Tuesday, July 02, 2024

Forget About Factors?

In its latest post, Finomial may have poured cold water on factor investing. One way that factors are used is as sort of rearranging the S&P 500 to weight it differently or sampling a smaller chunk of the 500 that have some trait in common. The more common ones are momentum, quality, low volatility, even value and growth could be considered factors too. Other ones that I would add to the list include dividends, buybacks, various option overlay funds might count too and there are also multifactor funds.

These tend to be long only funds. Finomial talked about long/short being better representatives of the factor investing, citing a couple of AQR funds as fitting this bill but those funds seem more like differentiated return streams than hoped for improvements versus market cap weighting. 

My take on factor investing is that I have long been intrigued but it feels like a puzzle I've been unable to solve. I made the following table  with the help of portfolio visualizer. 

To my point about being an unsolved puzzle, there's no pattern or consistency to when a given factor will outperform. Intuitively you might think that momentum would outperform when the S&P 500 is up a lot. From 2015 forward, the S&P 500 was up 20% or more four times. The iShares Momentum ETF (MTUM) outperformed only one of those four, in 2017. In 2018, the S&P 500 was up 18% and MTUM outperformed and it is outperforming so far in 2024. 

I've mentioned the quote from Cliff Asness about momentum plus carry being a very strong combination. I'm intrigued by that idea and have tried to replicate it with funds but haven't gotten there yet. Maybe there is a better momentum fund? Below are some of the bigger ones.

The market is shockingly top-heavy these days and SPMO has benefitted from that more than the others. SPMO will continue to benefit from the current narrow breadth for as long as that lasts. When or if the music stops, SPMO is very likely to get pasted. MTUM's weight in NVDA is close to the plain S&P 500 weight in the name and the others ones certainly are skewing high but that top ten for SPMO is very much a live by the sword weighting. 

And for MTUM

Since it listed in 2015, SPMO has compounded at 16.48% versus 13.36 for MTUM and 13.81 for VOO. If we only look until the end of 2023, then SPMO compounded at 13.45% versus 11.22% for MTUM and 12.74 for VOO. I think the better result up through 2023 is attributable to only going down 10% in 2022 versus 18% for the S&P 500. 

If you have a diversified portfolio, you have exposure to the the big tech stocks that are doing all the heavy lifting this year but being overweight in names that have gone parabolic takes on enormous risk. We can each decide for ourselves whether the extra risk is worth the incremental return opportunity. Yes there have been a couple of years of real outperformance for each of the factors but there have also been some very poor years too. The concept of factors still intrigues me but Finomial made a great point about their spotty performance.  

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

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