Specialist in Asia Pacific, Japan, China, India and South East Asia and Global Emerging Market equities.

Discover more

formerly Realindex Investments

Leader in active quantitative equities across Australian equities, global equities, emerging markets and global small companies.

Backed by a unique blend of research, portfolio construction and risk management, focused on uncovering original insights and translating them into investment strategies that are active and systematic, aiming to generate alpha.

Discover more

At Stewart Investors, we believe in putting people first. Our investment world-view is of a series of partnerships – with each other, with our clients, with the companies we invest in, the people who buy their goods and services, and with the wider society in which we all live and work.

Discover more

Zombies in Realindex Portfolios

Realinsights: Deep Dive



The first two papers in this series examined:

  • What zombie firms are and what their economic impact might be
  • Existing evidence on their emergence and characteristics
  • Whether we see the same trends and characteristics in our data

This final paper2 is somewhat shorter than the first two, and simply aims to look a little deeper into whether zombie firms appear in Realindex portfolios, and how a Quality factor acts as a repellent for these stocks. This is more important in Value-oriented portfolios as the potential appearance of lower quality “junk” firms, or even zombies, is higher here than in broader universes.

We had previously found that zombie firms are a much higher proportion in small cap stocks than for larger stocks, using our universe of investible names.  From our second paper:

Chart 1: Zombie firm proportions by size deciles

Chart 1

Source: Realindex, data as at 31 December 2019

Other work3 has found an increasing trend of zombie firms over time, to perhaps alarming levels, but these studies include all listed names, which means that very small and microcap names will be over-represented compared to our more investible universe. We do not find this trend – the chart below also comes from our second paper:

Chart 2: Zombie firm proportions over time


Source: Realindex, data as at 31 December 2019

Also recall that our measure of a “zombie” is slightly different to other papers:

  • Reported interest cover below 1 for three consecutive years
  • Firm older than 3 years
  • Tobin’s Q4 below sector median for the year

The quality versus value story for zombies is clearly an issue when we consider the following charts (again from our second paper) showing Price to Book (Chart 3) and Return on Equity (ROE) (Chart 4) for zombies and non-zombies in the MSCI ACWI universe. Zombie firms are both cheap and very low quality, using these metrics.

Chart 3:  Price to Book for zombies and non-zombies 

Chart 3

Source: Realindex, data as at 31 December 2019

Chart 4:  ROE for zombies and non-zombies

chart 4

Source: Realindex, data as at 31 December 2019

Using the Realindex accounting weighted process, we capture stocks which are good value but also those might be cheap “for a reason”. That is, firms with good value characteristics but which also might show poor quality. Using our enhancements overlay, which is largely quality based, we attempt to reduce our exposure to cheap low quality (“junk”) stocks, and as a result, to zombies.

There is always a chance that we will hold firms which we classify as zombies for two reasons:

  1. Our holding represents a trade-off between the stock’s value characteristics and its quality metrics, with the value component dominating by design. If a firm is cheap enough, it can outweigh the quality tilt and finish with a non-zero weight.
  2. Quality is a multi-dimensional idea. Characterising a firm using a simple profitability metric like interest cover (albeit with the Tobin’s q screen as well) misses other components of quality like gross profitability, uncertainty (for example, risk and volatility) and management (for example, payout, asset turnover and equity issuance).

What do we find? Three main takeaways

1       Proportion of zombies in our portfolios is low

The first takeaway is that the proportion of zombie firms in our portfolios is small. The table below shows this.

Source: Realindex, data as at 31 December 2020

2            Zombie exposure changes over time, but enhancement layer (i.e., quality) always matters

The second takeaway is that we do hold stocks which we have characterised as zombies, and in some cases our holdings are quite stable through time. However, our actual zombie holding percentages can vary over time. Further, our core model exposure is reduced using the enhancement layer in all regions and during all periods.

We break up our data set by region (Global, Emerging Markets (EM), Australian Large Caps (Aus Large), Australian Small Caps (Aus Smalls) and by time period. The values given in the tables are the averages throughout each period. The time periods are:

          Period A    Post Tech Crash (July 2002 to June 2006)

          Period B    Prior to and including GFC (July 2006 to June 2011)

          Period C    Post GFC (July 2011 to June 2016)

          Period D    Last 5 years (July 2016 to present)

Source: Realindex, data as at 31 December 2020

3       Dropping zombies makes no difference to our models

The third main takeaway is that the exposure of our models with and without zombie stocks is almost identical. This shows that their impact is very slight. We look at this in two ways: as a set of a portfolio metrics, and as contribution to risk factor exposure.

In terms of portfolio metrics, there is no noticeable change. Two models are given, the others have the same conclusions. Data is from Dec 2020.

Source: Realindex, data as at 31 December 2020

We can see a slightly greater impact when we look through a risk lens, but only on the Australian small cap model. Below we look at the risk contribution within the current and ex-zombies enhanced model exposures to a variety of risk factors from our Axioma risk model. Data is from Dec 2020.

Source: Realindex, data as at 31 December 2020

We can draw a few high level conclusions from this work:

  1. Zombie firms – which are necessarily cheap – can find their way into Realindex portfolios. This is entirely expected.
  2. Zombie firms do not have good long term characteristics, as we know, so the chance for them to recover and add value is limited.
  3. A brute force “exclude zombies” policy is too harsh. Firstly, our measure of zombie firms, while the accepted approach within the literature, is probably not all encompassing. We could inadvertently exclude names which are actually healthier using other measures, or include names which are poor on other measures.
  4. Instead, we let the enhancement layer of our process tilt us away from poorer quality names, which will help to drop or down-weight some firms which we would classify as zombies.
  5. The evidence we see here supports this, we see:
    a.       We do own small proportions of zombie firms
    b.       Applying the enhancement layer reduces both the weight and number of these firms
    c.       If we construct the portfolios with and without zombie firms, the exposures to aggregate stock metrics and risk factors is almost identical

This is the final paper on the topic of Zombie firms, but it is not the end of our exploration of low quality firms with the Realindex process. Next, we will look into other drivers of corporate distress, focusing on bankruptcy and its drivers.

For further information please contact:

Andrew Francis 
Chief Executive
+61 2 9010 5224
Iain McLear 
Investment Manager        
+61 2 9010 5298
Bonnie Chow
Investment Analyst
+61 2 9010 5240



2 This paper follows two earlier studies entitled “COVID and Credit and Zombies” and “Value and Realindex and Zombies”.

3 Banerjee and Hofmann (2018), “The rise of zombie firms: causes and consequences”, Bank of International Settlements. Banerjee and Hofmann (2020), “Corporate zombies: Anatomy and Life Cycle”, Bank of International Settlements.

4 Tobin’s Q refers to the ratio of asset market value to book value

5 Village Roadshow, privatised at end of Dec 2020

6 Reported as number of standard deviations multiplied by 100.

Important Information

This material has been prepared and issued by First Sentier Investors Realindex Pty Ltd (ABN 24 133 312 017, AFSL 335381) (Realindex). Realindex forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group.

This material is directed at persons who are professional, sophisticated or ‘wholesale clients’ (as defined under the Corporations Act 2001 (Cth) (Corporations Act)) and has not been prepared for and is not intended for persons who are ‘retail clients’ (as defined under the Corporations Act). This material contains general information only. It is not intended to provide you with financial product advice and does not take into account your objectives, financial situation or needs. Before making an investment decision you should consider, with a financial advisor, whether this information is appropriate in light of your investment needs, objectives and financial situation. Any opinions expressed in this material are the opinions of the Realindex only and are subject to change without notice. Such opinions are not a recommendation to hold, purchase or sell a particular financial product and may not include all of the information needed to make an investment decision in relation to such a financial product.

The product disclosure statement (PDS) or Information Memorandum (IM) (as applicable) for those registered managed investment schemes mentioned herein that are managed by Realindex (Funds), which are issued by Colonial First State Investments Limited (ABN 98 002 348 352, AFSL 232468) (CFSIL), should be considered before deciding whether to acquire or hold units in the Funds. The PDS or IM are available from First Sentier Investors.

CFSIL is a subsidiary of the Commonwealth Bank of Australia (Bank). First Sentier Investors was acquired by MUFG on 2 August 2019 and is now financially and legally independent from the Bank. Realindex, MUFG, the Bank and their respective affiliates do not guarantee the performance of the Fund(s) or the repayment of capital by the Fund(s). Investments in the Fund(s) are not deposits or other liabilities of MUFG, the Bank nor their respective affiliates and investment-type products are subject to investment risk including loss of income and capital invested.

To the extent permitted by law, no liability is accepted by MUFG, Realindex, the Bank nor their affiliates for any loss or damage as a result of any reliance on this material. This material contains, or is based upon, information that Realindex believes to be accurate and reliable, however neither Realindex, MUFG, the Bank nor their respective affiliates offer any warranty that it contains no factual errors. No part of this material may be reproduced or transmitted in any form or by any means without the prior written consent of Realindex.

In Australia, ‘Colonial’, ‘CFS’ and ‘Colonial First State’ are trade marks of Colonial Holding Company Limited and ‘Colonial First State Investments’ is a trade mark of the Commonwealth Bank of Australia and all of these trade marks are used by First Sentier Investors under licence.

Total returns shown for the Fund(s) are gross returns and do not take into account any ongoing fees. No allowance has been made for taxation. Past performance is no indication of future performance.

Copyright © First Sentier Investors (Australia) Services Pty Limited 2021
All rights reserved.