Our final Venn Factor Performance report of the year will consist of two sections: one in which we’ll reflect on 2020 full year factor performance and another that focuses on December 2020.


2020 Full Year Factor Performance


The table below shows factor returns for 2020, in addition to average annual returns and standard deviations dating back to 1996. The 2020 performance is also expressed as the number of standard deviations away from the long term average to put it in historical perspective. Commentary on the full year factor performance follows.

  • Several equity style factors book-ended factor performance in 2020:
    • On the positive side, the best performing factor in the Two Sigma Factor Lens for 2020 was Momentum, which delivered over 20% returns. The factor enjoyed an upward trend for most of the year with the exception of two short-term reversals in early June and early to mid November. 

    • The Quality factor also benefited in 2020, as high-quality names outperformed. These companies' relatively strong financial positions (lower leverage and earnings variability) might have allowed them to better weather the economic slowdown due to the pandemic.
    • Value was 2020’s worst performing factor, marking its fourth consecutive down year. All four of the factor’s components 1 lost, with Dividend Yield being the largest detractor. The poor performance was due in part to the factor’s general short positioning in “work-from-home” tech names that outperformed in 2020.
    • Low Risk also struggled in 2020, down over 30%. Both its Beta and Residual Volatility components detracted from performance. The factor suffered the most during the COVID market crisis in February and March 2020. As seen in other severe market sell offs, low beta stocks can underperform what their betas might suggest due to beta compression (i.e., when betas compress towards one in market panics, causing stocks with pre-crisis estimated betas of less than 1 to fall by more than expectations).2 Further, the factor relies on trusting your risk model, and “knowing” which stocks are low or high beta. Severe and sudden regime changes can upend risk models and beta estimates, perhaps leading investors to unwind large positions in stocks that they previously viewed as low risk.
  • Despite suffering a sharp drawdown during the COVID market crisis in February and March, the Equity factor managed to post double digit gains for the year. Global equity markets rallied 62% (on a currency hedged basis) after reaching their lows on March 23rd. The strong recovery was aided by unprecedented monetary and fiscal stimulus measures as well as positive vaccine developments.3
    • The U.S. and emerging equity markets outperformed global equity markets on risk-adjusted bases, contributing to the positive 5.73% and 1.40% returns for the Local Equity and Emerging Markets factors respectively.
  • Global government bonds also delivered positive returns in 2020. The Interest Rates factor ended the year up 5% supported in large part by monetary policy and market operations. For example, the Federal Reserve increased its portfolio of Treasury notes and bonds by 79% since March.4
  • While corporate bonds ended the year positive, Venn’s residualized Credit factor experienced -16% losses in 2020. The factor suffered a large drawdown during the COVID market crisis in February and March and didn’t experience any meaningful recovery thereafter. 

    • How can this be explained? In short, unique credit risk took a major beating during the COVID market crisis.5 A credit index made up of corporate investment grade and high yield bonds in the U.S. and Europe was down 14% YTD through March 23rd. This was a much larger drawdown than can be explained by credit’s shared risks with Equity and Interest Rates. Here’s a more detailed explanation for those that want to get into the math:
      • The sensitivity of the combined credit bond index to Equity and Interest Rates was ~0.3 and ~1.0 respectively, and those factors returned -29% and 2% over that same YTD period through March 23rd. This means that the combined credit index “should have” been down around 6.7% (or 0.3*-29% + 1.0*2%), but it was down 14%. The 7.3% difference can be attributed to unique credit or “failure-to-pay” risk. Venn scales that unique credit risk to a 7% annual volatility, and based on its recently realized volatility (which was quite low at ~3%), Venn scaled that -7.3% return to around -17% for the final, residualized, volatility-scaled Credit factor.
    • In Commodities, losses in some sectors, such as energy and livestock, more than offset gains in other sectors, such as precious metals. Venn’s residualized Commodities factor ended the year down nearly 10%, while the unresidualized Bloomberg Commodity Index input was down only 3%. Some of the performance of the index could be explained by its positive relationship with global Equity markets, so once Venn accounted for that positive contribution and zeroed-in on unique Commodities risk, the residualized Commodities factor ended even lower.
  • Finally, Equity Short Volatility experienced the most outsized returns (relative to its history) of any of the macro style factors. The factor sold off from late February through the end of June and recovered only slightly from there to year-end. Over the year, the VIX (an index that tracks the volatility of the U.S. equity market) increased from 13.78 to 22.75, peaking on March 16th at 82.69.6 Heightened equity market volatility in a year where equity markets were up (which is opposite of expectations) resulted in a large negative return for the factor.

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December 2020 Factor Performance

Source: Venn. The median and percentile columns measure the performance of each factor in the Two Sigma Factor Lens relative to the entire history of the factor in USD, using monthly data for the period March 1995 - December 2020.


  • Global Equity markets continued their rally from the previous month to end December up nearly 4% (on a currency hedged basis). A worsening pandemic situation (rising shares of positive tests7, emergence of a new, potentially highly contagious strain8, introduction of more stringent lockdowns9, etc.) was outweighed by positive vaccine news, such as government approvals and distribution. This generated optimism for an end to the COVID crisis, which sent global stocks higher and caused some major stock market indices, such as the Dow Jones and S&P 500, to end the year at record highs.10
    • The Local Equity factor in the USD factor lens posted negative returns, as the U.S. equity market underperformed global markets despite Congress passing additional stimulus.11
  • Oil finished December up, as OPEC agreed to slowly reintroduce supply in 2021 and expectations for demand increased with vaccine rollouts.12 This helped lift the Commodities factor to a 1.25% return in December, in addition to positive performance from other sectors like grains and precious metals.
  • The Foreign Currency factor in the USD factor lens gained, as the USD struggled due at least in part to rising inflation expectations.13
    • The Foreign Currency factor in the GBP factor lens, on the other hand, ended -0.51%. The GBP did well in December due in part to the finalization of a Brexit trade agreement between the U.K. and E.U.14
  • The Trend Following factor was the best performer in December, supported by continuation of trends in currency, commodity, and equity markets. Fixed income trend following was flat for the month.
  • In terms of the equity style factors:
    • Crowding delivered 0.76%, or 88th percentile performance, implying that stocks heavily shorted by the investment community underperformed those stocks that were less heavily shorted.
    • Small Cap stocks outperformed their larger cap counterparts, as small caps were viewed as beneficiaries of fiscal and Fed support as well as vaccine rollout.
  • Low Risk struggled again in December due to a rotation into riskier stocks on economic optimism going into 2021.
  • Value wasn’t able to perform positively despite some out-of-favor COVID names and sectors (such as Financials) outperforming.15
  •  

REFERENCES

1The four Value components are Book to Price, Long-Term Reversal, Earnings Yield, and Dividend Yield.

2 https://www.acadian-asset.com/viewpoints/quick-take-beta-compression-during-crises and https://www.sciencedirect.com/science/article/pii/S0304405X13002675

3 https://www.cnbc.com/2020/11/08/election-stock-market-futures-open-to-close-news.html, https://www.cnbc.com/2020/05/18/stock-market-today-live.html, and https://www.cnbc.com/2020/03/24/stock-market-live-updates-dow-futures-up-900-limit-up-hope-for-a-stimulus-deal.html

4https://www.pgpf.org/blog/2020/11/the-federal-reserve-holds-more-treasury-notes-and-bonds-than-ever-before

5The Credit factor also suffered during the Global Financial Crisis. To compare performance during these two crisis periods (as well as 9/11), please read the Venn ebook “Coronavirus -- Comparing Factor Performance During Three Crises.”

6https://ww2.cboe.com/products/vix-index-volatility/vix-options-and-futures/vix-index/vix-historical-data

7https://ourworldindata.org/coronavirus namely in Germany, Japan, and the U.K.

8https://www.hopkinsmedicine.org/health/conditions-and-diseases/coronavirus/a-new-strain-of-coronavirus-what-you-should-know

9https://www.nytimes.com/2020/12/19/world/europe/coronavirus-uk-new-variant.html

10https://markets.businessinsider.com/news/stocks/stock-market-news-today-new-years-eve-dow-wrap-2020-12-1029927511#:~:text=US%20stocks%20closed%20higher%20on,while%20the%20Dow%20gained%207%25.

11https://www.npr.org/2020/12/21/948862052/house-passes-900-billion-coronavirus-relief-bill-ending-months-long-stalemate

12https://www.cnbc.com/2020/12/03/opec-meeting-talks-resume-over-oil-production-cuts-amid-covid-crisis.html

13https://fred.stlouisfed.org/series/T10YIE

14https://www.nytimes.com/2020/12/24/world/europe/brexit-trade-deal-uk-eu.html

15The iShares Global Financials ETF outperformed the MSCI World Index by 0.84% in December 2020. This sector exhibited the largest Value factor exposure in 2020.

 

References to the Two Sigma Factor Lens and other Venn methodologies are qualified in their entirety by the applicable documentation on Venn.

This article is not an endorsement by Two Sigma Investor Solutions, LP or any of its affiliates (collectively, “Two Sigma”) of the topics discussed. The views expressed above reflect those of the authors and are not necessarily the views of Two Sigma. This article (i) is only for informational and educational purposes, (ii) is not intended to provide, and should not be relied upon, for investment, accounting, legal or tax advice, and (iii) is not a recommendation as to any portfolio, allocation, strategy or investment. This article is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. This article is current as of the date of issuance (or any earlier date as referenced herein) and is subject to change without notice. The analytics or other services available on Venn change frequently and the content of this article should be expected to become outdated and less accurate over time. Two Sigma has no obligation to update the article nor does Two Sigma make any express or implied warranties or representations as to its completeness or accuracy. This material uses some trademarks owned by entities other than Two Sigma purely for identification and comment as fair nominative use. That use does not imply any association with or endorsement of the other company by Two Sigma, or vice versa. See the end of the document for other important disclaimers and disclosures. Click here for other important disclaimers and disclosures.

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