Genus Factor Focus - May 2009

Factor Focus Vol. 1, No. 02— May 2009

Value focus shifts from junk to profitability O sharply. Outside of their cheapness, these stocks have weak fundamentals and remain unattractive. As investors become more discerning in their approach to value the junk-stock rally is losing steam.

ver the past two months the performance of stock selection strategies has been characterized by extremely negative performance from momentum strategies and extremely positive returns from value based strategies—predominantly deep value Price to Book strategies. The junk-stock rally has been driven by a sharp price reversion from stocks that sold off last fall on concerns about balance sheet strength and earnings prospects in the wake of the credit crisis and recession.

This was evident in May when value based strategies emphasizing earnings (value for a reason) rather than deep value factors (cheapness) came into play. The increased focus on earnings and profitability was reflected in the outperformance of Return on Equity and 2-Year EBITDA Growth. (Exhibit 1)

As investor appetite for risk returned on the back of improving economic prospects, low quality stocks with the most debt and the weakest earnings snapped back

Focusing on attractive ‘value for a reason’ stocks that are starting to come back into favour may provide the best alpha opportunities over coming months.

Exhibit 1: Stock Selection Factors (Canada) — Best and Worst Performers for May 2009 Financial strength

Return on Equity Price/Earnings

Valuation

2-Year EBITDA Growth

Earnings growth

Interest Coverage

Financial strength

EBITDA/Enterprise Value

Valuation

Dividend Yield Book/Price Size

Size

Quarterly Cash Flow

Earnings growth

Leverage

Financial strength Earnings growth

Quarterly Dividends Earnings Surprise

Street research

Analyst Agreement 6M Price Momentum Analyst Estimate Revision

Technicals Street research

Share Repurchase

Management signals Technicals

11M Price Momentum -8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Exhibit 1 shows the performance of our broader set of common factors in Canada. Across all these factors, the shift from momentum to value outperformance that started mid-March continued through May. However, as the market switched focus from deep value cheapness to profitability, the best performers were those valuation factors with a focus on balance sheet strength and earnings: Return on Equity, 2-Year EBITDA Growth and Interest Coverage. Momentum factors (11M Price Momentum, 6M Price Momentum, Analyst Agreement and Analyst Estimate Revision) continued to underperform in May. Factor Focus

1

Factor Focus — Black Swan still flying high Exhibit 2: Canadian Value Combo Versus Momentum Combo (3M rate of change) 80

Black Swan 60

5 Sigma

40

3 Sigma 20

0

Mean

-20

-40

-60 Apr 93 Apr 94

Apr 95 Apr 96 Apr 97 Apr 98 Apr 99 Apr 00 Apr 01 Apr 02 Apr 03 Apr 04

Apr 05 Apr 06 Apr 07 Apr 08 Apr 09

Exhibit 2 shows the extreme outperformance of value factors versus momentum factors in the past two months as investor appetite for risk was marked by a massive and rapid change in preference toward junk-diet deep value stocks that previously had been beaten down in price. Source: Genus/BARRA

Exhibit 3: S&P 500 Long-Term Risk Factor Index Performance 30

20

10

0

Still room for comeback in appetite for risk... -10

-20

-30 Jan 93 Sep 93 May 94 Jan 95 Sep 95 May 96 Jan 97 Sep 97 May 98 Jan 99 Sep 99 May 00 Jan 01 Sep 01 May 02 Jan 03 Sep 03 May 04 Jan 05 Sep 05 May 06 Jan 07 Sep 07 May 08 Jan 09

The S&P 500 Long-Term Risk Factor Index shows that investor appetite for risk continued its comeback through May. The index, comprised of Earnings Variation, Volatility and Leverage factors, has bounced back sharply after being oversold. The index is positively correlated with the performance of the market. Source: Genus/BARRA Factor Focus is published monthly by Genus Institutional Equity, a division of Genus Capital Management 6th Floor ~ 900 West Hastings St., Vancouver, BC, Canada V6C 1E5 T 604 683 4554 [email protected] www.genuscap.com