RELIANCE ASSET MANAGEMENT (MALAYSIA) introduces the Reliance Global Equity Style Monitor, a quarterly feature that will examine investment trends across global equity markets.
Looking back 2011 was certainly an eventful year. From the Arab Spring in the Middle East to a nuclear disaster in Japan and a debt crisis in the Eurozone, the last 12 months have been nothing if not dramatic. Although market volatility has subsided from the extreme levels of uncertainty experienced during the third quarter, investors clearly remain nervous. At the end of 2011, the VIX Index, a widely followed measure of estimated future volatility for the S&P 500 Index, remained around one third higher than at the end of 2010.
Despite the heightened uncertainty and relentlessly negative news headlines of the past 12 months, it might therefore come as something of a surprise to learn that global equities posted only moderate declines in 2011. Total return indices across the global developed economies finished the year 6.3% lower, with Shariah compliant equities once again outpacing their conventional counterparts with a marginal 2.4% decline. However, this performance mainly reflects the relative strength of the US equity market, which managed a flat performance in 2011, helping to offset steep declines in European and Asian equity indices.
How then are we to make sense of the events of 2011 and their influence on investor behaviour? Fortunately, a quantitative approach allows us to shed some light on the underlying trends. By combining a broad array of fundamental metrics, such as the price to earnings Ratio (PER), revisions to analysts’ forecasts and measures of management efficiency such as return on equity (ROE), we are able to describe a range of investment ‘styles’, such as Value, Growth, Momentum or Quality. Using correlation analysis, we can identify which styles have best predicted share price performance over the past 12 months, providing a constantly evolving picture of how equity investors are reacting to economic events.
This type of style analysis forms the basis of Cognition: the in-house stock selection model utilized by Reliance Asset Management Malaysia. Cognition is a proprietary computer-driven expert system which observes most of the indicators that traditional investors analyze, but in a systematic, data-intensive way. The calculations derive a score that rates each company by its relative attractiveness within its sector. The investment approach is to examine each economic sector within six key geographic regions independently. This helps ensure that our style analysis is not biased towards the largest market, and does not overlook potentially significant variations across the world. We can use the style building blocks that create the Cognition score to take a snapshot of equity market style preferences at any point in time.
In order to draw a ‘heat map’ of global style preferences we tally the number of sectors where analysis by Cognition over the past twelve months assigns a greater than equal weight to any given style, against those where it assigns a less than equal weight. This has the advantage of ignoring the relative size of sectors and countries and focusing on the breadth of the style trend in question. Each cell in Table 1 displays the number of sectors in which Cognition was ‘overweight’ for each style at the end of December 2011, followed by the 12-month change in brackets. Red shading indicates areas where more than 50% of the sectors in a region are overweight a given style (‘hot’). Blue shading is used to indicate where less than 50% of sectors are overweight (‘cold’).
So what can we say about 2011? Two key messages stand out. First, Financial Strength and Low Volatility were clearly ‘hot’ investment styles. Investors retained a cautious stance, continuing to emphasize a preference for defensive investment styles across most sectors and regions around the world. This was accompanied by a shift towards the Low Volatility style during the year, with only Japanese investors moving away from this style. Such a trend should come as no surprise given the increasing concerns over a double dip recession in Europe and the US, with a combination of private sector de-leveraging and fiscal tightening likely to remain a drag on economic growth.
Second, it is also clear that investors were ‘cold’ on Value. With the exception of Japan, all regions were net underweight Value by the end of the year, and the number of sectors overweighting Value moved lower in all regions apart from the UK. At times of economic uncertainty Value tends to be the least trusted of all investment styles. This reflects the fact that, at this stage of the economic cycle, the cheapest stocks in the market also tend to be the most economically sensitive. This is compounded by the fact that consensus earnings forecasts often lag behind economic reality, meaning that further downgrades may cause apparently cheap stocks to continue to get cheaper.
The picture for 2011 is, then, quite clear. But what about more recent trends? If we focus our style analysis on changes to style preferences during the final quarter of 2011, an interesting pattern emerges. Whilst defensive styles clearly remain in demand, we note a shift towards Value in four of the six regions we monitor.
Reliance Asset Management Malaysia is the investment manager of the WSF Reliance Global Shariah Growth Fund. This fund utilizes the Cognition investment process.