Macro forces have determined the variability in returns, “swamping” all stock and style characteristics. In particular, value and quality have underperformed. The report, entitled ‘The Time for Value Investing Will Come’ argues that some resolution of the credit crunch and a return of confidence are needed for systematic strategies to perform. When companies bear the full brunt of the credit shortfall, value and quality are expected to perform. Citi expects the impact of the crisis on the real economy to be ugly – but it will show how extensively companies have been hurt. From this vantage point, quantitative analysis will be more effective.

According to Citi, value will perform “only when investors have regained their confidence in the financial system and earnings visibility improves”. Given that some commentators are predicting the impact of the credit crisis to continue for up to two years or more, value managers will be hoping this is not the case.

A BEAR MARKET HISTORY

It is more than one year since markets awoke to the subprime mess, and the bear market is still in an early stage, Kightley says. Bear markets typically begin with indiscriminate selling by market participants “there is panic, and people don’t pay attention to value” – followed by an adjustment to the new environment.

Those who offload stocks are generally only able to sell their most liquid holdings, resulting in bigger volumes of large and mid-cap stocks being put on the market. The next phase sees investors prepare for the impending effects on the real economy. The regional chief executive of La- zard, Rob Prugue, says the current turmoil is driven by the unwinding of one factor, price momentum, which he sees as the major determinant for resources stock prices throughout the last bull market and its decline.

The factor explains the “energy” created by a security as it outperforms or underperforms its peers, Prugue says, and can be especially potent in cap-weighted indices. Compared to other pricing factors, it became a key contributor to inflated pricing during the last bull market. “The market dynamics of the last 12 months has been more indicative of the unwinding of a single factor, rather than style metrics.”

The extent to which value managers can preserve capital in the bear market will vary because some employed price momentum as an execution tool during the resources boom, Prugue says. This allowed them to hold stocks as their prices rose, boosting their performance relative to value peers, but has detracted from their returns in the past year. “The value manager should preserve capital better in a downward market. They should have lost less money, all things being equal. But in the value categorisation there could be a large dispersion because of the influence of a non-style factor called price momentum.” Prugue argues that momentum has made the index more volatile, and that it produced unusually high tracking errors in the returns of benchmark-aware funds. “You presuppose that the index is neutral.

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