Understanding Factor Investing (2nd part)

In this second part, I will evaluate how these six academically-proved factors performed globally from late 1998 to September 2018. For my purpose, I selected the MSCI ACWI Index family, which attempts to represent the performance of the full opportunity set of large-and-mid cap stocks globally by including stocks across 23 developed and 24 emerging markets. In March 2018, the index was made up of 2.400 different stocks, approximately representing 85% of the free float-adjusted market capitalization in each market. Covering 11 sectors, the index had 3.7 trillion in benchmarked assets globally in December 2017.

With regard to factor indexes, the indexes chosen are part of the MSCI High Capacity Factor Indexes. High Capacity Factor Indexes are the closest to the parent index (Capitalization-weighted index) and is elaborated by tilting market capitalization weights of all of the components forming the parent index according to the relevant factor score. As MSCI explains, all constituents of a parent index are then reweighted accordingly. For example, the MSCI AWCI Value Index contains all the stocks composing the MSCI AWCI Index (its parent) while try to capture large-and-mid cap securities exhibiting overall value style characteristics across 23 Developed Markets and 24 Emerging Markets by reweighting the stocks according to three value-considered variables: book value to price, 12-month forward earnings to price and dividend yield. Besides, the index is reviewed semi-annually (May and November) in order to reflect change in the style characteristics of the underlying equity markets.

The reason for having chosen this category lays on the high investability they offer in contrast with other factor indexes categories, which could not offer sufficient liquidity and capacity.

Therefore, as you can see below, six different High Capacity Factor Indexes (Value, Low Volatility, Quality, Momentum, Size and Dividend) were selected:

Global Markets – MSCI ACWI INDEX:


Factor performance across the globe:

As we can observe in Chart number 2, all factor indices derived from the MSCI ACWI outperformed their benchmark (MSCI ACWI Index) in terms of accumulated returns over the approximately 20-year period. Clearly, the index that tilts to low volatility stocks is the big winner, registering a holding period return of more than 400% in 20 years.

msci acwi

A descriptive table was elaborated in order to better explain how these indexes behaved and beat their parent counterpart.


While all factor indexes outperformed the market according to return/risk calculations, the MSCI ACWI Volatility did it by a larger extend, doubling the return/risk ratio of the parent index.

As a second step, I analyzed the performance of factor indexes during different market periods: During the strong performance after the recovery of the dot com crash (from April 2003 to October 2007), the stock market meltdown (from November 2007 to February 2009) and the subsequence recovery (from March 2009 to September 2011) to end up assessing the market boom period after this (from October 2011 to September 2018). As one can see in the following graphic, the vertical lines correspond to the start and the end of each of the periods described above.

graphic Çii

Main Conclusions:

Market Boom: In terms of accumulated returns, the Size factor was the best performance among all other indexes, registering an increase of 190,67% between April 2003 and October 2007. As a result, the Size factor also presented the higher Annual Time Weighted Return, which was 26,21% for the analyzed period. However, the ranking changes when considering outperformance as higher risk-adjusted returns (Return/Risk). In this context, as it happened in the whole period, the MSCI ACWI Volatility Index is the best performing factor index.

It is also worth noticing that even though the Quality factor outperformed the parent index during this period, it did so by a minimum margin and lies at the bottom of the ranking. I personally attribute this fact to the variability of the price of Quality that has been academically studied. Academics state that Quality price tends to be lower during market booms, when other riskier securities outperform and risk-aversion gets lower. Therefore, this theory matches my findings: Quality presents a better performance relative to other factors and relative to the benchmark after market booms (in market crashes) and in recovery periods.

Market Crash: More defensive factors, like low-Volatility, Quality or Dividend also proved their more resilient behaviour in front of market meltdowns since they offer higher return/risk ratios during the period. In this case, Value and Size are not able to beat the market. The smaller size of these companies and the usually higher leverage that may present make value and small-size stocks bad bets in turbulent This fact empirically proves the existence of factor cyclicality, which claims that factor investing strategies can deliver some periods of underperformance. Besides, it is also worth mentioning the increasing correlation that all factors experience during turbulent times.

Recovery: Along with the recovery, strong revalorizations came for more volatile factors, with Size leading the way with an increase of almost 60% in approximately three years. Again, Value was not able to beat the market in this period either.

General Conclusion:

Even simple factor strategies, which do not significantly differ from the broad-and-liquid market, are able to beat it in terms of risk-adjusted returns; at least they did so over the 20-years period analyzed.

Besides, Volatility-factor strategy seems the work better regardless of the market period since it presented risk-adjusted returns which in all cases were higher than those of the parent index and its factor counterparts.

Ferran Capella Martínez

Miembro del Servicio de Estudios y Publicaciones de la Bolsa de Barcelona, BME.

Categorías:Análisis fundamental, Economía, General

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