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Factor investing is an investment approach that involves targeting specific drivers of return across asset classes. Investing in factors can help improve portfolio outcomes, reduce volatility and enhance overall portfolio diversification. When we talk about factors in a smart beta context, we are generally talking about style factors as opposed to macro factors. The typical style factors we find quoted in academic literature are:
The appeal of factor investing is that factors have been shown to outperform the broad market over the long term.
Source: Bloomberg Finance L.P., MSCI, Indexes are MSCI Factor indices in AUD.
Time horizon is an important consideration for factor investing, as longer time frames increase investors ability to harvest factor premiums when compared to shorter periods of time, where factors may experience periods of underperformance.
One factor that has come under more scrutiny than others has been Value. In particular, over the last two years, the underperformance of Value has garnered more attention. Over this period Value has significantly underperformed the broader index.
Source: Bloomberg Finance L.P., MSCI, MSCI Value in AUD.
Year to date, the MSCI Value Index has underperformed the MSCI World Index by almost 15%. However the underperformance of Value can be attributed to two key themes.
As we think about 2020, the first quarter sell off for the stock market was broad but the recovery has been relatively narrow, and is driven by the information technology sector, the consumer discretionary sector and the consumer services sectors. These three sectors being categories of the FAANGs (Facebook, Amazon, Apple, Netflix and Google) – which make up over 10% of the MSCI World Index by themselves. These sectors and stocks have driven the performance of the Growth and Quality factors and resulted in the relative underperformance of Value.