EXECUTIVE SUMMARY
With a wealth of smart beta indices to choose from, market participants may find it difficult to decide when each factor-based strategy is best suited to deliver returns. Is it wise to rely solely on the performance of one factor? If not, what multi-factor approaches could be considered and how effective are they?
- Single-factor equity strategies (namely quality, value, momentum, and low volatility) may have rewarded market participants with active returns over the long term, but each is susceptible to unique, cyclical drawdowns.
- Choosing and timing exposures to single factors requires considerable foresight (or luck) to navigate optimally between them.
- The low correlations between the active returns of each factor generate a diversification benefit in a multi-factor portfolio, which can result in more stable excess returns.
- Adopting a bottom-up, “stock-level,” multi-factor selection process may increase overall exposures to the desired factors when compared with allocating to multiple single-factor portfolios (a topdown “index of indices” approach).
- The historical risk/return characteristics of the S&P 500® Quality, Value & Momentum Multi-Factor Index compare favorably to the best-performing single factors over varying time horizons.
- For market participants wishing to avoid the risk in choosing between single-factor strategies, multi-factor indices may offer a viable alternative without compromising on performance.
1. THE RISK OF CHOOSING BETWEEN SINGLE FACTORS
Given the unique cycles across the returns of single-factor strategies, how can those market participants without a factor view avoid putting all their eggs in the wrong basket?
1.1 The Cyclicality of S&P DJI’s Single-Factor Indices
Single-factor equity strategies have been widely adopted to harvest the unique risk premium of a particular systematic factor that could reward market participants over time. Out of the widely accepted equity factors extensively studied in academic literature, S&P DJI’s single-factor index offerings include four key factors: quality, value, momentum, and low volatility. The application of these single-factor strategies in the form of simple, rules-based indices has enabled market participants to seek active returns while benefiting from the low-cost, transparent methodology of passive investing.
