock to those particular companies because they see that almost like as a safe haven.
Paul Davidson (06:54):
In an environment like we've seen over the past couple of months, and even moving forward from here, are there advantages to making investments based on quantitative data, as opposed to allowing for more subjective and qualitative input?
Dr. Eric Shirbini (07:13):
Subjective qualitative input is all very well. If you can look through the rear view mirror, but we don't have that benefit. So in terms of going forward, this is a piece of research that we are doing right now. And what this research shows is that when it comes to the recovery, after a crisis, factor strategies do particularly well. They get hit during a crisis, but in terms of recovery, if you look at the average recovery time, it tends to be half the average recovery time than you get from a straight [inaudible 00:00:07:51]. Or if, you like from the average market index. So recovery tends to be very strong for multi-factor type of products.
Paul Davidson (08:04):
Okay. And just switching over to take a closer look at the concentrated Canadian equity mandate, it has experienced some challenges in comparison to the broader market, the S&P/TSX, so far in 2020. Is that based on performance or certain sectors, or are there some unusual anomalies you may have noticed when looking at the broader Canadian index? I wonder if you could provide some insight on that?
Dr. Eric Shirbini (08:29):
Yes. We've had a look at that index, and we've looked at it from a sector perspective. So we've done a sector attribution analysis. And in sector attribution analysis, you can try to work out how much of the performance is coming from your over-weights and under-weight to certain sectors, and then the rest of the performance can be attributed to the companies you've selected, the you've under-weighted.
Dr. Eric Shirbini (08:57):
Now, in terms of the sectors, the profitability factor did over-weight and under-weight sectors, but that did not contribute to the overall performance of the index. It contributed negatively, but only slightly by around about half a percent. So really, the performance was very much driven by the individual companies and the individual stocks. So it's very much a stock-specific story.
Dr. Eric Shirbini (09:27):
Now, it's very difficult to work out exactly what happened with the factor over such a short period of time, given the number of companies in the Canadian market. So it's very difficult to work out what the factor performances were in Canada. But what this particular index was dominated by was a stock-specific effect, much more so than factors. The stock-specific effect accounted for something like 80% of the performance of the strategy. So it was entirely driven individual stock stories, as opposed to by factors.
Paul Davidson (10:10):
And I wonder, just looking forward, we're currently seeing a fairly significant rebound in the markets, at least for North America and even globally as well. Can you provide us with some thoughts on the staying power of the recent recovery that we're seeing? Do you feel that multi-factor strategies are positioned well to deliver consistent returns, going forward from here?
Dr. Eric Shirbini (10:34):
Yes. Well, certainly if you look at past crisis, as we've done, we see that the recovery time tends to be about half the recovery time of the overall market. So for factor-strategies, you do tend to get a very strong recovery. In terms of the individual factors, we've seen quite a strong recovery, from the size-factor, that has performed particularly well. But in general, yes, we do see a strong performance from factor strategies following your recovery.
Paul Davidson (11:07):
There's been some recent press and some conversations recently about equity style, and particularly, thinking about growth and value. I wonder if you had some thoughts on these two equity styles, and how they've performed recently?
Dr. Eric Shirbini (11:22):
Yes, absolutely. As we saw during this crisis, during the first quarter, value stocks, which are companies with a high book to market, are companies with very large fixed assets in place, and therefore are more exposed to economic shocks. Because those companies can't react as quickly. I'm thinking of things like in [interred 00:11:51] companies with industrial plants, with moneys and so on. So value stocks do tend to suffer during a crisis. But it's, precisely because of that, why you expect a premium in the longterm from investing in value stocks, is because value companies are less flexible, they are more risky, more exposed to economic shocks that you would expect to receive a premium for those kinds of stocks.
Dr. Eric Shirbini (12:20):
Now, on the other hand, a growth company, a company that grows and can cut back on growth during a crisis, it tends to do very well over a very short period of time during a crisis. But in a long-term that strategy doesn't pay. Because, essentially what you're doing is if you're buying growth companies during a crisis, you're kind of protecting yourself and protection is something that costs.
Dr. Eric Shirbini (12:47):
So over the long-term, a growth strategy tends to underperform. Because what you're doing, essentially, is buying safety during a crisis, and that's going to cost you over the long term. It's only buying the risky stocks, the ones that are exposed to the crisis, where you expect to be well rewarded. Which is the value companies. So over the long-term, we expect a positive return, positive premium, from value. Even though during a crisis, they will suffer more.
Dr. Eric Shirbini (13:19):
And for growth companies, you expect a negative return to growth companies, or if you like an under-performance to growth companies. Because what you're doing is buying safety, you're buying something that is less risky, and therefore you should expect lower returns from investing in growth companies. So it's an important point and to think about value and growth in this way, in terms of what happens during a crisis, and what happens over the long term.
Paul Davidson (13:48):
This is great information, Eric. Thank you so much for being with us today.
Dr. Eric Shirbini (13:52):
Thank you Paul.