30 Juni 2023

Update on RAM European Stock Selection Strategies Q2/2023 [ENG]

European Stock Prices Disconnect from Fundamentals with Small Caps Behind

Strong optimism across European markets has recently led some European indices to new highs despite clear decelerating economic trends and monetary tightening by the European Central Bank (ECB).
Equity Flows have largely flown towards large caps, as investors seem to have invested back into European markets through passive vehicles mostly, which has led to a historical underperformance of small caps, at levels not seen before, not even during the financial crisis (cf. fig.1). 

MSCI Europe Smal-Large Cap

The move has been synchronous to a sharp appreciation of Growth stocks versus Value (cf. fig.2), as mega-cap growth names still dominate the index.

MSCI Europe Growth - Value 12M Spread Return

This leads to a compelling opportunity to allocate into flexible cap approaches able to capture attractive valuation opportunities across market cap segments, which provide strong risk-adjusted returns over the long-term.

Momentum Not Immune

In a remarkable conjunction of factors, companies with resilient earnings and price momentum dynamics have also suffered since the beginning of the year, as the market has priced in a reversal into risk-on, without underlying company fundamentals indicating any turnaround so far.
Model Long-Short portfolios across the Value, Momentum, Low Risk inefficiencies we capture have all underperformed recently. These inefficiencies are played integrating dozens of inputs capturing alpha within Value, Momentum and Low-Risk universe. The recent underperformance across engines is rare and is reminiscent in its magnitude of the drawdowns of 2016 and 2020, all followed by strong recoveries of the strategies towards their long-term expected returns (last in 2021, when our European Market-Neutral strategy recovered by 19%). 

Model Inefficiency Portfolios Rolling 1-yr L/S Return

As painful as it has been to be mindful of risk and hold on market neutrals in the last five years, we believe that the asset class provides diversification benefits that practically no asset class provides, and that it is particularly important when the current reversal of monetary policy is exposing the downside risks of our highly leveraged economies.

Long-term Returns

We seek to constantly improve how we capture market inefficiencies by improving our stock selection process and integrating more data inputs (for an example of new inputs see the Go Beyond Sentiment, September 2022 paper on the integration of financial news in the process using Large Language Models).
Over the long-run, these inefficiencies persist in the market and have helped us generate significant positive returns (excess returns for the long-only) for investors.

European Equities Strategy Gross Cumulative Performance
European Equities Statistics Since Inception

We thrive to enhance the returns of our market neutral strategy by adding more inputs or by capturing more inefficiencies (for illustration, check out The Benefits of Diversifying Frequencies, November 2022 paper). The Market Neutral strategy has delivered sub-par returns versus the long-term in the last five years of continuous exogeneous shocks (COVID-19, vaccines, the Russo-Ukrainian War) but we are confident the strategy stands to deliver strong returns when valuation of the most overvalued growth segments of the market normalise again (as it did in 2021, check out Capitalising on valuation normalisation, May 2022 in the Hedge Fund Journal).

EU Market-Neutral Strategy Gross Cumulative Performance
EU Market-Neutral Statistics Since Inception

Our systematic stock selection process aims to optimally leverage all information inputs on stocks but retains very strong fundamental qualities which are key over the long-term.
Here are the current fundamentals of our Long and Short single-name selections in the strategy, illustrating the strong value and quality bias of our selection on the Long side, and the financing fragility of our short picks in the current tightening environment (for instance negative free cash flow dynamics):

RAM EU Market Neutral


To conclude, the recent surprisingly strong risk-on in a shaky economic environment has benefitted a fraction of large cap growth stocks in the market. This has negatively impacted the performance of our European Long-Only Equities and Market Neutral strategies, given their value bias and net mid cap exposures. The recent risk-on by the market is leading to a very attractive set of relative value opportunities to capture. 
Across valuation, risk and earnings growth dynamics, the recent rally stands out of the norm, which tends to be followed by strong recovery of our systematic stock selection engines towards superior long-term returns.


by RAM AI's Systematic Equity Team - Emmanuel Hauptmann, Valentin Betrix, Nicolas Jamet, Tian Guo, Louis-Alexandre Piquet




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