Andrew Lapthorne, global head of quantitative research at Société Générale, has said the small cap space is currently a hunting ground for alpha as the market gets driven by leading US tech stocks.
Speaking at ETF Stream’sBeyond Beta Europe Digital event, Lapthorne (pictured) discussed the performance behaviours for the different factors and questions on whether the performances acted differently to how investors would expect.
Notably, Facebook, Amazon, Apple, Netflix and Google (FAANGs) – the leading stocks in both the US and globally – are all similar growth stocks within the technology sector and have been driving the market which has overshadowed value’s performance.
Lapthorne commented on how the MSCI World ex USA index has significantly underperformed the MSCI World by 5% per annum.
“If you were to compare a value index to the World ex USA index, then it probably would not look that bad,” he continued.
In addition to the dominance of the US, quantitative easing (QE) has divided the market. Lapthorne argued QE has driven the market as opposed to fundamentals which replicates what the market was like 20 years ago during the 'dotcom' bubble.
For growth stocks which do not survive in the leading indices such as the S&P 500, they will end up falling into the Russell 1000 or maybe even the Russell 2000.
“Once you are there, you are stuck and therefore quality matters far more when you are in the smaller cap space because you do not have the survivor bias you have in the large cap universe,” Lapthorne explained.
He added there are a few hidden gems within the small cap space that could provide significant alpha once you filter out all the zombie companies.
However, Lapthorne warned a portfolio of value is a portfolio of problems.
“They are the cheaper stocks in the market and by their very nature, they must have a problem,” he said. “You might be buying banks because there is an interest rate problem or maybe you are buying old autos because there is a Tesla problem or you might be buying oil and gas because there is an ESG problem.”
Why market cap-weighted benchmarks are not good momentum bets
Value is essentially a call option on good news, Lapthorne stressed, and like any option, you buy it in the hope that good news will appear, however, he added that buying value after seeing the good news is a pointless exercise.
Some 90% of returns to value are concentrated in inflection points. “This is why value investors are so miserable,” he continued. “They wait two years for the performance, it all happens in five days and then have to wait another two years waiting for the next problem to be resolved.”
He highlighted how investors are combining value with momentum to counteract this play but the issue they face over the past couple of years is there is zero overlap between the two factors.
“You are either a bond proxy or a cyclical risk play.”
