Investment Research

Factor Performance in Emerging Markets

Taras Ivanenko, CFA, Director, Portfolio Manager/Analyst
Alex Lai, CFA, Senior Vice President, Portfolio Manager/Analyst

Factors can be defined as underlying exposures in financial assets that drive risk and return, and certain factors have
generated long-term premiums over the broad market. Emerging markets equities and, in particular, the value factor
offer fascinating case studies for historical performance analysis. Emerging markets equities have significantly lagged
developed stocks in recent years. Notably the value factorwhich has been closely followed by investors and widely
studied by academicshas underperformed as well. Factor analysis can provide insight into the exposures that have
been in and out of favor in equity markets. This analysis helps investors in quantitative approaches but also, we argue,
stock pickers as well.

In this paper, we analyze over a decade of factor returns in the emerging markets and discuss the long- and short-term
patterns of performance. We then compare the data with that of developed regions, as well as provide a more detailed
look at the value factor. Our results help clarify part of why varied stock-selection styles have recently struggled in
emerging markets. For quantitative investors, the difficulty in predicting factor performance leadership and the cyclicality
of factor returns support the benefit of incorporating a multi-factor approach.
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Introduction Exhibit 1
Factor investing is not a new conceptthough it became increasingly Factors and Definitions
well known in the years after the global financial crisis through increased Factor returns reflect the return differential, computed monthly, for an equal-
investor awareness and asset growth in single factor portfolios (so-called weighted composite of stocks ranked in the top/bottom 20% (quintile) for
each measure. P/E and P/B are calculated from the differential of lowest
smart beta). For at least three decades, academics and practitioners versus highest quintile, all other measures are high minus low.
have known that certain characteristics can explain the riskreturn pat-
Style Factor Definition
tern of a given asset. These characteristics, or factors, can be defined as
Value P/E Current market price divided by
underlying exposures in financial assets and some of these exposures 1-year trailing earnings.
have generated a long-term premium over the broad market. Factor
P/B Current market price divided by
performance is measured by constructing factor portfolios, which book value.
are typically built by sorting an investment universe on a specific Dividend Yield Most recent dividend divided by
characteristic, and then calculating the return difference between the current market price.
highest-ranked securities and the lowest-ranked securities. The exact Growth Historical EPS Growth Five-year trailing earnings per
cause of factor premiums is an extensive and unresolved debateas share growth.
premiums can be attributed to risk or behavioral driversthat is beyond Projected EPS Growth I/B/E/S analyst forecast for 35
year earnings per share growth.
the scope of our discussion. Regardless of the reason for the existence of
factor premiums, we believe it is crucial to understand factor exposures. Historical Sales Growth Five-year trailing sales growth.
Momentum Price Momentum 12-month change in USD price.
Emerging markets equities are a compelling case study for historical
EPS Revision (3-month Change in the average EPS
factor performance. Over the last five years, emerging markets equities Analyst up/down) estimate over the past three
have struggled to keep pace with other equity marketssignificantly months.
lagging developed markets. By examining factor returns, we can gain Quality Operating Margin Net operating income divided
insights into the investment styles that have been rewarded (and penal- by total revenue.

ized) and develop a better understanding of their performance drivers. ROE Net income divided by share-
holders equity.
However, timing factor performance is challenging, at best. In this
Risk Beta 36-month beta calculated
paper, we: 1) discuss the historical factor/style results in emerging mar- against local market indices.
kets, 2) compare these with developed regions, and 3) closely examine
Volatility 270-day standard deviation of
the value factor. USD-based price returns.

Our data sample covers the period from December 1999 to September
2015 and is based on the company universe from S&P BMI indices,
for companies over $200 million in market cap, using Worldscope
Exhibit 2
financial data, and relying on the MSCI Emerging Markets Index Factor Performance in Emerging Markets, 19992015
country classification (in certain cases we used the S&P PMI universe,
Index, December 1999=100, Log Scale
which is a subset of BMI).
10,000

Historical Factor Performance

We begin by analyzing raw factors, which are then combined 1,000
(through averaging) into groups we call investment styles, or styles
(Exhibit 1).1 Of course, generic (or so-called nave) factor definitions
can vary, as other researchers can adjust some of the parameters, 100
but the basic ideas are the same and these generic factors set up an
appropriate baseline comparison.
Since December 1999, the P/E and dividend yield factors were 10
the highest performers in emerging markets (Exhibit 2). Beta and 2000 2003 2006 2009 2012 2015
volatility were the worst, but keep in mind that based on the factor Annualized Performance (%) (%)
definitions this means low-beta, low-volatility stocks performed PE 23.7 Operating Margin 6.8
DY 18.1 12-Month Momentum 6.3
more favorably than high-risk stocks (i.e., high risk was out of favor). EPS Revision 13.3 MSCI EM 5.6
Quality, growth, and momentum underlying factors had mixed per- ROE 12.2 Historical Sales Growth 0.4
formance, with some of these factors in the top and bottom halves. Historical EPS Growth 8.4 Projected EPS Growth -1.5
PB 7.8 Beta -7.1
Volatility -8.6
In terms of styles, value was the best performer for the period under
review, which is consistent with empirical findings on the consistency As of 30 September 2015
of the value premium (Exhibit 3). As mentioned, P/E and dividend The performance quoted represents past performance. Past performance is not a
reliable indicator of future results. This information is for illustrative purposes only and
yield were the two top-performing factors and these two compose the does not represent any product or strategy managed by Lazard.
value style along with P/B, which did not perform as favorably. This Source: I/B/E/S, Lazard, Standard & Poors, Worldscope
highlights the fact that a deep value strategy based on P/B has not
 3

been rewarded by the market; however, the combination of all three

Exhibit 3 value metrics obtained favorable results.
Style Performance in Emerging Markets, 19992015
Index, December 1999=100, Log Scale Momentum was the second-best style, and in a shorter time frame it
10,000 has been the lead performer (more on this later). We have included the
Value Momentum Risk MSCI Emerging Markets Index for comparison and one can loosely
Growth Quality MSCI EM think of this cap-weighted benchmark as a form of momentumas
1,000
stocks rise in price they command a higher weight. Quality performed
closely in line with momentum, and notably the growth style signifi-
100 cantly lagged the other styles and the index. In a later section we will
come back to the notable performance of quality across emerging
markets and other regions. As noted, the risk style shows negative per-
10
formance, which means positive results for a low volatility approach.
2000 2003 2006 2009 2012 2015

As of 30 September 2015 Correlations among the different styles, for the most part, were
The performance quoted represents past performance. Past performance is not a not meaningful (Exhibit 4), highlighting the distinct investment
reliable indicator of future results. This information is for illustrative purposes only and
does not represent any product or strategy managed by Lazard.
approaches. The exceptions are the negative correlation between value
Source: I/B/E/S, Lazard, Standard & Poors, Worldscope and momentuma well-known feature in factor investingand a
somewhat high correlation between risk and growth, which seems to
highlight the high-beta nature of growth factors. Importantly, the
correlations are not completely static. The most recent three-year time
Exhibit 4 period illustrates what may be an important change on the value style
Style Correlations and Sub-Periods, 19992015
given its relatively more elevated correlation with the market.
Correlation January 2000 to September 2015
Emerging markets equity performance has struggled in recent years. In
Value Growth Momentum Quality Risk MSCI EM
light of this performance, results show that since 2012 momentum has
Value 1.00 been the only style that has worked, significantly outperforming all
Growth -0.07 1.00 other styles and the MSCI Emerging Markets Index (Exhibit 5). When
Momentum -0.34 -0.09 1.00 examining the underlying factors, not surprisingly, the two momentum
Quality -0.12 0.14 0.28 1.00 components were the best performers, displacing the two value factors
Risk 0.03 0.37 -0.48 -0.43 1.00 P/E and dividend yieldthat had the best performance in the longer
MSCI EM 0.08 0.56 -0.25 -0.29 0.68 1.00 period shown in Exhibit 2. However, over the shorter time frame
value was significantly dragged down again by P/B, highlighting that
Correlation September 2005 to September 2015 difficult times persist for those pursuing a deep value strategy. Quality
gained significant traction in the six months up to September 2015.
Value Growth Momentum Quality Risk MSCI EM
Value 1.00 Momentum is also often called sentiment, and this name is apt at
Growth -0.15 1.00 explaining its recent success. We believe stocks that have been past
Momentum -0.65 -0.09 1.00
Quality -0.25 0.19 0.40 1.00
Risk 0.20 0.57 -0.45 -0.48 1.00 Exhibit 5
Style Performance in Emerging Markets, 20122015
MSCI EM 0.15 0.66 -0.26 -0.25 0.75 1.00
Index, September 2012=100
Correlation September 2012 to September 2015 190
Value Momentum Risk
Growth Quality MSCI EM
Value Growth Momentum Quality Risk MSCI EM 160
Value 1.00
Growth -0.37 1.00 130
Momentum -0.73 0.41 1.00
Quality -0.33 0.25 0.44 1.00 100

Risk 0.10 0.24 -0.24 -0.60 1.00

70
MSCI EM 0.45 0.13 -0.44 -0.39 0.52 1.00 2012 2013 2014 2015

As of 30 September 2015 As of 30 September 2015

The performance quoted represents past performance. Past performance is not a The performance quoted represents past performance. Past performance is not a
reliable indicator of future results. This information is for illustrative purposes only and reliable indicator of future results. This information is for illustrative purposes only and
does not represent any product or strategy managed by Lazard. does not represent any product or strategy managed by Lazard.
Source: I/B/E/S, Lazard, Standard & Poors, Worldscope Source: I/B/E/S, Lazard, Standard & Poors, Worldscope

winners, as measured by 612 month performance, have continued
uninterrupted as investors search for stability in a few high-quality
names. Global accommodative monetary policies have contributed, in
our view, to a lack of differentiation from investors as they look at fun-
damental stock characteristics, thereby rewarding price-based metrics
like 12-month momentum.
To conclude this section, we can draw two key takeaways from histori-
cal performance. First, the variability of performance across factors
indicates that a multi-factor approach is sensible, as predicting a single
factors leadership is challenging. Second, for fundamental investors,
the short-term factor data can help explain why stock picking has
proven substantially challenging in recent times for emerging markets
investors. Both value and growth exposures have been significantly
outpaced by momentum and quality.
Comparing Emerging Markets with
Other Regions
We extended our analysis to Europe, Japan, and the United States, as
we think it is instructive to see if any factor or style performance has
been particular to emerging markets or applies more broadly. Over the
past ten years, value was positive globallywhich again seems consis-
tent with findings related to the value premium. (left chart in Exhibit
6). In a similar way, low risk equities have also done favorably, as is
supported by recent studies explaining that low risk has done better
than high risk, contrary to theory.
Growth, momentum, and quality show mixed results. The positive
effect of momentum is notable in Europe (in addition to emerging
markets). The performance of quality factors in the five-year period
20102015 is notable in emerging markets and Europe, indicating the
increase of risk aversion and flight to quality in these equity markets
since the financial crisis (right chart in Exhibit 6). Overall, long-term
factor preferences in emerging markets are generally consistent with
developed regions. However, in the more recent period the momen-
tum performance surge has been especially strong there.
Exhibit 6
Style Performance Globally
20052015
Annualized Return (%)
22
11
0 0
-11
Value Growth Momentum Quality
Emerging Markets United States Japan
As of 30 September 2015
The performance quoted represents past performance. Past performance is not a reliable indicator of future results. This information is for illustrative purposes only and does not represent
any product or strategy managed by Lazard.
Source: I/B/E/S, Lazard, Standard & Poors, Worldscope
4
Sector and Country Bias from
Factor Construction
The selection method for building factor portfolios
may lead to sector and country concentration. Since a
universe of stocks is filtered based on a factors defini-
tion, the process can end up selecting stocks from a few
sectors. For example, if we select the highest quintile
of dividend-yielding stocks we could be concentrated
only in the utilities and telecommunications sectors.
With this in mind, one can control the sector exposure
of factors by looking at the topbottom 20% by sector
and then averaging. From our analysis, we do not see
sectors biasing the overall results. Similarly, one can
also construct country factors by, for example, buying
the cheapest countries and selling the most expensive.
However, this does not lead to favorable results, high-
lighting that underlying fundamentals are more important
than country membership of a given set of stocks.
ValueA Deeper Dive
Long-term data on the value premium illustrate its favorable track
record.2 The first academic studies on the value premium were pub-
lished more than three decades ago, but Benjamin Graham advocated
this approach as far back as the 1930s. However, over the years several
different tribes of value investors have emerged, using different defi-
nitions for stock valuation. With this in mind we explored the value
factors beyond emerging markets, to see how global exposures behave
and thus how investors can harvest the value premium. Over the last
decade the P/E factor worked in every region and extremely well in
20102015
Annualized Return (%)
22
11
-11
Risk Value Growth Momentum Quality Risk
Europe
 5

emerging markets. P/Bassociated with deep valueworked in

Japan but not in other areas. Cash flow to price performed favorably Exhibit 7
Value and Momentum Cycles in Emerging Markets
across all regions.
One-Year Rolling Return (%)
In emerging markets, value factors and style have an outstanding long- 90
term record. Given this backdrop, values unfavorable results over
Value
the short term are worth exploring. The first point is that despite a
45
strong cumulative record, performance over rolling periods reveals the
cyclicality of returns and as a result the difficulty of timing. The 1-year
rolling performance for value and momentum are generally negatively 0
correlated (Exhibit 7), so combining factors in an investment frame-
work may improve outcomes through diversification. For fundamental Momentum
value investors, in general, data show that value outperformance has -45
2001 2003 2005 2007 2009 2011 2013 2015
corresponded to momentum underperformance, which can help
investors understand frustrating bouts of underperformance because of As of 30 September 2015
The performance quoted represents past performance. Past performance is not a
this type of market polarization. reliable indicator of future results. This information is for illustrative purposes only and
does not represent any product or strategy managed by Lazard.
One historic characteristic of value stocks has been their generally Source: I/B/E/S, Lazard, Standard & Poors, Worldscope
low systematic risk. However, it would appear that in the post-crisis
period, systematic risk as measured by beta was on the rise for value
stocks. Measured by P/B or P/E for the cheapest 20% of stocks, beta
trended upward for a number of years but an inflection point is vis- Exhibit 8
In Emerging Markets Value Appears to Have More
ible in 2014 (Exhibit 8, top chart) suggesting this may be subsiding. Systematic Risk
The performance implication of this phenomenon would suggest that
Three-Year Rolling Betas and Correlation
value stocks were not defending as expected. In addition, the value
1.4
style returns have exhibited a rising correlation to the broad market
(represented by the MSCI Emerging Markets Index). In similar fash-
1.3
ion to beta, correlation has been rising (Exhibit 8, bottom chart). As a
result, the value style moved more in tandem with the overall market 1.2
trend. In our view, these two dynamics can give some clues as it relates
to explaining values recent underperformance. 1.1
PE Beta (Median) PB Beta (Median)

Conclusion 1.0
PE Beta (Cap Weighted) PB Beta (Cap Weighted)

2008 2009 2010 2011 2012 2013 2014 2015

We believe factors offer an objective view of the underlying building
blocks of performance.
Three-Year Rolling Correlation: Value, MSCI EM
We observed value has performed very favorably in emerging markets 1.0
over long periods. However, when we focused on the most recent
three years (20122015) we see the dominance of momentum invest- 0.5

ing, which is even more striking given that momentum is not a global
0.0
success. It has worked in Europe but not in Japan and the United
States, in contrast to values long-term premium, which is present in
-0.5
all regions reviewed.
Despite the favorable long-term performance of value in emerging -1.0
2008 2009 2010 2011 2012 2013 2014 2015
markets and elsewhere, or the short-term leadership of momentum
in emerging markets, no single factor/style dominates consistently at As of 30 September 2015
The performance quoted represents past performance. Past performance is not a
every point. This highlights the importance of considering a multi- reliable indicator of future results. This information is for illustrative purposes only and
factor approach. For stock pickers, factor performance can provide an does not represent any product or strategy managed by Lazard. For beta calculation,
on a monthly basis each characteristic is ranked from most attractive to least attrac-
additional dimension for explaining a strategys returns and informing tive. The mean and cap-weighted betas are then taken from the top 20% of stocks.
the overall stock-selection processes. Source: I/B/E/S, Lazard, Standard & Poors, Worldscope
 6

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.

Notes
1 To further clarify on nomenclature, outside of this paper factor may be used indistinctly to what we call styles. For example, other publications may refer to the value factor which may
include one or many underlying exposures. In our case, we chose the word factor for one characteristic (e.g., P/E) and distinguish this from groups of characteristics, which we call style.
2 See Ken French data library which contains US value data since 1926: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

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Published on 30 March 2016.
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