Qontigo Insight Quarterly — January 14, 2022

Qontigo Insight Q4 2021 Quarterly Risk Highlights: High returns, continued risk decoupling and factors behaving as expected

by Applied Research Team

Top takeaways: strong returns but rising risk

  • Last quarter we discussed how markets seem to have decoupled. That has continued in Q4 as risk rose in the US (now among the riskiest markets but just around its long-term median) but was flat or fell in others
  • Asset correlations were an important driver of Q4 risk changes, as they were in Q3
  • “Pandemic Profiteers” had a major impact on returns; without them, the US market would have still been up in Q4, but much less than it was with them
  • Macroeconomic factors were a huge influence on returns in 2021, accounting for 80%-90% of total returns. Their influence was less all-encompassing in Q4, but they were still important
  • In a continuation of performance from Q3, factor returns remained within the bounds of expectations based on the predicted risk at the beginning of the quarter, as well as compared with realized volatility over the life of most models. Returns were also generally in the “expected” direction
  • Exposure correlations for Momentum and Value versus other factors shifted substantially in 2021 – Momentum is cheaper while high beta is more expensive

Short-horizon predicted volatility

Source: FTSE Russell, Qontigo

  • As noted, predicted short-horizon risk saw mixed results in Q4, down by more than a third in China but up by a similar proportion in Canada
  • Australia and the UK currently have the lowest predicted volatility among major markets, while US small cap and Japan have the highest, the UK stands in contrast to its third-highest ranking a year ago
  • US large-cap is now the third most volatile, a substantial change from last year and even versus the end of Q3, where it stood in the middle of the pack

Decomposition of the last 3 month change in short-horizon risk – single country benchmarks

Source: FTSE Russell, Qontigo

The increase in volatility of individual stocks was by far the highest in the US, while Canadian stock correlations were a major driver of the increase in risk in that market. Both drove factor volatility up in most major single country benchmarks except Australia, and Japan’s factor volatility increased due to higher asset correlations.


Decomposition of the last 3 month change in short-horizon risk – multi-country benchmarks

Source: Qontigo

Stock volatility and correlations fell in developed Asia ex Japan and emerging markets, driving down factor volatility, whereas volatility and correlations were higher in Europe, Global developed and global developed ex-us. Some of the increase in developed ex-US driven by higher volatilities was offset by lower factor correlations.


…Prominence of pandemic profiteers drove the US market in 2H…

Cumulative Return vs. STOXX USA 900

  • “Profiteers” drove the index up in Q4, gaining more than 17%, vs. an index return of about 9.5%
  • An index that excluded just those 20 stocks would have been up about 6.5% in Q4, lagging the USA 900 by almost 3%
  • The dominance of these stocks waned in the last few weeks of the year, even as Omicron heated up

Source: Qontigo
*20 names whose stocks seemed to benefit the most from the COVID resurgence


Emerging vs. Developed

  • Emerging Markets, has seen risk fall below that of its developed market counterpart, an unusual occurrence compared with history
  • The main difference is that aggregate developed market country risk increased in Q4 (likely driven by the increase in US risk), whereas emerging markets’ country risk was flat

Source: Qontigo


Macro factors drove 2021 US equity performance…

  • Macroeconomic factors accounted for about 80% of the US market return for the year
  • Macro influence ebbed in Q4, but still accounted for about 1/3 of the total market return
  • The GBP BBB spread was the only major detractor for the year, but it had little influence in Q4
  • Market exposure to US inflation remained positive throughout the year (i.e., it would benefit from an increase in break-even inflation) and along with commodity prices had the biggest impact on 2021 and Q4 returns
  • For data on other markets, please contact us

Source: Qontigo


Factor block contributions, STOXX USA 900: Macro factors do not always drive Returns

Source: Qontigo


A closer look at US Style returns

  • Although style factor returns were largely in the “right” direction, many had unusually high or low returns relative to history
  • Liquidity had its third most negative return of the 160 quarters since the model’s inception, Volatility’s was the fourth lowest

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


US Factor alternative portfolios

  • These returns help us see the impact of common real-life constraints on factor returns and results of heuristic portfolio construction
  • Top quintile portfolios in Momentum, Value and Earnings Yield fared far worse than an optimized counterpart
  • The long-only constraint hurt most factors in Q4 (i.e., factors fared better on the short side)
  • Being restricted to a large cap investment universe hurt in Earnings Yield in Q4, but helped for the year
  • Low Volatility fared better among large cap stocks but also on the short side (i.e., high vol stocks did particularly poorly)
  • Profitability also garnered a lot of its return on the short side
  • For results in other regions please download the presentation slides or contact us
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

  • The correlation between Momentum and Value continued to hover around zero in 2021, after being highly negative. Similarly, Dividend Yield and Momentum have become far less negatively correlated
    • Momentum is no longer so expensive, or (more likely) Value is picking up some Momentum

  • Momentum is also no longer positively correlated with Growth
  • Market Sensitivity turned positively correlated with Momentum earlier this year, but although it remains positive the correlation has fallen
    • High-beta and high-growth stocks no longer have momentum

  • 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
    • i.e., high beta is no longer cheap

  • Earnings Yield and Value have become progressively more correlated
  • Most other factor pairs’ correlations have not changed signs

Source: Qontigo


Looking ahead

  • Based on the performance of the Pandemic Profiteers recently, it looks like the market has moved on from its COVID concerns, and investors, who remain risk averse, are focusing more on the economy
  • Although reported inflation hit a 40-year high in December, break-even inflation actually dropped a bit, suggesting investors are not as concerned about it as consumers. The implication is that they believe the Fed and other central banks will successfully fight inflation, for right now exposures are generally still positive, but could turn if…
  • Continued high realized inflation starts to eat into corporate profits, either current or expected
  • Higher interest rates eliminate the argument that “equities are the only game in town”
  • If concerns about inflation and higher interest rates (along with high valuations, continued COVID concerns, etc.) do start to increase, they could lead to higher correlations, and as we saw, high correlations drove risk higher in several markets

For more information, view the recording of our Qontigo Insight™ Quarterly Risk Review – Q4 2021 webinar or download the presentation slides.

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