Time to read: 5 min
The fourth quarter of 2018 was exceedingly tough for US equities, with no gains to be found in any of the indexes tracked by our quarterly factor scorecard. And yet, certain factors — namely Low Volatility and Dividend Yield — were able to significantly cushion the blow suffered by the broad market. While the S&P 500 Index lost 13.52% in the quarter, the S&P 500 Low Volatility Index fell just 5.22%, and the S&P 500 Low Volatility High Dividend Index fell just 6.77%.
These two factors outperformed in the small-cap space as well, which was the hardest-hit in the quarter. While the S&P SmallCap 600 Index lost 20.10% in the quarter, the S&P SmallCap 600 Low Volatility Index fell just 12.64%, and the S&P SmallCap 600 Low Volatility High Dividend Index fell just 13.92%.
The world is always clear in retrospect, but exposures to the Low Volatility and Dividend Yield factors would have helped to soften the blow of the fourth quarter sell-off. In my view, this reinforces the usefulness of factor strategies designed to help mitigate risk. All told, there were 14 equity factor indexes that outpaced the S&P 500 in the fourth quarter, and 11 for all of 2018.
Low volatility and dividend factors were supported by a 65.7% rise in the VIX Index, which jumped from 12.12 to 25.42 during the fourth quarter. Likewise, high yield spreads (as defined by the Barcap US Corporate High Yield to Worst -10 Year Treasury Spread Index) surged 109.7%, widening from 3.18% to 5.27%. The flaring of risk was also a drag on the small-cap sector.
The lagged impact of monetary tightening and a flatter yield curve, coupled with slower profit growth, are expected to keep equity volatility elevated in 2019. I believe this has the potential to support the Low Volatility and Dividend Yield factors.
According to Standard & Poor’s as of Dec. 31, 2018, S&P 500 earnings are expected to rise 9.4% in 2019 compared to 26.1% in 2018. In a slowing growth environment, companies with strong balance sheets and financial health — which are included in the Quality factor — have tended to provide an attractive option for investors looking to take more risk than offered by the Low Volatility and Dividend Yield factors.
A factor is a measurable characteristic of an investment that helps explain its performance.
Academic research has shown that certain equity factors have the potential to outperform the broad market over the long term (even while they may have bouts of short-term underperformance). In particular, research has identified six main “rewarded” equity factors:
- Low volatility
- Dividend yield
Other factors may not display the same potential for long-term outperformance, but their potential for short-term outperformance may make them useful for tactical exposures in a portfolio, in my view. Some of these factors include growth and high beta, for example.
To show the large difference in factor performance in various market environments, we list a comprehensive range of factors in our quarterly analysis.
Factor index returns (sorted by Q4 performance)
|Factor||Index||Q4 2018 (%)||Full-year 2018 (%)|
|Low Volatility||S&P 500 Low Volatility Index||-5.22||0.27|
|Dividend Yield||S&P 500 Low Volatility High Dividend Index||-6.75||-5.87|
|Yield Weighted||Dow Jones Industrial Average Yield Weighted Total Return Index||-7.59||0.25|
|Low Volatility (Mid-Cap)||S&P MidCap 400 Low Volatility Index||-7.89||0.04|
|Low Volatility/Rising Rate||S&P 500 Low Volatility Rate Response Index||-10.29||-2.60|
|Dividend Growth||NASDAQ Dividend Achievers 50 Index||-10.59||-6.98|
|Value (Mid-Cap)||Russell Midcap Pure Value Index||-11.12||-9.36|
|Value (Larg-Cap)||Russell Top 200 Pure Value Index||-11.47||-8.26|
|Multi Factor (Large Value)||Dynamic Large Cap Value Intellidex Index||-12.00||-13.43|
|Value||S&P 500 Enhanced Value Index||-12.24||-9.20|
|Low Volatility (Small-Cap)||S&P SmallCap 600 Low Volatility Index||-12.64||-5.13|
|Equal Weight (large Cap)||S&P 100 Equal Weight Index||-12.73||-6.33|
|Low Beta Equal Weight||Russell 1000 Low Beta Equal Weight Index||-13.48||-7.06|
|Multi-Factor (Large Growth)||Dynamic Large Cap Growth Intellidex Index||-13.50||1.64|
|S&P 500 Index||S&P 500 Index||-13.52||-4.38|
|Fundamental||FTSE RAFI US 1000 Index||-13.83||-8.26|
|Buyback||NASDAQ US Buyback Achievers Index||-13.89||-9.92|
|Equal Weight||S&P 500 Equal Weight Index||-13.90||-7.64|
|Low Vol/High Div (Small-Cap)||S&P SmallCap 600 Low Volatility High Dividend Index||-13.92||-7.53|
|Quality||S&P 500 Quality Index||-14.76||-6.79|
|Equal Weight (large-Cap)||Russell 1000 Equal Weight Index||-15.37||-8.77|
|Growth (Large-Cap)||Russell Top 200 Pure Growth Index||-15.55||2.14|
|Momentum||S&P 500 Momentum Index||-16.34||-0.04|
|Multi-Factor||Dynamic Market Intellidex Index||-16.52||-5.23|
|Value (Large-Cap)||S&P 500 Pure Value Index||-16.61||-12.00|
|Growth (Large-Cap)||NASDAQ-100 Index||-16.76||0.04|
|Growth (Large-Cap)||S&P 500 Pure Growth Index||-16.93||-4.22|
|Quality (Small-Cap)||S&P SmallCap 600 Quality Index||-17.07||-5.74|
|Growth (Mid-Cap)||Russell Midcap Pure Growth Index||-17.18||7.16|
|S&P 400 Index||S&P MidCap 400 Index||-17.28||-11.08|
|Value (Small-Cap)||Russell 2000 Pure Value Index||-17.75||-11.66|
|Equal Weight (Mid-Cap)||S&P MidCap 400 Equal Weight Index||-18.01||-11.94|
|Momentum (Mid Large)||Dorsey Wright® Technical Leaders Index||-18.61||-5.98|
|Fundamental (Mid Small)||FTSE RAFI US 1500 Mid Small Index||-19.66||-11.19|
|S&P 600 Index||S&P SmallCap 600 Index||-20.10||-8.48|
|Equal Weight (Small-Cap)||S&P SmCap 600 Equal Weight Index||-20.81||-10.26|
|High Beta||S&P 500 High Beta Index||-21.12||-15.26|
|Growth (Small-Cap)||S&P Small Cap 600 Pure Growth Total Return Index||-21.94||-7.46|
|Sector Rotation||Dorsey Wright Sector 4 Total Return Index||-22.03||-12.48|
|Growth (Small-Cap)||Russell 2000 Pure Growth Index||-22.33||-2.94|
|Momentum (Small-Cap)||Dorsey Wright® SmallCap Technical Leaders Index||-23.93||-9.65|
|Value (Small-Cap)||S&P Small Cap 600 Pure Value Index||-24.38||-19.28|
|Spread between max and min return||19.16||19.55|
Source: Bloomberg. L.P. as of Dec. 31, 2018. Investments cannot be made directly into an index. Past performance is not a guarantee of future results.
Factor indices use different methodologies and techniques to define a factor and choose stocks within the index that have the factor characteristic. As a consequence, returns may vary and differences can be attributed to variations in the stock selection processes.
Blog header image: Anna Om /Shutterstock.com
All data sourced from Bloomberg, L.P., as of Dec. 31, 2018, unless otherwise noted.
Volatility is a statistical measurement of the magnitude of up and down asset price fluctuations over time.
Factor investing is an investment strategy in which securities are chosen based on certain characteristics and attributes.
Value applies to investments trading at discounts to similar securities, based on measures like book value, earnings or cash flow.
Size represents the potential higher-than-benchmark returns associated with relatively smaller stocks within the universe being considered.
Momentum identifies investments with positive momentum (recent strong returns) or negative momentum (recent weak returns) to calibrate portfolio exposure to either.
Low volatility describes investments that consistently demonstrated lower volatility than securities in the same asset class.
Quality characterizes companies with strong measures of financial health, including a strong balance sheet.
Dividend yield reflects stocks that have paid higher yields and generated higher total returns over time than lower-yielding assets.
Growth targets stocks that are expected to grow at an above-average rate compared to the industry or overall market.
High beta describes seeking higher relative returns by investing in stocks that are more volatile than the market benchmark.
Low volatility cannot be guaranteed.
Momentum style of investing is subject to the risk that the securities may be more volatile than the market as a whole, or that returns on securities that have previously exhibited price momentum are less than returns on other styles of investing.
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.
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.
Investment Performance of Common Stocks in Relation to Their Price-Earnings Ratios: A Test of the Efficient Market Hypothesis, S. Basu, The Journal of Finance, 1977.
Common Risk Factors in the Returns of Stocks and Bonds, Eugene F. Fama, Kenneth R. French, Journal of Financial Economics, February 1993.
Overconfidence, Arbitrage, and Equilibrium Asset Pricing, Kent D. Daniel, David Hirshleifer, and Avanidahar Subrahmanyam, The Journal of Finance, June 2001.
Risk and the Rate of Return on Financial Assets: Some Old Wine in New Bottles, Robert A Haugen and James Heins, The Journal of Financial and Quantitative, Analysis, December 1975.
Benchmarks as Limits to Arbitrage: Understanding the Low Volatility Anomaly, Malcolm Baker, Brendan
Bradley and Jeffrey Wurgler, Financial Analysts Journal, January/February 2011.
The Relationship Between Return and Market Value of Common Stocks, Rolf W. Banz, Journal of Financial Economics, March 1981.
Common Risk Factors in the Returns of Stocks and Bonds, Eugene F. Fama, Kenneth R. French, Journal of Financial Economics, February 1993.
The Capital Asset Pricing Model, Jack Treynor (1961-1962) William Sharpe (1964), John Lintner (1965) and Jan Mossin (1966).
Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, Narasimhan
Jegadeesh, Sheridan Titman, The Journal of Finance, March 1993.
On Persistence in Mutual Fund Performance, Mark. M. Carhart, The Journal of Finance, 1997.
Do Stock Prices Fully Reflect Information in Accruals and Cash flows About Future Earnings? Richard G. Sloan. July 1996; The Other Side of Value: The Gross Profitability Premium. Robert Novy-Marx. June 2012.
The Effects of Dividends on Common Stock Prices: Tax Effects or Information Effects? Robert T. Litzenberger and Krishna Ramaswamy. May 1982.
About the indexes
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 Barcap U.S. 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 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 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 Dow Jones Industrial Average Yield Weighted Index is designed to provide exposure to high-yielding equity securities in the Dow Jones Industrial Average™ by their 12-month dividend yield over the prior 12 months. Only securities with consistent dividend payments over the previous 12 months are included in the index. The index is computed using the gross total return, which reflects dividends paid.
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 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 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 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 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 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 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 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 S&P 100® Equal Weight Index equally weights 100 major blue-chip companies across multiple industry groups in the S&P 500® Index.
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 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 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 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 S&P 500® Equal Weight Index equally weights the stocks in the S&P 500® Index.
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 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 Russell 1000 Equal Weight Index captures the risk and return performance of an equal weight investment strategy for US large-cap stocks.
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 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 Dynamic Market Intellidex Index seeks to identify and select companies from the US marketplace with superior risk-return profiles.
The S&P 500® Pure Value Index measures the performance of securities that exhibit strong value characteristics in the S&P 500® Index. Value is measured by the following risk factors: book value-to-price ratio, earnings-to-price ratio and sales-to-price ratio.
The Nasdaq-100 Index® includes 100 of the largest domestic and international nonfinancial companies listed on the Nasdaq Stock Market based on market capitalization.
The S&P 500® Pure Growth Index measures the performance of securities that exhibit strong growth characteristics in the S&P 500® Index. Growth is measured by the following risk factors: sales growth, earnings change to price and momentum.
The S&P SmallCap 600® Quality Index is composed of 120 securities in the S&P SmallCap 600® Index that have the highest quality score, which is calculated based on the average of three fundamental measures: return on equity, accruals ratio and financial leverage ratio.
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 S&P MidCap 400 Index is an unmanaged index considered representative of mid-sized US companies.
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 S&P MidCap 400® Equal Weight Index equally weights mid-cap securities in the S&P MidCap 400® Index.
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 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 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® Equal Weight Index equally weights small-cap securities in the S&P SmallCap 600® Index.
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 SmallCap 600® Pure Growth Index measures the performance of securities that exhibit strong growth characteristics in the S&P SmallCap 600® Index. Growth is measured by the following risk factors: sales growth, earnings change to price and momentum.
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 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 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 S&P SmallCap 600® Pure Value Index measures the performance of securities that exhibit strong value characteristics in the S&P SmallCap 600® Index. Value is measured by the following risk factors: book value-to-price ratio, earnings-to-price ratio and sales-to-price ratio.
Senior Equity Product Strategist
Nick Kalivas is a Senior Equity Product Strategist representing Invesco’s exchange-traded funds (ETFs). In this role, Mr. Kalivas works on researching, developing product-specific strategies and creating thought leadership to position and promote the smart beta equity lineup.
Prior to joining Invesco, Mr. Kalivas spent the majority of his career in the futures industry, delivering research, strategy and market intelligence to institutional and high net worth clients centered in the equity and interest rate markets. He was a featured contributor for the Chicago Mercantile Exchange, and provided research services to a New York-based global macro commodity trading advisor where he supplied insight on equities, fixed income, foreign exchange and commodities. Nick has been quoted in the Wall Street Journal, Financial Times, Reuters, New York Times and by the Associated Press, and has made numerous appearances on CNBC and Bloomberg.
Mr. Kalivas has a BBA in accounting and finance from the University of Wisconsin – Madison and an MBA from the University of Chicago Booth School of Business with concentrations in economics, finance, and statistics. He holds the Series 7 and Series 63 registrations.