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Oleg Ruban

Oleg Ruban
Head of Analytics Applied Research for Asia Pacific

Which factors mattered in China?

Chinese equity prices have hardly been music to investors’ ears so far in 2018. The MSCI China A Onshore IMI Index — the broadest MSCI A shares index designed to represent the performance of the overall A shares market — has declined more than 25% in local currency terms through Oct. 31, 2018. Were there factors in this market that outperformed?

Analyzing the behavior of systematic sources of returns, or factors, we identified those that have been associated with outperformance in China regardless of market regime. These consistent factors largely maintained their expected performance in the recent China market drawdown.


Striving for “first chair”

Overall market performance can often hide the diversity of individual company and strategy returns. The exhibit below is sometimes called a violin chart. The width of the “violin body” shows the frequency of assets achieving a given return in a particular year. A longer and thinner violin represents greater differentiation of returns and potentially more opportunities for managers to differentiate their performance from the broad market. Looking at the distribution of returns in the A shares market from Jan. 1, 2014 to Oct. 31, 2018, we see that although the dispersion of performance has declined since 2015, there was still a significant difference in returns between the best- and worst-performing assets.

Violin chart of cross-sectional dispersion in China A shares returns

In this tough, wide-bodied-violin environment, could managers have created investment strategies that better leveraged certain factors? We looked at whether one answer might have been to focus on the cross-sectional characteristics of stocks captured by style factors. We found that while some styles behaved directionally — their returns were positive or negative depending on the behavior of the broad market — others had more persistent performance in different market environments.

The exhibit below illustrates this difference in behavior for Chinese equities. To construct the chart, we took the monthly history of China country and style factors and returns from the Barra China Equity Model, using data from January 2008 to December 2017. We sorted the months from highest to lowest by country factor returns.1 We then segmented the data into quintiles, so that the top quintile corresponds to months with the most positive market performance, while the bottom quintile corresponds to months with the most negative market performance. Next, we assessed the relationship of market performance to the style factors with the most alpha-like characteristics, factors with long-run information ratios (returns above the benchmark relative to the volatility of those returns) that were meaningfully different from zero.2

We found3 that in China:

  • Returns of the beta and earnings yield factors tended to be higher at times when the market return was higher; this direct relationship held when the market was lower as well (positive directionality).
  • Returns of the momentum, profitability and growth factors tended to be lower when the market return was higher; this inverse relationship held when the market was lower as well (negative directionality).
  • Returns on book-to-price, dividends yield and industry momentum were positive in months with the highest market returns as well as those with the lowest (had some convexity).4
Factors with positive directionality

Data from January 2008 to December 2017

Factors with negative directionality

Data from January 2008 to December 2017

Factors with “convexity”

Data from January 2008 to December 2017


Finally, a large number of factors had consistently positive or negative returns regardless of the overall China A market.

  • Liquidity, size and mid-cap factors had consistently negative returns, meaning that less liquid, small- and mid-cap companies, all other things equal, likely would have outperformed on average in all market regimes.
  • Short-term reversal, analyst sentiment and seasonality factors had consistently positive returns, meaning that stocks with positive exposure to these factors, all other things equal, likely would have outperformed in all market regimes.
Factors with consistently negative or positive returns regardless of overall market

Data from January 2008 to December 2017

How did these “consistent” factors perform during the recent market drawdown?

These factors behaved largely as expected based on historical analysis of their returns before 2018. Comparing the realized average monthly factor returns in 2018 to the historical pattern, we see that all the “consistent” factors maintained their positive or negative performance. Illiquid, small- and mid-cap stocks, as well as stocks with positive exposure to short-term reversal, analyst sentiment and seasonality have outperformed, once we control for other characteristics.

Market drawdowns present a tough environment for managers, especially those with long-only portfolios. Analyzing the behavior of factors may have helped focus on those characteristics that have been associated with outperformance in China during the study period regardless of market regime.


1 The country factor in the China model represents the performance of the broad China A-shares market.

2 We assess this by testing the statistical significance of the information ratio.

3 This blog contains analysis of historical data, which may include backtested or simulated performance results. There are frequently material differences between backtested or simulated performance results and actual results subsequently achieved by any investment strategy. Past performance — whether actual, backtested or simulated — is no indication or guarantee of future performance. None of the information or analysis herein is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision or asset allocation and should not be relied on as such.

4 The appearance of momentum in this category might be surprising. While momentum is a high risk factor, it is negatively correlated with the market return in most countries and regions, giving it a hedging property against market drawdowns.

Further Reading

Vive la Difference: Active factor strategies in China A shares

How the low volatility factor has performed in China A shares

Can your investment strategy work with China A shares?

China A shares: The journey continues

Are you ready for China A shares?

Factor investing webpage

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