The upswing in broad stock market benchmarks in 2023 has lifted many boats, but it’s also left a few behind. This is particularly true of factor-linked exchange-traded funds, which have been performance laggards since the start of the year. What’s going on?
Factor ETFs are tied to single strategies—seeking value stocks, for instance, or momentum plays or companies with low volatility. Such financial attributes are designed to reduce volatility and improve equity returns. But this year, such funds have underperformed widely held ETFs like the Invesco QQQ ETF and State Street’s SPDR S&P 500 ETF.
The Fidelity Momentum Factor ETF (FDMO), for example, has gained only 6.75%, while the Invesco QQQ fund is up a sizzling 31.11% and the State Street fund is up 9.79%. The Invesco S&P 500 Low Volatility ETF (SPLV), meanwhile, has done worse, sliding 4.44%, while the iShares MSCI USA Value Factor ETF (VLUE) is down 2.20%.
The rebound in growth sectors like technology and communication services has been key to this year’s stock market rally. Yet these three factor funds have less exposure to these industry groups, and that’s contributed to their underperformance.
Among the few factor fund success stories are those ETFs linked to the growth, like the iShares Factors US Growth Style ETF (STLG). That fund’s 18.71% return this year is tied up with the Russell 1000 Growth Index, which includes a mix of large and mid-cap companies with accelerating revenues. Apple, Microsoft and Nvidia are among the iShares fund’s top 10 holdings.
Despite their mixed performance, the enthusiasm for factor ETFs hasn’t been dampened overall.
Assets in factor ETFs have jumped to over $1 trillion, according to Bloomberg Intelligence. This number includes both single and multi-factor funds along with ESG products.
Why Factors?
By isolating the criteria in their stock selection, by factors such as momentum and volatility, investors can express their viewpoint about the types of stocks they want to own. For example, environmental, social and governance factor investing, also known as “ESG,” excludes companies that don’t rise to the standards of impact investors.
While factors are not new to investing, the ETF market has made it easy and affordable for investors and their advisors to align money with certain attributes in mind.
The first ever factor ETF to be launched in U.S. markets, the Invesco S&P 500 Equal Weight ETF (RSP), just celebrated its 20-year anniversary on April 24, 2023. Although the fund owns the same components as the S&P 500, it weights each stock with an even 0.20% allocation. This strategy reduces the possibility of one or a handful of mega-cap stocks overwhelming a fund’s performance and volatility.
Over the past 20 years, the Invesco equal weight fund has outperformed State Street’s flagship S&P 500 fund, enjoying a cumulative gain (not including dividends) of 546.45% over SPDR’s 533.41% gain. The impressive historical outperformance of equal weight strategies has given credibility to factor investing.
Advisors looking for a more diversified approach should look at multi-factor ETFs. Instead of concentrating risk on a single factor, these ETFs incorporate multiple strategies within a single fund. The Hartford Multifactor Developed Markets (ex-US) ETF (RODM) is one such example.
The fund ranks non-U.S. stocks across 22 developing countries. Large and mid-cap stocks with a value rating account for half of the score, while quality and momentum represent the remaining portion. The end result is a multi-factor ETF that leans toward large-cap international value.