16 Jun Structural Advantage Adjusted for Value and Momentum
- Food and Healthcare maintain a structural advantage after adjusting for the performance contributions of value and momentum.
- Sector portfolio sensitivity to value and momentum returns deviated from the long-term averages after the Great Financial Crisis and began to revert in 2018 when volatility increased.
Food and Healthcare have generated “structural alpha” since 1975. Structural alpha describes the performance of their factor portfolios relative to any combination of the 3-month treasury rate and the U.S. equity market portfolio return.
The sectors’ structural alphas persist after adjusting for the contributions of value and momentum. Structural alpha and structural beta combine to form the sector’s factor portfolio return. In this study, structural beta includes the returns to value, momentum, and the U.S. equity market. Structural alpha is the sector factor portfolio return less the structural beta return.
Structural alpha is positive for Food and Healthcare after accounting for the contributions of value and momentum. The returns to the value and momentum factor portfolios were 2.1% and 6.0%, respectively, over the period.
Shorter time periods show less consistent results. From 1975 – 2008, structural alpha was positive. The end of the period coincides with the Great Financial Crisis (“GFC”).
After the GFC, from 2009 to 2020, structural alpha remained positive, but it declined for both sectors. Food’s alpha declined 1.0% and Healthcare’s declined 2.0%.
Sub-periods within the post-GFC period obviate the impact of value’s underperformance and momentum’s increased return. When volatility increased in 2018, value and momentum detracted from the Food factor performance. As a result, from 2018 to 2020, structural alpha was negative. During the same period, structural alpha was positive for Healthcare with positive contributions from value and momentum. Sensitivities to value and momentum reverted to their pre-2008 averages.
In summary, recent factor volatility in the returns to value and momentum have negatively impacted structural alpha for Food. Nonetheless, for the long-term, Food and Healthcare maintain a structural advantage relative to any combination of the U.S. equity market and the 3-month cash rate. Their reputations as defensive sectors remain intact.
Note
The sector returns are based on Fama/French sector returns. Food is an average of Agriculture, Food Products, and Candy & Soda. Healthcare is an average of Healthcare, Medical Equipment, and Pharmaceutical Products.