Markets & Equities

How well have the different factor investors done so far in 2018?

At the time of writing, the Springboks were getting ready for their first test match against one of the northern hemisphere’s teams: England. As they were announcing the South African team, I couldn’t help but think that this actually presented the perfect opportunity to explain how factor investments work. Although Faf de Klerk may be one of the best rugby players in the world, he probably wouldn’t have made it into the Springbok team if he decided to change his position from scrumhalf to prop.

I believe without a doubt that he is extremely talented, but let’s face it, weighing in at 80kg, he would have had more than just a little bit of trouble facing off against someone like Tendai “Beast” Mtawarira, which weighs in at around 120kg. But make no mistake – Beast will also have his fair share of trouble in the position of scrumhalf, because as fit as he may be, being everywhere on the field all the time will be a drag with an extra 40kg in weight.

In the same way that we find different positions on the rugby field, fund managers also have different investment styles. I have made several references to different investment themes in the past that investors can use, such as the Rand and IT cycles and so too investment styles can be used as an investment theme to invest in. Before I continue, however, I just want to explain very briefly the concept of styles in share portfolios. When we analyse different shares, they can be divided into different categories, like momentum shares, value shares and quality shares.

Momentum investors focus mainly on shares that rise sharply, while avoiding or selling shares that decline in value.

Value investing is more focused on shares that have a higher earnings yield, a lower price-to-book ratio and a lower enterprise value (EV) to earnings before interest, taxes, depreciation, amortisation (EBITDA) and enterprise value-to-EBITDA ratio (EV/EBITDA).

Quality shares are valued based on strong returns on equity (ROE) and the lowest possible EV-to-free-cashflow ratio, with low volatility shares that focus mainly on shares with the lowest possible volatility ratios.

We decided to test these different strategies based on data for the last 16 years and the results were quite surprising:

Graph 1: Returns on different investment styles (source: PSG Old Oak & Iress)

If you had singled out the 16 shares with the strongest style characteristics on a quarterly basis over the last 16 years, it becomes clear that if you had followed a momentum- or quality-driven style approach, that you wouldn’t just have followed the most successful strategy, but that you also would have outperformed the FTSE/JSE All Share Index (JSE) quite comfortably.

There are, however, three problems with this. Firstly, the data is based on historical figures, which as we know, offers absolutely no guarantees for future performance. Secondly, these two strategies correlate narrowly with each other and would have caused much more volatility (risk) in your personal portfolio. Finally, individuals who followed these two investment styles this year, would have had a tougher time than Faf de Klerk would have facing off against Beast in a scrum.

A Momentum- and value-driven strategy, however, would have given you a much better inverse correlation, which would have given you the opportunity to both scrum well and move about more freely like a scrumhalf.

Graph 2: Relative returns on styles vs. the FTSE/JSE All Capped Index (source: PSG Old Oak & Iress)

When we place the various investment styles relative to the JSE, not only do we notice this inverse correlation effect graphically, but it also shows us how tough value fund managers had it up to the end of 2015. Over the last three years, however, with the JSE not performing too well, value has started to emerge once again.

My message this week is simply that as with my Faf and Beast analogy, you shouldn’t only choose funds based on their performance over the last year or two. Just because they performed well under one set of circumstances, does not mean that they will perform as well when those circumstances change. Rather combine your styles in such a way that you end up with an above-average performance.


The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice.  This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.

 

Schalk Louw
As Portfolio Manager at PSG Wealth Old Oak and with over 20 years’ experience in the investment industry, Schalk has consistently delivered solid returns to his clients and has certainly become one of South Africa’s most well-known strategists. He started his career in 1994 at the stockbroking company, Huysamer Stals (later ABN Amro). He joined SMK Securities in 1997, (later became BoE Personal Stockbrokers) and was later appointed as director and branch manager. In 2001 he co-founded Contego Asset Management and managed the company as CEO up to March 2014, after which he joined PSG Wealth Old Oak. Schalk has also become a regular household name with investors, with his reports being published in many of the national press. He completed his MBA in 2008.

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