The performance of factor investing during the era of heavy quantitative easing : evidence from the European stock market

Abstract

This thesis examines the performance of conventional factor-investing strategies in the four largest national stock markets in Europe from the 2010-decade until the end of 2021. The key motivation is to compare the performance of factor-investing strategies in an environment where the central bank has set its key policy rates at unprecedented low levels alongside an injection of an abundant amount of liquidity into the economy via various asset purchase programs. It is important to expand the knowledge of whether any of these well-acknowledged risk factors have impaired, diluted, or reversed during the dovish monetary policy era set forth by the ECB. Seven factors examined in this study are market, size, value, profitability, investment, momentum, and volatility factors. Factor portfolios are re-formed at the end of April at 1- and 3-year frequencies.

The key findings of this thesis indicate that growth and momentum factor-investing strategies both in small- and large-cap segments yielded the most superior returns during an era that was heavily characterized by various stimulus measures set by the ECB. Substantial stimulus measures reversed the performance of certain factors, such as value and investment. The findings partly evidence a shift in market participants’ perception of risk when the cost of cash reduced to ultra-low levels and more funds were directed into assets with growth and momentum features. Risk-adjusted performance measures also revealed that the volatility of the underlying stocks in the best-performing portfolios was rather subdued, reinforcing the potential shift in the perception of risks by market participants. Moreover, the analysis of matching portfolios uncovered that a stock with high momentum features has been simultaneously attributable to a high growth characteristic, revealing the interlinkage between growth behind the momentum. The same phenomenon is visible for growth stocks where a strong co-movement was observed with the high profitability stocks.

Finally, the full sample were decomposed into country specific factor portfolios in order to check the robustness of the findings based on the full sample. The cross-country analysis revealed that especially the small-cap momentum, growth and robust profitability factors outperformed significantly against the market portfolio whereas loser, weak profitability and high-beta factors underperformed in the same terms.