As Uncertainty Soars, a Moment for Core Quantitative Investing
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Lazard
Perspectives
As Uncertainty
Soars, a Moment
for Core
Quantitative
Investing
As the global economy reopens, the
market environment is extraordinarily
uncertain. The course of COVID-19 and
vaccine distribution are the most immediate
concerns, but the pandemic has also
radically altered social and economic
behavior over the past year, which may,
in turn, disrupt important secular and
structural trends.
How, then, can investors approach capital
allocation in a forward-looking way?
We believe the key is diversification of
portfolio exposures across both macro
(industry, country, and size) and investment
style dimensions. This is exactly what
core quantitative investment strategies
are designed to do: evaluate the universe
of companies every day to find those that
meet strict investment criteria. Importantly
for investors now, improving fundamentals
over the past six months have dramatically
increased the investment opportunities
for many core quant strategies, which
we see reflected in their impressive first-
quarter returns.2
“Vaccine day” changed the world last November, and the growth rally, particularly in technology and internet-related
that includes the equity markets. Since Pfizer-BioNTech stocks, the performance difference between growth and value
announced an astonishing 90%-plus efficacy rate for its rose to its highest level ever. As experienced investors, we
COVID-19 vaccine on 9 November, many investors have also know that such an existential threat goes a long way to
pivoted toward companies they see as likely to benefit most encourage change, and value businesses have indeed been
from economic recovery. For the most part, the “COVID under pressure to reform, strengthen, and modernize.
trade”—buying fast-growing companies that gained from
We believe it is significant, then, that the overlap, or
pandemic trends—appears to have faded.
correlation, between value and quality metrics has increased
Thus began the recent style rotation into value from dramatically in recent months. Essentially, value companies
growth. It has marked a sharp reversal from a period of are improving in quality, or to put it bluntly, cheap companies
severe underperformance for value stocks and raises an increasingly appear to be good companies. Lately, the
important question for all investors: Is this the “trade” correlation has risen to levels last seen in the early 2000s, a
of the future? There are good reasons to believe it could period when value outperformed growth (Exhibit 1). Because
be. Value is in favor not only because it has historically measures of quality, such as cash flow return on investment
outperformed in the early stages of economic recovery; (CFROI), typically move slowly—quality stocks tend to stay
value is also supported by fundamental considerations, quality stocks for extended periods—we believe the current
including rising quality and improving earnings forecasts for higher correlation between quality and value will continue
value companies, based on our analysis. for some time. Historically, the two have had some overlap,
but over the last decade, the relationship had weakened.
However, as the global economy reopens, the market
We believe this may be part of the explanation for why value
environment is extraordinarily uncertain. The course of
persistently underperformed growth during that time.
COVID-19 and vaccine distribution are the most immediate
concerns and will affect the speed and magnitude of the
economic recovery this year and next. But also, the pandemic Exhibit 1
so radically altered social and economic behavior over the Rising Correlation: Global Value and Quality
past year that it may change important secular and structural Monthly Cross-Sectional Correlation
trends that have been in place for a decade or more, from Information Coefficient (x)
0.4
disinflation and historically low interest rates to globalization.
What may appear to be a clear opportunity, then, could easily
0.3
become clouded later by a significant change.
0.2
How can investors approach capital allocation in a forward-
looking way in such an uncertain climate? First, it is possible
0.1
to invest without forming a strong position on the future by
taking very broad exposure—essentially, diversifying. In our 0.0
1997 2000 2003 2006 2009 2012 2015 2018 2021
view, it is also important to remain nimble enough to position
for change as it happens. Core quantitative investing strategies As of 31 March 2021
Source: Lazard, FactSet
can provide these advantages. They select stocks based on
multiple investment characteristics, or metrics, and reassess
the universe of companies daily to detect changes. After its
Value companies are also enjoying a sharp revival in
outstanding performance in the first quarter, we believe the
sentiment, a metric that can be measured through stock price
outlook for core diversified quant investing is bright.
performance, investor interest, media coverage, and arguably
most important, analysts’ ratings and earnings forecasts
Value: Improving Credentials (Exhibit 2). Share prices and investor interest sometimes rise
In times of great uncertainty, focusing on what we do know simply because investors anticipate outperformance, but
can help. We do know that growth companies have generally when analysts upgrade their ratings and earnings forecasts,
outperformed value for the better part of two decades. Over this reflects industry experts’ on-the-ground research on
the past year, as the pandemic initially poured more fuel on specific companies.3
divergence, in the high concentration of stocks driving index
Exhibit 2
Sentiment toward Value Has Improved Sharply
returns, and in investors’ exuberance for young, disruptive
companies that had long-term potential but often lacked any
Information Coefficient (x) Monthly Quintile Spread (%)
0.0 20 real sign that profitability would be achieved soon.
Rolling 6-Month Cross Sectional Value and Sentiment [LHS]
During the past 12 months, the shock from the pandemic
and unprecedented fiscal stimulus have upended
-0.1 10
those certainties and other previously held norms. The
economic downturn in 2020 was unique, with widespread
-0.2 0 supply disruptions, fiscal support for individuals as well
as businesses, and a surge in household savings as a
consequence of lockdowns. Investors’ views have started to
Monthly Value Performance [RHS] diverge as a result. For instance, some believe the flood of
-0.3 -10
1997 2000 2003 2006 2009 2012 2015 2018 2021 stimulus will drive US inflation to double digits later this year,
As of 31 March 2021 while others think the disinflationary forces that have steered
Source: Lazard, FactSet
the markets for years will win out.
Improving quality and analysts’ upgrades are positive For now, many investors appear to believe the recovery will
indications in themselves, and they show that value’s market be robust; bond yields have risen, and cyclical stocks have
leadership over the past several months has been underpinned regained their footing. From a style perspective, this has led
by fundamentals, which bodes well for the current rally. Less to the rotation from growth to value, arguably the biggest
appreciated but equally important, in our view, improving sustained move in 20 years (Exhibit 3).
quality and sentiment also mean the universe of attractive
value companies is increasing significantly—in both depth
Exhibit 3
and breadth. In other words, the opportunity set for investors
MSCI World Value: Sustained Rally versus MSCI Growth
that are valuation sensitive but also require a diverse array of
MSCI World Value Minus MSCI World Growth, Monthly (%)
fundamentals is growing considerably. 8
Certainty Upended 4
To make asset allocation decisions, investors typically want 0
to know whether current trends are likely to continue.
Therein lies the dilemma for investors today. With the onset -4
of the pandemic in 2020, uncertainty skyrocketed. Numerous
indices measuring uncertainty of all kinds—economic, -8
1979 1985 1991 1997 2003 2009 2015 2021
political, and social—hit record highs over the last year. 1976 1982 1988 1994 2000 2006 2012 2018
As of 31 March 2021
Source: Lazard, MSCI
This contrasts sharply with the years that preceded the
pandemic. Despite the dramatic nature of the Global
Financial Crisis in 2008–2009, there was far more certainty
Structural change is always a feature of investor debate,
over the immediate future in the latter parts of that
but it is particularly relevant after the pandemic, which
crisis. Although deep worries over the global economy
dramatically changed behavior. Has the pandemic brought on
persisted, many of the secular trends that drive markets
or accelerated structural changes? The questions range from
remained intact: the growth of online activity, globalization,
industry-specific—whether consumers will prefer bricks and
deflationary pressures, industrial automation, and the
mortar to online shopping after stores reopen—to broader,
dominance of monetary policy. This narrative was so
macro issues. Will the supply disruptions of the past year lead
consistent that it caused “herding”: Investors flocked to the
to reshoring of supply chains? Where and when will household
areas of the market that were most likely to perform well,
savings be deployed in the economy? Will governments use
notably growth companies. After several years, the result
fiscal policy more readily in the future? We may not know the
was an equity market characterized by extremes: in style
answers to these and other questions for several years.4
The potential for structural change affects not only broad Can we anticipate that IAG will return to its higher
asset allocation but also everyday investment decisions. pre-pandemic EBITDA and Kingfisher will return to its lower
To illustrate, we compared companies from two different pre-pandemic EBITDA? Instinctively, an investor might
industries that were deeply affected by the economic assume that air travel would increase and demand for
lockdowns during the pandemic: IAG, the parent company home improvement products would decrease as the world
of several airlines including British Airways; and Kingfisher, reopens. But what if some changes brought about by the
a home improvement company with many retail banners, pandemic become permanent? For example, there could
including B&Q in the UK. be a structural reduction in business travel or a structural
increase in home improvement demand, or both. Based on
In general, IAG suffered significantly from sharply reduced
these assumptions, a 27% discount for IAG shares may be
travel during the pandemic, while Kingfisher benefited greatly
somewhat hopeful, while a 20% discount for Kingfisher stock
from the stay-at-home environment.
could be understated. Ultimately, however, investors have no
Exhibit 4 shows the divergence in their financial fortunes way of knowing or even making educated guesses. Due to
during 2020. First, IAG had a significant increase in net debt the pandemic, uncertainty is pervasive.
and large share-count dilution for investors because the
While the companies in this example represent two ends of
company needed to raise capital in the depths of the crisis.
the spectrum, some 5,000 companies lie in between them,
These will likely cap the upside for per share financial metrics
many also seeing significant disruption to their financial
even as sales and profits will likely recover in the months
statements and some far more nuanced.
ahead. Second, despite similar discounts in their share
prices versus their typical trading ranges in 2015–2019, the
companies’ 2020 EBITDA figures (earnings before interest,
An Environment for Quantitative
taxes, depreciation, and amortization) are vastly different— Approaches
IAG’s has fallen steeply and is now negative. We believe the key to investing in such an uncertain
environment is diversification—from both macro and
investment style perspectives. This is exactly what core
Exhibit 4
The Divergence in Financials for IAG and Kingfisher quantitative investment strategies are designed to do: evaluate
IAG Kingfisher
a universe of companies to find those that meet certain strict
Market cap £B 9.85 6.71
financial criteria. They do not rely deeply on forecasts, which
Total net debt (ex lease obligation) £B 1.16 -0.71
means a strong view on the future is not a crucial part of the
Total net debt (ex lease obligation) £B
process. Instead, they use financial metrics to form holistic
(Prev. Year) -1.51 0.25 stock assessments: analyzing financials, stock prices, trading
Change in net debt total £B 2019–2020 2.67 -0.96 volume, news coverage, and analysts’ forecast changes. By
Share count 4,966 2,105 scanning the universe of companies every day, core quant
Share count (previous year) 2,900 2,102 strategies also detect small changes in behavior and uncover
Change in share count 2019–2020 (%) 71 0 trends in formation. In other words, they can spot changes as
Current EV £B 11.01 6.00 they are unfolding and act on this information quickly, another
Average EV/EBITDA 2015–2019 4.11 7.11 important advantage in a highly uncertain environment.
Current EV/EBITDA 2015–2019 3.01 5.66
Lazard’s core quantitative strategies seek investments using
Current EV discount vs. 2015–2019 Average (%) -27 -20
four different financial metrics: value, growth, quality, and
2015–2019 EBITDA 3.65 1.06
sentiment. After the economic earthquake of vaccine day
2020 EBITDA -2.01 1.46
in November, investors have started to prefer the greater
As of 31 March 2021
certainty of cash flows and the likelihood of higher near-
Source: Lazard, FactSet
term earnings typically found in value companies relative
to growth. As interest rates have started to rise—with the
benchmark US 10-year Treasury bond yield now around 1.6%
from under 1% last year—investors have also swung to value
companies for their overall lower durations versus growth.5
Significantly, through our quantitative approach, we
Exhibit 5
have found that this rotation into value is supported by Lazard Core Quantitative Strategies: Strong First-Quarter
fundamentals, specifically improving quality and sentiment. Performance
We believe it is difficult to overstate the significance of this (%)
development for a core quantitative approach. With value, 10
quality, and sentiment pointing in the same direction, the Global Alpha March 20
investment opportunities have increased dramatically. We 5
believe recent results show it: In the first quarter, Lazard’s
core quant strategies significantly outperformed the broader
0
market and reported their best performance in more than a
decade (Exhibit 5).
-5
Many uncertainties will linger long after this year. With 1997 2000 2003 2006 2009 2012 2015 2018 2021
economies yet to fully reopen, enormous fiscal packages As of 31 March 2021
The chart depicts the performance by monthly quintile spread of the Lazard Global
signed, and pent-up savings and demand still on the Equity Stock Selection Model, which had its best performance in 19 years in the first
quarter. Three strategies on the Lazard Advantage platform (Lazard Emerging Markets
sidelines, we believe the outlook for core quant investing is Advantage, Lazard International Equity Advantage, and Lazard International Small Cap
very bright indeed. Advantage) also experienced their best quarters in at least the last 12 years.
Past performance is not a reliable indicator of future results.
Source: Lazard, FactSet, MSCI, S&P Global BMI6
This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management.
Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a
robust exchange of ideas throughout the firm.
Important Information
Published on 24 June 2021.
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