From Invesco: Small-size, momentum and growth strategies paced factor performance during the third quarter of 2017. By contrast, low volatility, low beta and value struggled as standalone factors during this time — although a late spike in 10-year Treasury yields helped value shares reverse some of their losses earlier in September.
As has been the case so far this year, factor dispersion was significant in the third quarter. The spread between the best- and worst-performing factors was 8.77% for the quarter and 29.17% year to date. This dispersion in returns highlights the differentiated risk and return profiles present in investment factors, and underscores the benefits of factor diversification.
Factor performance: Q3 2017 and year-to-date 2017
|Factor||Index||Q3 2017||YTD 2017|
|Small-cap momentum||Dorsey Wright SmallCap Technical Leaders Index||10.58%||17.54%|
|Multi-factor large-cap growth||Dynamic Large Cap Growth Intellidex Index||8.99%||23.19%|
|Sector rotation||Dorsey Wright Sector 4 Total Return Index||8.12%||11.90%|
|Large-cap growth||Russell Top 200 Pure Growth Index||7.49%||27.90%|
|Multi-factor broad||Dynamic Market Intellidex Index||7.38%||14.05%|
|High beta||S&P 500 High Beta Index||6.77%||9.32%|
|Large-cap momentum||S&P 500 Momentum Index US Dollar Gross Total Return||6.38%||17.55%|
|Fundamental small-mid||FTSE RAFI US 1500 Mid Small Index||6.06%||9.60%|
|Small cap||S&P SmallCap 600 Index||5.96%||8.92%|
|Small-cap low volatility||S&P SmallCap 600 Low Volatility Index||5.83%||7.26%|
|Mid-cap growth||Russell Midcap Pure Growth Index||5.75%||24.60%|
|Large-cap broad market||S&P 500 Index||4.48%||14.24%|
|Large-cap value||Russell Top 200 Pure Value Index||4.45%||10.06%|
|Fundamental large-cap||FTSE RAFI US 1000 Index||4.34%||9.24%|
|Small-cap value||Russell 2000 Pure Value Index||4.32%||0.93%|
|Low volatility rising rate||S&P 500 Low Volatility Rate Response Index||4.29%||14.97%|
|Small-cap growth||Russell 2000 Pure Growth Index||4.17%||18.86%|
|Buyback||NASDAQ Buyback Achievers Index||4.13%||11.39%|
|Momentum mid-large||Dorsey Wright® Technical Leaders Index||4.05%||16.02%|
|Large-cap equal weight||Russell 1000 Equal Weight Index||4.00%||10.79%|
|Multi-factor large-cap value||Dynamic Large Cap Value Intellidex Index||3.86%||12.65%|
|Large-cap quality||S&P 500 Quality Index||3.81%||12.45%|
|Large-cap value||S&P 500 Enhanced Value Index||3.38%||10.38%|
|Mid-cap value||S&P MidCap 400 Index||3.22%||9.40%|
|Large-cap low volatility||S&P 500 Low Volatility Index||3.05%||12.19%|
|Dividend growth||NASDAQ Dividend Achievers 50 Index||2.97%||4.13%|
|Large-cap low volatility high dividend||S&P 500 Low Volatility High Dividend Index||2.77%||7.65%|
|Small-cap low volatility high dividend||S&P SmallCap 600 Low Volatility High Dividend Index Total Return||2.22%||-1.27%|
|Low beta equal weight||Russell 1000 Low Beta Equal Weight Index- Total Return||2.12%||10.34%|
|Mid-cap value||Russell Midcap Pure Value Index||1.96%||0.14%|
|Mid-cap low volatility||S&P MidCap 400 Low Volatility Index||1.81%||9.08%|
|Number of factor indices exceeding the S&P 500 Index||11||9|
Source: Bloomberg L.P., Sept. 30, 2017. Past performance is no guarantee of future results. Index returns do not represent fund returns. An investor cannot invest directly in an index.
Economic fundamentals favor small-cap factor combinations
The best-performing factor combination during the quarter was small-cap momentum, as evidenced by the Dorsey Wright SmallCap Technical Leaders Index, which outperformed the S&P SmallCap 600 Index by 4.62% during the quarter. Firming economic growth and renewed prospects for tax cuts supported the overall performance of small-cap stocks, which have the potential to do well in a strengthening economy. Within small-cap momentum, strong stock selection in information technology, consumer discretionary, health care and industrials drove excess returns. By contrast, light exposure to energy and poor selection in materials acted as drags to performance.
The worst-performing factor combination in the third quarter was mid-cap low volatility. During this time, the S&P 400 Low Volatility Index lagged its parent index, the S&P MidCap 400 Index, by 1.41%. Mid-cap stocks may have been hurt by a rotation into smaller-cap shares on expectations of accelerating economic growth and tax cuts. Although the S&P SmallCap 600 Index performed well during the third quarter, the small-cap index still lags the S&P MidCap 400 Index year to date. Mid-cap low volatility shares were weighed down by the poor performance of certain industrials and basic materials in the third quarter, while health care was most supportive to performance.
Low volatility, tightening credit spreads drive growth, momentum strategies
Macroeconomic conditions supported the growth and momentum factors during the third quarter. In the table of factor return drivers below, note the trends of low and falling volatility (via the CBOE Volatility Index), tight and falling credit spreads (high yield spreads) and low correlation among stocks. Low correlations tend to correspond with wider return dispersion, which, in turn, typically supports momentum stocks. Strong economic growth, as seen in the ISM Manufacturing Index, coupled with improvement in the Citi Economic Surprise Index, boosted small-cap stocks in the third quarter, but did not translate to strength in the value factor, which faced the headwind of low interest rates.
Congressional action, economic expansion could be key to fourth quarter performance
I believe that factor performance in the fourth quarter of 2017 will likely depend on whether or not the Republican-controlled Congress can pass tax reform legislation. Also key will be continued global expansion, which I believe appears solid, given the September manufacturing Purchasing Managers Index readings in both developed and emerging markets. Cyclical economic strength could lead to higher interest rates and continue September’s trend of value stocks outpacing growth shares. Both the small-size and value factors have the ability to prosper during periods of strong economic growth and rising long-term interest rates.
Nonetheless, geopolitical risks are plentiful, given ongoing US tensions with North Korea and military and political conflict in the Middle East. In addition, there is no shortage of political turmoil in Europe, including the Catalan succession vote, Brexit, the rise of the Alternative for Germany (AfD) party (a populist and euro-sceptic party), and growing anti-euro sentiment in Italy. Stateside, the US Congress has failed to pass meaningful legislation — and tax reform alone will be major undertaking. Given these risks, investors may wish to consider maintaining a low volatility allocation in the coming months.
Correlation is the degree to which two investments have historically moved in relation to each other.
Factor investing is an investment strategy in which securities are chosen based on certain characteristics and attributes.
There is no guarantee that low-volatility stocks or ETFs will provide low volatility.
Investing in securities of large-cap companies may involve less risk than is customarily associated with investing in stocks of smaller companies.
Stocks of small- and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
A momentum style of investing is subject to the risk that the securities may be more volatile than the market as a whole, or that the returns on securities that have previously exhibited price momentum are less than the returns on other styles of investing.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.
Treasury securities are backed by the full faith and credit of the US government as to the timely payment of principal and interest.
Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.
An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Investments focused in a particular industry or sector are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.
The funds are non-diversified and may experience greater volatility than a more diversified investment.
Shares are not individually redeemable, and owners of the shares may acquire those shares from the fund and tender those shares for redemption to the fund in creation unit aggregations only, typically consisting of 10,000, 50,000, 75,000, 100,000 or 200,000 shares.
Spread represents the difference between the yield on a corporate bond and a similar maturity US Treasury bond.
Volatility is a statistical measurement of the magnitude of up and down asset price fluctuations over time.
The Bloomberg Barclays US Corporate High Yield to Worst?10-Year Treasury Spread Index, which displays the yield spread between a portfolio of high yield notes as defined by Barclays Capital and the 10-year Treasury yield, measures risk in the high yield market.
The CBOE Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.
The Citigroup Economic Surprise indexes are quantitative measures of economic news, defined as weighted historical standard deviations of data surprises; a positive reading of the Economic Surprise Index suggests that economic releases have on balance been beating consensus estimates.
The CRB BLS Spot Index measures price movements of 22 sensitive basic commodities from markets presumed to be among the first to be influenced by changes in economic conditions.
The Dorsey Wright Sector 4 Total Return Index selects up to four exchange-traded funds from the PowerShares DWA Momentum Sector lineup of ETFs with the objective of gaining exposure to the strongest relative strength sectors in the US equity space on a monthly basis.
The Dorsey Wright SmallCap Technical Leaders Index includes securities pursuant to a Dorsey, Wright & Associates, LLC proprietary selection methodology that is designed to identify companies that demonstrate powerful relative strength characteristics. Approximately 200 companies are selected for inclusion from a small-cap universe of approximately 2,000 of the smallest US companies selected from a broader set of 3,000 companies.
The Dorsey Wright Technical Leaders Index includes approximately 100 US companies from a broad mid- and large-capitalization universe. The index is constructed pursuant to Dorsey, Wright & Associates, LLC’s proprietary methodology, which takes into account, among other factors, the performance of each of the approximately 1,000 largest companies in the eligible universe as compared to a benchmark index, and the relative performance of industry sectors and sub-sectors.
The Dynamic Large Cap Growth Intellidex Index seeks to provide capital appreciation while maintaining consistent stylistically accurate exposure. The Style Intellidexes apply a rigorous 10-factor style isolation process to objectively segregate companies into their appropriate investment style and size universe.
The Dynamic Large Cap Value Intellidex Index is designed to provide capital appreciation while maintaining consistent stylistically accurate exposure. The Style Intellidexes apply a rigorous 10-factor style isolation process to objectively segregate companies into their appropriate investment style and size universe.
The Dynamic Market Intellidex Index seeks to identify and select companies from the US marketplace with superior risk-return profiles.
The FTSE RAFI US 1000 Index is designed to track the performance of the largest US equities, selected based on the following four fundamental measures of firm size: book value, cash flow, sales and dividends. The 1,000 equities with the highest fundamental strength are weighted by their fundamental scores.
The FTSE RAFI US 1500 Small-Mid Index is designed to track the performance of small and medium-sized US companies. Companies are selected based on the following four fundamental measures of size: book value, cash flow, sales and dividends. Each of the equities with a fundamental weight ranking of 1,001 to 2,500 is then selected and assigned a weight equal to its fundamental weight.
The ifo Business Climate Index is a highly-regarded early indicator of economic developments in Germany published on a monthly basis.
The ISM Manufacturing Index, which is based on Institute of Supply Management surveys of more than 300 manufacturing firms, monitors employment, production inventories, new orders and supplier deliveries.
The NASDAQ US BuyBack Achievers Index is designed to track the performance of companies that meet the requirements to be classified as BuyBack Achievers. It is composed of US securities issued by corporations that have effected a net reduction in shares outstanding of 5% or more in the trailing 12 months.
The NASDAQ US Dividend Achievers 50 Index is composed of 50 stocks selected principally on the basis of dividend yield and consistent growth in dividends.
The Purchasing Managers Index (PMI), a commonly cited indictor of the manufacturing sectors’ economic health, is calculated by the Institute of Supply Management.
The Russell 1000 Equal Weight Index captures the risk and return performance of an equal weight investment strategy for US large-cap stocks.
The Russell 1000 Low Beta Equal Weight Index tracks US large-cap stocks that exhibit low beta, with all index constituents weighted equally within the index.
The Russell 2000 Pure Growth Index is composed of securities with strong growth characteristics selected from the Russell 2000 Index. Securities are weighted based on their style score.
The Russell 2000 Pure Value Index is composed of securities with strong value characteristics selected from the Russell 2000 Index. Securities are weighted based on their style score.
The Russell Midcap Pure Growth Index is composed of securities with strong growth characteristics selected from the Russell Midcap® Index. Securities are weighted based on their style score.
The Russell Midcap Pure Value Index is composed of securities with strong value characteristics selected from the Russell Midcap® Index. Securities are weighted based on their style score.
The Russell Top 200 Pure Growth Index is composed of securities with strong growth characteristics selected from the Russell Top 200 Index. Securities are weighted based on their style score.
The Russell Top 200 Pure Value Index is composed of securities with strong value characteristics selected from the Russell Top 200 Index. Securities are weighted based on their style score.
The S&P 500 Enhanced Value Index is designed to measure the performance of the top 100 stocks in the S&P 500 Index with attractive valuations based on “value scores” calculated using three fundamental measures: book value-to-price, earnings-to-price and sales-to-price.
The S&P 500 High Beta Index consists of the 100 stocks from the S&P 500 Index with the highest sensitivity to market movements, or beta, over the past 12 months. Beta is a measure of relative risk and is the rate of change of a security’s price.
The S&P 500 Low Volatility High Dividend Index is composed of 50 securities traded on the S&P 500 Index that historically have provided high dividend yields and low volatility.
The S&P 500 Low Volatility Index consists of the 100 stocks from the S&P 500 Index with the lowest realized volatility over the past 12 months.
The S&P 500 Low Volatility Rate Response Index is designed to measure the performance of the top 100 companies of the S&P 500 Index that have exhibited low volatility and are less sensitive to changes in interest rates.
The S&P 500 Momentum Index is designed to measure the performance of securities in the S&P 500 Index universe that exhibit persistence in their relative performance.
The S&P 500 Quality Index screens holdings based on three fundamental measures of quality — profitability, earnings quality and financial robustness — which help to assess a company’s potential future profitability, as well as the financial risk each company faces.
The S&P MidCap 400 Index is an unmanaged index considered representative of mid-sized US companies.
The S&P MidCap 400 Low Volatility Index consists of 80 out of 400 medium-capitalization range securities from the S&P MidCap 400 Index with the lowest realized volatility over the past 12 months.
The S&P SmallCap 600 Index is a market-value-weighted index that consists of 600 small-cap US stocks chosen for market size, liquidity and industry group representation.
The S&P SmallCap 600 Low Volatility High Dividend Index seeks to measure the performance of the 60 least-volatile high dividend-yielding stocks in the S&P SmallCap 600 Index.
The S&P SmallCap 600 Low Volatility Index consists of 120 out of 600 small-capitalization range securities from the S&P SmallCap 600 Index with the lowest realized volatility over the past 12 months.
The US Dollar Index measures the value of the US dollar relative to majority of its most significant trading partners.
The Global Industry Classification Standard was developed by and is the exclusive property and service mark of MSCI, Inc. and Standard & Poor’s.
The PowerShares S&P 500 Low Volatility Portfolio (SPLV) was unchanged in premarket trading Thursday. Year-to-date, SPLV has gained 13.37%, versus a 15.14% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Invesco.
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