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In the aftermath of the COVID-19 crisis, central banks and government authorities injected massive amounts of economic stimulus to support their economies from the market meltdown which led to a rapid increase in money supply, pushing up consumer prices. In the same vein, the ongoing global economic recovery and winter season in Europe has led to a surge in global demand and pushed energy prices back to pre-pandemic levels, exacerbating the already high consumer prices. As of January 2022, the US consumer price index (CPI) stands at 7.5%, the highest level since 1982. This significant change in economic fundamentals has led to a rotation from growth to value as long-duration stocks are more negatively impacted by higher interest rates compared to short-duration stocks, where a large proportion of their cash flow is expected to be delivered in the near future. The continued recovery of the global economy combined with the ongoing conflict between Ukraine and Russia has the potential to push energy prices to even higher levels. This could compel global central banks, particularly the Federal Reserve to move towards and maintain a more hawkish monetary policy stance to bring consumer prices down to levels in line with their long-term inflation targets.

The Eurekahedge Bottom-up/Value Absolute Return Fund Composite, which tracks the performance of 350 active fund managers who incorporate a value investing approach in their investment processes recorded a return of 13.69% in 2021. This compares with the 22.55% return of their top-down absolute return peers, and the 23.66% return of their exchange-traded fund counterpart as represented by the Vanguard Value Index Fund ETF Shares.

Figure 1: Performance of Eurekahedge Bottom-up/Value Absolute Return Fund Composite since 2007

Figure 1 depicts the performance of the Eurekahedge Bottom-up/Value Absolute Return Composite versus comparable benchmarks since the end of 2007. Bottom-up/value absolute return funds generated an annualised return of 5.88%, outperforming their top-down absolute return peers and exchange-traded funds counterpart as represented by the Vanguard Value Index Fund ETF shares which generated annualised returns of 3.08% and 5.73% respectively. In the same vein, value investing absolute return funds also recorded a higher annualised return compared to global equities and value-focused equities as seen in the 5.07% and 1.50% annualised return of the MSCI AC World Index and MSCI World Value Index respectively.

Source: Eurekahedge

Table 1 summarises the key performance statistics for the Eurekahedge Bottom-up/Value Absolute Return Composite relative to comparable benchmarks. Key takeaways include:

1. Bottom-up/value absolute return funds have consistently outperformed their top-down peers, exchange-traded funds counterparts and the underlying value-focused equity market in terms of risk-adjusted return over the short and long-term horizon. Over the last two, three, five and ten year periods, bottom-up/value absolute return funds recorded Sharpe ratios of 0.65, 0.71, 0.71 and 0.77 respectively, comparatively higher than their mentioned peers as seen in the table.
2. In 2020, during the onset of the COVID-19 crisis which caused the market meltdown in February and March, bottom-up/value absolute return funds exhibited a strong rebound in the following months as they ended the year with a double-digit return of 13.28%, while their underlying value-focused equity market and exchange-traded funds counterparts ended the year in the red, returning -2.85% and -0.74% in 2020 respectively.
3. In an environment of rising inflation rates and higher interest rates, short duration stocks are expected to generate higher returns. Between 2016 and 2018, when the Federal Reserve started its monetary tightening, bottom-up/value absolute return funds generated an accumulated return of 20.45%, over the three-year period, while their top-down peers and the underlying global equity market had only recorded 10.43% and 13.36% respectively.
4. Despite posting the worst performance in 2008, bottom-up/value absolute return funds have spent the shortest time underwater as they recovered their losses in 34 months, while the other four investment vehicles and benchmarks have spent 80 months underwater on average.
   

Table 2 provides the correlation values between the performance of bottom-up/value absolute return fund managers against the benchmark indices and value ETFs. As expected, driven by their long-biased portfolio against the underlying equity market, bottom-up/value absolute return funds displayed a very strong correlation of 0.93 and 0.92 against the MSCI AC World and MSCI World Value respectively.

Table 2: Correlation matrix

Source: Eurekahedge

Figure 2 shows the 3-year rolling annualised standard deviation of the bottom-up/value absolute return funds and other benchmarks. Despite the high correlations displayed by the bottom-up/value absolute returns funds against the underlying equity market, the mandate has consistently maintained a less risky profile as seen in its three-year rolling annualised volatilities, which has consistently been on the lower end over the ten-year period depicted in the chart.

Figure 2: 3-year rolling annualised volatilities of Bottom-up/Value Absolute Return Composite and other benchmarks

Figure 3 shows the 12-month rolling Alpha of bottom-up/value absolute return funds against the underlying equity markets and their ETF counterpart as represented by the MSCI AC World Index, MSCI World Value and Vanguard Value Index ETF Shares respectively. During bull-markets, bottom-up/value absolute returns funds usually outperform their peers as seen in the positive alphas generated in 2009, 2017 and 2020. Against the MSCI World Value and MSCI AC World Indexes, the bottom-up/value absolute return funds have generated excess returns more than 55% of the time. On the other hand, against the Vanguard Value Index Fund ETF Shares, excess returns have been generated around 60% of the time.

Figure 3: 12-month rolling alpha of Bottom-up/Value Absolute Return Composite vs. benchmarks (RFR = 0.25%)

Figure 4 below shows the annual performance distribution of bottom-up/value absolute return funds since 2008. From 2010 onwards, the spread of returns has narrowed considerably compared to the levels witnessed in 2009, when around 80% of funds posted returns between 128.73% and 10.93%. During the last 14 years, the top 10% of bottom-up/value absolute return funds have also done exceptionally well, generating average returns in excess of 30% during 9 out of the last 14 years.

Their best performance was recorded in 2009 when the Top 10% posted an exceptional average return of 128.73% while their worst performance was recorded in 2008 where even the Top 10% posted an average return of -17.13%, demonstrating the devastating impact that the Global Financial Crisis had on the performance of bottom-up/value absolute return funds. Looking at the more recent years of 2020 and 2021, the spread of returns has been between 35.42% to -8.62% and 36.56% and -10.83% respectively, while median returns were 9.90% and 12.36% respectively. This shows that at least 50% of bottom-up/value absolute return funds were able to maintain returns that are close to 10% or more during 2020 and 2021 despite the challenges posed by the ongoing COVID-19 pandemic, strongly demonstrating the resilience of bottom-up/value absolute return funds in helping investors get through periods of economic uncertainty.

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