Q1 2023 Factor Performance Report: Insights for Investors

• Markets rallied in Q1, led by a strong January, as investors believed we were nearing the end of aggressive rate hikes. Developed markets outperformed their developing peers.
• Within the standard style box, large growth outperformed their small value counterparts in the U.S. and international developed markets. Mega caps led the way in the first quarter with the largest 15 names contributing over 70% of the Russell 1000 index return.
• Within the extended style box, quality outperformed as markets turned their attention to potentially tighter credit conditions following several high-profile bank failures. Momentum struggled as the factor was unable to find the trend given rapidly changing sentiment. Not surprisingly, minimum volatility lagged as is typical during periods of strong returns.

What happened in the U.S. in Q1?

With the start of a new year, investors began to anticipate a Fed pivot, believing the cycle of rate increases that began in early 2022 was likely nearing an end. Markets rallied, with the S&P 500 index gaining over 6% in January. Sentiment shifted in February, as positive economic news, led by strong employment data, and continued elevated inflation, refocused investors’ attention on interest rate risk. Meanwhile, the collapse of Silicon Valley Bank in early March, and concerns of a broader banking crisis, exposed cracks in the economy that were forming as a result of the Fed’s aggressive rate hikes. With the crisis seemingly contained, the markets recovered to finish the quarter up 7.5%,¹ led by growth stocks that benefitted from falling yields.

How did developed and emerging markets fair in Q1?

International markets followed a similar pattern, rallying to open the year only to see a pull-back in February before regaining their footing in March. The MSCI World ex-U.S. index led returns, posting a gain of 8% for the first quarter.

Performance was generally more muted across the emerging markets, with the MSCI EM Index finishing up 4% for the period. The technology and communication sectors delivered double-digit returns, while energy, health care, and utilities struggled. Asian markets led the way, with Taiwan and South Korea gaining 14.75% and 8.6% repectively. Notable lagards included India (-5.6%) and Brazil (-2.7%).²

Q1 Style Box Returns

Within developed markets, large caps outperformed small caps while growth topped value. Within emerging markets, value and growth performed roughly in line with the notable exception of small growth. Small growth saw strong outperformance relative to small value as well as the rest of the emerging markets.

Value cools – The value rally, sparked in part by higher inflation and rising rates, slowed in the first quarter. Sentiment shifted, and investors rewarded the growthier parts of the market. Growth exposure also benefited from outsized gains seen by several relatively expensive names within semiconductors and software (technology) and internet media (communications).

Large companies outperformed – Mega cap names dominated in the first quarter, with the largest fifteen names driving just over 70% of the Russell 1000 index return. Stocks such as Meta Platforms, Inc. (META) and Nvidia (NVDA), which lagged for much of 2022, rebounded sharply (gaining 76% and 90% respectively). This trend was consistent, with returns decreasing as you look into small cap names.³

Q1 Extended Style Box Returns

Across the extended style box (Quality, Momentum, and Minimum Volatility), Quality outperformed while Minimum Volatility and Momentum trailed the market.

Quality shows resilience – As several high-profile bank failures sparked fears of contagion, the market turned its attention to the potential for tighter credit conditions. Exposure to higher quality firms, particularly those with lower leverage and consistent earnings growth, was rewarded. Meanwhile, stocks carrying higher levels of debt, most notably bank stocks, lagged the market.

Market moved risk-on – The traditionally defensive parts of the market led performance in 2022, as investors sought downside resiliency in the face of a strong market sell-off. The new year saw markets rally, with the S&P 500 index returning over 6% in January, and almost 7.5% for the quarter. As is typical in periods of strong returns, lower-risk sectors (e.g., utilities and health care) struggled while higher volatility exposures, such as technology, led performance. 

Momentum struggles to find the trend – Rapidly shifting sentiment, initially into growth and more recently high quality, challenged trend-following strategies in the first quarter. Energy and defensive stocks, which led performance for much of 2022, saw limited gains in the period. Meanwhile, growthier parts of the market, including technology and communications, rebounded as investors eyed an end to the Fed’s hiking campaign.

The iShares MSCI Quality Factor ETFs (QUAL and IQLT) led performance within the iShares suite of single factor large cap equity ETFs, as the funds’ focus on lower leverage and consistent earnings growth was rewarded. Strategies that focus solely on profitability typically struggled, demonstrating the benefits of a multi-metric approach to quality investing.

With value out of favor, our MSCI Value Factor ETFs, VLUE and IVLU, lagged the broad U.S. and developed international markets respectively. However, both funds outpaced their respective style box returns. Sector neutral construction, which avoids the persistent sector biases present in traditional value approaches (e.g., underweight technology and overweight financials), benefitted relative performance.

A dramatically shifting investment landscape challenged MTUM and IMTM, the iShares MSCI Momentum Factor ETFs. The funds’ focus on energy and healthcare exposures limited gains, as did an underweight to growthier technology names.

With the markets appearing to favor a risk-on profile, the suite of iShares MSCI Minimum Volatility ETFs lagged their respective market indexes, as expected. Notably, the funds’ approach, which gates sector bets at +-5%, preserved value relative to competing strategies that are unconstrained.

Despite the challenging environment for factors, the iShares suite of multifactor funds held up reasonably well. SMLF, the iShares US Small-Cap Equity Factor ETF, outpaced the Russell 2000 index by 0.7%. A preference for software and semiconductors (technology) over banks (financials) and biotech (health care) were notable drivers of outperformance. In U.S. large caps, several high-profile names that look relatively unattractive through the multifactor lens (expensive, mega-cap, high volatility) saw outsized returns in the first quarter, weighing on performance for LRGF. However, the risk-aware approach of the methodology limited the size of those underweights, preserving value.

With our view of near-term recession expectations, portfolio resilience remains essential. Quality and minimum volatility may help investors navigate these markets. Read more here.