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Qontigo Insight Quarterly — October 11, 2021

Qontigo Insight Q3 2021 Quarterly Risk Highlights: It is remarkable how unremarkable the risk environment turned out to be

by Applied Research Team

Short-Horizon Predicted Volatility: Markets’ Risks Decoupled, as Some Rose and Some Fell in Q3 vs. Q2

Source: FTSE Russell, Qontigo

  • In Q3, risk rose slightly in the US, somewhat more in Emerging Markets, Japan and Australia, and substantially in China and Asia ex-Japan
  • In contrast, risk fell in Global Developed Markets, Developed ex-US and Europe
  • It is more common to see most markets’ risk move in the same direction, and investor indecision is highlighted in what happened in Q3
  • US Small Cap remains the riskiest of the markets we track closely, while Canada is the least risky
  • Euro STOXX saw the biggest “improvement” in relative riskiness, from one of the riskiest to slightly lower than average at the end of Q3, Asia Pacific saw the biggest decline

US Short-Horizon Fundamental Predicted Risk: Fell by Mid-September, But Retraced Its Steps by Quarter End

US short-horizon fundamental risk reached a near-term low, and a ranking just above the top decile in mid-September, but has increased 28% since then and risk now falls in the 38th percentile

Source: Qontigo. Risk figures are based on the Axioma Market Portfolio US-LMS, which represents the broad US investment universe

US Small Cap vs Large Cap: Relative Risk Neared a Peak in September But Fell by Quarter End

  • US small cap relative to large cap risk neared a 20-year high level in early September
  • Although the relative risk ratio has backed off since then as small cap risk rose less than large cap, it remains quite high relative to where it has been historically
  • Similarly, the tracking error of the Russell 2000 to the Russell 3000 has fallen over the past year, but it remains high compared with historical levels
  • Small cap allocations against a broader benchmark are likely to entail more risk currently than they have historically

Source: FTSE Russell, Qontigo
*Risk figures are based on Axioma Market Portfolios US-LMS-xTop 1000 (small-cap) and US-Top 1000 (large-cap)

Macro factors waned in influence in the US in Q3 but still had substantial impact in Europe and Japan

Source: Qontigo

Macro Factor Exposures of STOXX Global 1800: Exposure to Several Factors Shrunk Toward Zero

  • The exposure to commodities dropped substantially from March to June, and stayed low
  • More recently, EUR and GBP credit spread (BBB) exposures inched toward zero as well (i.e., stocks and credit were less correlated)
  • Inflation exposures have remained steady
  • We would expect macro factor influence to increase again if central banks act to stem inflation and cut off the liquidity gravy train, bond yields continue to rise, and other economic influences continue to dominate the news

Source: Qontigo

Average monthly asset-return dispersion*: Back to the Old Normal

Source: Qontigo
*Normalized: (Actual Return – Long-Term Average)/Realized Standard Deviation
**Rank: Percentile relative to long-term history. Bold means top or bottom decile
Red denotes factors with big returns opposite the long-term average

Here we are showing the factor returns for the macro model factors for the third quarter and year to date. We compare the returns to the long-term average over the same period and then divide it by the long-term standard deviation to calculate a return normalized for historical volatility. You can see that in Q3 only the two inflation figures highlights produced unusually high returns relative to historical averages (which happen to be very close to zero). And only EU inflation, British corporate spreads, and Oil have produced unusually high returns year to date. Note that if the numbers are in red it means that the quarterly or annual return was in the opposite direction from the long-term average.

A Closer Look at US Style Returns

Source: Qontigo

*Normalized: (Actual Return – Long-Term Average)/Realized Standard Deviation
**Rank: Percentile relative to long-term history. Bold means top or bottom decile
Red denotes typically compensated factors with big returns opposite to the long-term average

  • In some regions, the return to Market Sensitivity has been so positive it has flipped the long-term average from negative to positive, and even the negative return in Q3 did not flip it back (in WW4 and APxJP4)!
  • Growth’s return in Q3 was one of the highest historically, while Dividend Yield, Liquidity and Volatility had among their most negative returns. (Note that of those, Volatility’s remained in the expected direction)
  • With those exceptions, most factor returns were well within a one-standard deviation range versus the long-term average •Although returns were not “outsized”, Medium-Term Momentum, Profitability and Value all had positive returns

US Factor Alternative Portfolios

  • These returns help us to see the impact of common real-life constraints.
  • In Q3 it looks like Momentum actually worked better in the large cap universe, although other factors seemed to fare better in small cap.
  • The no shorting constraint imposed on the long only portfolios also hurt returns in all factors except value. This suggests that it was more difficult to capture the factor return in a long only portfolio, or in other words the factor fared better on the short side.
  • Monthly rebalancing versus daily didn’t seem to make much of a difference, except in Momentum where it hurt return.
  • The performance of momentum in the optimized portfolios versus the top quintile is also interesting, in that it suggests the top quintile must have been dragged down by its other style and sector bets. We don’t see those differences in the other factors.
Source: Qontigo

Notes: Returns are scaled to a factor exposure of 1 for comparability. Differences over 1% for the quarter and 2% YTD are highlighted

US Factor Exposure Correlations

  • After a long period of highly negative correlations, Momentum and Value are now (slightly) positively correlated, suggesting Momentum has gotten cheaper and/or Value is picking up momentum.
  • Market Sensitivity is also now positively correlated with Momentum, as the market has generally been led by higher-beta names
  • Market Sensitivity and Value have gone from a positive to a negative correlation, as big moves in high beta has rendered those stocks more expensive
  • Most other factor pairs’ correlations have not changed signs

Source: Qontigo

More Information

For more information, view the recording of our Qontigo Insight™ Quarterly Risk Review – Q3 2021 webinar or download the presentation slides.

For questions or comments about this data, please contact Qontigo Applied Research team.