Discover the driving forces behind asset-class returns in the equity realm through factors, the key market drivers. Academic consensus supports a limited set of rewarded factors like Value, Size, Momentum, Low Volatility, High Profitability, and Low Investment. These factors offer investors compensation for the additional risks they entail, making factor strategies a compelling investment option. By providing exposure to rewarded risk factors alongside market risk, factor strategies can potentially deliver superior risk-adjusted performance compared to cap-weighted benchmarks over the long term.
Reflecting on the year 2022, investors witnessed the outperformance of equity risk factors amidst challenging circumstances. While the financial media attributes much of the recent factor performance to the Value factor, the resurgence in factor performance was more widespread and impactful than commonly portrayed.
Expanding Factor Performance Across Markets
Diving deeper into factor performance unveils a broader tale, with nearly all factors in the United States portraying positive performance in 2022. Momentum, Low Investment, and Value stood out by surpassing their long-term average returns, although not reaching their best 5% annual rolling returns. Even factors like Low Volatility and Size managed to secure positive performance despite falling below their long-term averages. Interestingly, High Profitability was the outlier, posting negative performance that surpassed its worst 5% rolling return over several decades.
2022 Highlights: US Factor Performance
| US Factors | Size | Value | Mom | Low Vol | High Pro | Low Inv | 6-F EW |
| 2022 | 3.5% | 8.4% | 19.9% | 4.3% | -10.1% | 15.4% | 6.9% |
| Avg. Rolling Annual Return |
8.8% | -1.7% | 3.9% | 8.5% | 3.8% | 4.1% | 4.1% |
| Worst 5% Rolling Return |
-22.0% | -20.5% | -20.9% | -17.4% | -9.1% | -9.2% | -3.9% |
| Best 5% Rolling Return |
53.8% | 14.4% | 27.9% | 36.9% | 22.5% | 21.3% | 18.7% |
Unravel the impact of the macroeconomy on factor behavior in specific environments. A macro framework developed by leading experts offers insights into how macro variables like short rates, term spreads, default spreads, and inflation influence factor performance. Surprisingly, these macro variables significantly explained potential shifts in US equity factors in 2022, shedding light on the intricate relationship between macroeconomic conditions and factor returns.
The Future of Factors
While predicting the behavior of factors in the upcoming years is challenging, an economic backdrop dominated by monetary policy appears likely. How this scenario influences sectors and factors remains uncertain, underlining the importance of diversified investments across rewarded factors. Despite market fluctuations and macro developments, historical data suggests that the long-term benefits of risk factors persist. Therefore, a comprehensive multi-factor strategy with balanced exposures to the six rewarded factors is poised to continue yielding favorable returns in the future.
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Disclaimer: The expressed opinions are solely those of the author and not investment advice. Views do not necessarily reflect those of CFA Institute or the author’s employer.
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