Much has been made about the poor performance of quantitative equity strategies over the past five years, or so. With a corresponding increase in assets allocated to such strategies, it would seem that overcrowding has led to profit margins being squeezed as markets become more efficient. We caution against drawing conclusions from short time series and emphasise the importance of acknowledging the uncertainty on performance estimates.
In 1993, Fama and French published Common risk factors in the returns on stocks and bonds in which they argued that value stocks earned a risk premium. They showed that an investor can profit from being long high-value stocks and short low-value (or “growth”) stocks.
These ideas appeared to be vindicated a decade or so later when such strategies performed well after the dot-com bubble. This led to a surge in assets following value-based strategies, and those exploiting similar effects such as the size, momentum and quality. These “smart beta” products aim to improve on the performance of a market-capitalisation-weighted index.
Just as quickly as an idea comes into fashion, it can fall out of fashion; especially in the face of a few years of relatively poor performance. In Figure 1, we show the rolling five-year return of the Fama-French Value factor, after we risk adjusted the returns to target an annualised volatility of 10% [1, 2].
Figure 1: Rolling five-year return of the Fama-French Value factor