By Philip Lawlor, managing director, Global Markets Research
UK factors seem to be dancing to the beat of a different drummer than those in other equity markets. Last year, while its global peers held to a strong defensive bias, the riskier Size (or smaller-cap) factor not only outstripped all other factors in the UK but everywhere else as well.
Similarly, amid this year’s brutal sell-off, the outperformance of defensive factors was far more muted in the UK than elsewhere, even as the UK Size rally evaporated. Quality lagged in the UK (bucking the global trend), while Low Volatility, followed by a modest rebound in Profitability, were the standout performers.
To illustrate these stark divergences, the chart below compares the relative returns of Quality and Size between the UK and the US.
Source: FTSE Russell. Data as of March 31, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
Differing exposures to sectors and macro sensitivities Sector exposures explain much of this performance gap. For example, UK Quality is far less weighted toward health care stocks than its US counterpart (a difference of 3.5 percentage points), which were among the more resilient sectors in both markets over the past 12 months. US Quality also got a bigger boost from technology stocks, which rose strongly in the US but fell sharply in the UK. Moreover, UK Quality is significantly more overweight oil & gas and basic materials, among the worst performers of the past year.
UK Quality also benefited far less than its peers from the widespread rotation into stocks with lower debt burdens, a key gauge of corporate quality. As the top chart below shows, measures of low leverage, led by forward net debt/equity, significantly outperformed in the US, but significantly lagged in the UK.
The differences between the two markets were less extreme when we isolated the components of high profitability, as the second chart below illustrates. In particular, forward ROE performed far better in the UK than in the US.
Leverage factor components relative returns vs broad market – Q1 2020
Profitability factor components relative returns vs broad market – Q1 2020
Source: FTSE Russell. March 31, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
UK factors are also more sensitive than those in the US to shifts in key macroeconomic metrics. Notably, UK Value and Size are far more negatively correlated to moves in the US dollar than their US counterparts, while UK Low Volatility, Profitability and Quality are more positively correlated.
Correlations to US Dollar Since March 2019
Source: FTSE Russell. March 31, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Much of the spectacular outperformance of UK Size in Q4 2019 was driven by the strong appreciation in sterling amid waning hard-Brexit fears, which favored smaller-cap, more domestically oriented UK stocks over their large-cap, globally exposed peers. Sterling weakness also explains the factor’s subsequent downfall this year.
UK Size relative return to broad market (rebased, TR) vs trade-weighted sterling
Source: FTSE Russell. March 31, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
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