Factor investing is playing an increasing role in the Asia Pacific region, with growth and momentum-oriented measures the highlights this year. So with the MSCI AC Asia Pacific ex Japan index scaling new heights, up 27% year to date, and our new offices in Australia and Tokyo just opened, we thought it a great time to take a look at investment opportunities and factor trends across the region.
When we more broadly examined Emerging markets earlier this month, growth and revisions were ruling the roost, so with a 68% overlap between the Emerging and Asia Pacific ex Japan main indices, you’d expect to find some similarities.
First, the disclaimers. We construct factor portfolios using Style Research Markets analyzer, following these criteria:
- We include the top half of the market, ranked by each factor, ensuring that portfolios remain country and sector neutral
- The portfolios are market cap weighted and rebalanced monthly
- Each resultant portfolio is well diversified with a low tracking error, but with a tilt to the factor
- We exclude China ‘A’ shares (these will be covered in a forthcoming blog)
Figure 1 shows the annualised factor returns relative to the market over the last 20 years. Focussing on a range of popular styles, it’s clear that many of the factors ‘discovered’ and employed in the US have also delivered premia in Asian markets.
Starting with value factors (in blue), most have fared well, with flow measures such as high earnings yield (low P/E) and cashflow/price leading the way. On the other hand, book/price, perhaps the oldest value factor, has had more of an index-like performance over the period. Sometimes regarded as a proxy for distressed companies, this factor was badly hit during the Asian crisis, and though it recovered strongly in the early 2000’s, its recent behavior has been dull, with flat returns since 2010.
Though highly correlated with other value metrics, we have separated yield-related factors (in dark blue). Seasoned Style Research clients will recognize this as an example of the greater factor categorisation flexibility that we have recently introduced. Historic dividend yield has been a consistent performer, other than in the run into the global financial crisis. But since then it has been a good bet.
Growth (criteria based on historic or forward growth in earnings, dividends, etc. – not the opposite of value – shown in green bars) has also outperformed over the past two decades. Dividend growth, in particular, has been a strong performer.
This analysis is based on a universe of the largest 1000 stocks in the region, and size has not been an important factor over this period. In a broader universe (3000 stocks) there have been times, such as 2000-2007, when smaller caps have prospered, but these returns have been given back during crises as investors have sought safer havens.
Low-vol a hit
A popular theme in recent years has been the success of low volatility strategies. In common with other regions, lower beta and volatility stocks have done well in Asia. Momentum and revisions have been strong too, though not dominating to the extent seen in Emerging markets over the last few years. The behavior of short-term momentum is interesting – a systematic underperformance through most of the period. Observed in several other markets, this factor captures the advantages of buying (selling) over-sold (-bought) stocks based on recent performance.
Finally, we review quality, which can be thought of as profitability and stability type factors. Both classes produced good factor returns, with forecast ROE at the head of the pack.
A closer look at 2017 factor performance
As a whole across this 20-year span, many of these popular styles and factors have mirrored their behavior in western markets and delivered similar factor premia in Asia longer term. But what about more recently? Figure 2 displays the factor returns over the first three quarters of 2017.
Value results inconsistent
This year has been mixed for value factors. More cyclical measures of value such as sales/price have been rewarded, whereas flow measures like earnings yield have lost out. As ever, this underlines the importance of viewing factors individually, providing granularity that is often lost when factors are bundled into groups. Investors in more speculative value (higher sales, lower margin companies) have benefitted year to date. In addition, high yield stocks have been weak.
Dividend growth drives performance
As in Emerging markets, growth has been in the ascendant. Foremost amongst these factors is dividend growth. Higher volatility and momentum stocks also outperformed, but quality has been more mixed. Stability factors have been weak, but profitability, notably expected ROE, provided positive premia. Though the influence on the inclusion or exclusion in each factor portfolio of high performing stocks (such as Tencent and certain Chinese real estate companies) should be recognized, the factor returns have been quite pervasive across the region. For example, forecast ROE has done well in 10 and dividend growth in 11 of the 13 countries included in this analysis.
Have fund managers been well positioned?
Given this picture, how have managers been positioned? Figure 3, covering 129 funds in the Morningstar Asia Pacific ex Japan peer group, shows the range of Style Tilts™ for these factors. Such peer groups can commingle funds with a variety of different regional benchmarks, so we use a common index (FTSE All World Asia Pacific ex Japan), and employ country and sector adjusted tilts to mitigate further the different country biases across funds.
Funds’ positioning on weakly performing book/price has been favorable year to date, with most biased away from this factor. But managers have also been holding low sales/price stocks, which would have been detrimental to returns. Exposures to growth factors have been the right way around – three-quarters of managers are tilted to higher growth. The same is true for momentum and revisions where there has been a distinct shift in exposures to stocks with higher revisions over recent months. And funds, to their benefit, have been consistently overweight on higher forecast ROE companies. And that has fed through to returns: two-thirds of this universe beat the index over the last six months. Perhaps active management is making a comeback!
Looking strong to close out 2017
Where to from here? Neither of this year’s best performing factors (higher forecast ROE and dividend growth) look particularly expensive compared to their historical ranges on a forward P/E basis. But the best performing value factor, sales/price, is at valuation levels not seen since 2009, so perhaps it has run its course for now. By maintaining their current positioning, funds may be well set to see out the rest of the year on a winning basis.