Over the last several years, the magic of “factor analysis” was promoted by the academic and investment community as an innovative way to add value to an investment portfolio. As it goes, certain factors, such as low volatility, momentum, quality, and size, represented by certain investments were proven to outperform broad benchmarks. For example, stocks that had shown low volatility (i.e., low standard deviation of return) tended to outperform stocks that had more volatility. Some factors were more robust and better predictors of better returns including low volatility, momentum, quality, and size. All of these studies, of course, were based upon long term studies that inevitably showed some short term periods of underperformance; a period where we seem to be in now (for some of the factors).
On a year-to-date basis through yesterday, the S&P 500 (IVV) has returned -4.58% whereas the only popular factor to produce outperformance has been the momentum factor (MTUM) with a total return of +3.04%. All the other factors have lagged significantly over this short term horizon, except the quality factor (QUAL) that just barely underperformed at -5.42%. Low volatility (USMV and SPLV) and small cap (SCHA and IJR) showed negative returns of -8.18%, -15.52%, -15.35%, and -21.11%, respectively. The chart below shows the dramatic variation of price return of each of these factors against the S&P 500 (the bold black line).
This short snippet of time demonstrates the importance of being a long term investor. Though we all wish that our investments would always outperform the broad benchmarks over every time horizon, we know this will not be the case. This situation reaffirms the need to match an investment strategy with your objectives and then sticking to it.