So far, 2018 has been marked by a clear decoupling of emerging and developed equity markets. This has led to a divergence in the performance of our low volatility strategies across the world.
Developed and emerging markets appear to have taken different routes in 2018. While developed markets (DM) have experienced a continuation of the uptrend seen in previous years, mainly driven by the strong performance of US stocks, emerging markets (EM) have been through a rough patch. Sentiment has especially deteriorated in countries like Brazil, South Africa, Turkey and China. Unsurprisingly, low-risk and high-dividend investment styles have worked relatively well in these markets.
The different trajectories of EM and DM stocks are reflected in the performance of different factors in both regions, as shown is Figure 1. Low volatility, the main factor in the bottom-up selection process of Robeco’s Conservative Equities strategies, illustrates this very clearly. Since the low volatility factor helps reduce losses, its contribution to performance has been negative in DM and positive in EM. The significant outperformance of the MSCI Emerging Markets Minimum Volatility Index relative to its DM counterpart also shows how low-risk stocks have done much better in EM than in DM, relative to the market index.
This is fully in line with our expectations, given the higher volatility in emerging markets this year. It should also be noted that while it did not support performance in the US, the low volatility factor had a positive impact in more troubled developed markets such as Europe and Japan.
A similar observation can be made for the value and momentum factors. This is important as value and momentum characteristics are also taken into account in the stock selection process of our Conservative Equities strategies, although low volatility remains the main driver.
Momentum stocks are the most telling example. The momentum factor, which has delivered a stellar performance in both developed and emerging markets over the last few years, has continued to do well in developed markets, but not in emerging markets. This is shown in Figure 2.
This performance gap is also in line with our expectations, as several trends in emerging markets have reversed in 2018. The most notable have been the changing fortunes of Chinese stocks, as the rise of index heavyweights Alibaba and Tencent (which together currently account for 25% of the MSCI China) has faltered this year.
The divergence in performance across factors and regions has been clearly visible in the relative returns of our Conservative Equities strategies this year. As low volatility and high dividend stocks have performed well in emerging markets, Robeco’s EM Conservative Equities strategy has shown clear added value compared to the volatile MSCI EM Index. Meanwhile, as the value factor and in particular the high dividend style clearly haven’t paid off in DM, Robeco’s DM Conservative Equities strategy has lagged the market index.
Although defensive and high dividend strategies have lagged the market in the US this year, it is reasonable to expect that these investment styles will do relatively well when volatility rises again. The recent volatility seen in emerging markets and the subsequent relative factor performance might be a sign of more turbulent times ahead. And the relatively high valuation multiples seen in the US equity market should also be considered a warning sign. In a previous paper1, we showed that high valuation levels are historically associated with higher risk levels going forward.
1 P. van Vliet, 2018, ‘Risky CAPE Repair the roof when the sun is shining’, Robeco article.