QE vs. Factor Investing

Quantitative easing and monetary policy are likely the only real factors driving your portfolio, GAM managers argue.

Investors relying on long-only factors are at the whim of central banks rather than company fundamentals, two managers have argued.

Anthony Lawler and Adam Glinsman, fund managers at Swiss group GAM, warned in a report that investing with the view that factors such as value and quality will push up equity prices in the near-term “introduces single-factor bet risk into a portfolio.”

“This factor—company and security-level fundamentals—could continue to underperform if prices remain disconnected from fundamental drivers,” the managers wrote. “Instead, market technicals and macro issues—namely the size of central bank balance sheets and the methods of quantitative easing [QE]—could continue to be the main factor in determining prices.”

The US Federal Reserve ended its massive QE program in 2014 after buying $4.5 trillion of assets. Each new wave of QE sparked stock market rallies, while the decision to end it caused yields on US treasury bonds to spike in 2013.

During the US’ first round of QE, which ran from December 2008 to March 2010, MSCI’s World Quality index gained 45% according to data from FE Analytics. The firm’s momentum and minimum volatility indexes both rose by roughly 21%. The second round, from September 2012 to December 2013, saw the three indexes rise by between 17% and 27%.

In Europe, the European Central Bank earlier this year increased its QE program by a third to €80 billion ($88 billion) a month, including corporate bond purchases. The Bank of England reintroduced QE following the UK’s vote to leave the European Union in June, planning to add £60 billion ($73.4 billion) of government bonds to its balance sheet.

Fundamental valuation metrics such as price-to-earnings ratios “have taken a backseat to central bank policy in driving price determination,” Lawler and Glinsman wrote. “All liquid assets, including equities and bonds, have rallied with the rising tide of liquidity provided by the world’s central banks. There has not been much reward for seeking out fundamental value. Either you were in the boat—long equities and bonds—as the tide rose or you were not.”

Related: Factor Investing: Allocation vs. Integration & The Problem with Value Investing