06 Oct 2020 3 min read

Factor checking the market

By Tim Armitage

We look at how the technology sector is affecting the performance of factor portfolios.



A wide range of equity risk factors (or styles) have been identified in academic literature, yet there remain relatively few that are both compensated (i.e. they deliver a positive risk premium over time) and transparent (i.e. there is a plausible and widely accepted rationale for their persistence). Five factors have historically exhibited both characteristics: value, low volatility, quality, size, and momentum.

While individual factors can go through sustained periods of relative under- or outperformance, they are likely to do so at different times. It follows that a balanced portfolio of factor exposures should provide cost-effective exposure to the range of positive risk premia over the long term, while the diversification across factors should reduce volatility when compared with individual factor exposure or factor-timing strategies.

But although correlations among equity risk factors remain low over long periods, this does not necessarily translate to consistent positive performance. There are other risks to consider, including factor degradation, crowding, a rise in correlations between factors, and the outperformance of the largest stocks in the universe.

This year has been tough on US equity factor portfolios, largely because of the outsized influence of technology stocks. The outperformance of the largest stocks in the market-cap weighted index has weighed heavily on the returns of any diversified equity strategies that move away from the ‘tallest trees’ in the index.

We can see this effect simply by looking at the performance of an equally weighted version of the S&P 500 index, which has underperformed its market-cap weighted equivalent by 10% over the year to the end of September. Part of that underperformance reversed in September as some of the froth in tech has been removed, but it is undoubtedly too early to call a sustained rotation in the US.

The same cannot be said of factor portfolios outside the US, however, where there is much less of a tech bias. The recent bout of risk aversion has seen non-US factors behave more in line with expectations, with quality, momentum and low volatility stocks outperforming, while value has underperformed. Where we have allocated to a basket of non-US factors, their positive contribution has been an effective diversifier over the past month.


Appendix: performance of indices cited

  S&P 500 Net Total Return (Equal Weights) S&P 500 Net Total Return (Mkt Cap Weights) MSCI EAFE Value vs MSCI EAFE, Net Total Return MSCI EAFE Quality vs MSCI EAFE, Net Total Return MSCI EAFE Minimum Volatility vs MSCI EAFE, Net Total Return MSCI EAFE Momentum vs MSCI EAFE, Net Total Return
2015 -2.78% 0.75%     8.83%  
2016 14.11% 11.23%   -4.06% -2.78%  
2017 18.23% 21.10% -1.74% 0.49% -2.73% 2.80%
2018 -8.18% -4.94% -2.60% 3.90% 9.39% 0.76%
2019 28.43% 30.70% -6.42% 7.46% -4.32% 1.54%


Tim Armitage

Quantitative Strategist

Tim is a former musician reincarnated as a quantitative strategist, and subsequently spends more time writing code than songs these days. When not thinking about swaption strategies and risk indicators, you’ll find him running marathons, and secretly hoping there’s a day his three sons form a band that becomes the next Kings of Leon.

Tim Armitage