Rising interest rates mean momentum may no longer be the best exposure going forward
Momentum has dominated the winners’ circle but the changing market conditions mean other factors are coming to the fore.
The long-term strategy of factor-based investing means all, if implemented correctly, will perform well down the road but as investors reassess portfolios and bring their exposures together, value and small cap could be set for a relative rebirth.
Mark Stacey, head of portfolio management and co-chief investment officer at AGFiQ, said that a low-growth environment has meant momentum stocks have performed strongly because investors, through a discounted cash flow evaluation, will happily pay a premium.
However, Stacey argues that with higher interest rates, these already expensive stocks look less appealing, which is where the likes of value comes in.
He said: “What we see in the market right now is interest rates going up a little bit and so I think that changes the dynamic for the factors that haven’t done as well like value, which has underperformed significantly. Versus history we are at unprecedented levels.
“When interest rates go up, investors will start to think about the leverage of companies, interest payments and the ability to maintain debt.”
Stacey also said there are potentially better times around the corner for small cap.
He said: “Small cap versus large cap will also be better because you’ve had large cap do well and I think from our perspective you have seen people be forced out of traditional yield assets, the bonds, and they’ve moved into equities; into large cap, steady, stable, higher yielding stocks.
“As we start seeing interest rates move higher, we will likely see the smaller caps versus larger caps do a little better, so that’s where we would think when we go forward.”
As factor-based investing becomes more in vogue, Stacey also stressed that advisors must have a handle on how exposures are built into their portfolio and whether the investor is actually capturing the one they want.
He said: “I believe there are momentum strategies that only rebalance semi-annually – momentum needs higher turnover so you may think you are buying that factor and exposure but you may not be.
“So you do need to take a look at what the objectives are and whether you are actually capturing that factor or not. That would be the big tip.
“Some might have sector bias or country bias so even though they say have a factor, they are actually only exposed to a few sectors or countries.”