Equity watchFactor analysis: What has been working recently?

Over the past couple of decades, the field of behavioral finance has amassed a body of research exploring the structure of equity markets. The findings suggest that certain factors appear to be relatively persistent — even if they are sometimes quite modest in scale. (We also note that there have certainly been periods when these long-run patterns cease to be effective, or even go into reverse.) So: What can we say about factors embodied in the current state of U.S. equity markets, based on what we’ve seen as of August 31, 2014? Here are four observations.

  • Value factors appear to be effective: the names that look inexpensive (in terms of their prices relative to their earnings or free cash flow) have been outperforming their more expensive counterparts. This suggests to us that investors who have been seeking out inexpensive names have likely been pleased with the results.
  • Most quality factors have also worked reasonably well: the companies that have delivered higher returns on equity, or that have generated sufficient cash flow to cover capital expenditures and other requirements, are generally outperforming peers that we feel are less well positioned on these metrics.
  • In 2014 to date, larger-capitalization companies have delivered higher total returns than their smaller counterparts. To some extent, this has been a natural snapback from the outperformance of smaller-capitalization companies in 2013, and it also goes against the longer-term trend in which smaller companies tend to deliver slightly higher total returns than their larger peers. (We note here that in terms of trailing price-to-earnings ratios, small caps still look somewhat more expensive than large caps, though the gap has narrowed considerably.)
  • Extensive academic research shows that companies that have delivered strong returns over the prior twelve months are slightly more likely to continue outperforming their peers going into the next period; but in 2014 to date, companies with the strongest medium-term momentum have generally done comparatively poorly. This has probably been helpful for contrarian investors, who often seek to buy names that have recently experienced price declines.

Analyses above are supported by internal research conducted by Delaware Investments. Data were obtained via Compustat, Worldscope, and FactSet.

The views expressed represent the Manager's assessment of the market environment as of September 2014, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.

For institutional client use only. Not for use with the public.

9/29 (13255)

9/29 (13255)

Notes from the desk