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Andrew's Angle

Factors in indexes: going beyond
market averages

Andrew Ang |Apr 5, 2018

The capacity of factor strategies appears large 

We build portfolios with indexed investments, assuming their exposure is broadly diversified. But just how many factors are in market indexes?

I have a hard time buying clothes off the rack because I’m not average. The average American man is 5’9” tall, weighs 196 pounds and has a 40-inch waist, according to the CDC.1 Mr. Average has certain characteristics, but individual men’s attributes and preferences are likely different. There’s nothing wrong with being average. In fact, as a man who is 5’4” on a good day, I’d love to be average.

Market indexes — used as investment benchmarks — represent the average. Because they can be offered transparently and cheaply in easy-to-use investment vehicles, they can appropriately serve as core building blocks for our portfolios.

But just like Mr. Average, the market has a certain makeup in its factor exposures. You might be different: you might want a different combination of factor exposures than what’s offered by the market average, want to specialize in fewer factors or want to express a bullish view of a particular factor. In short, you might not want to be average.

What are the factors in the market?

We analyzed several popular indexes to uncover their inherent factor exposures through time. We considered exposures to five style factors — value, size, quality, momentum and minimum volatility — and found that many indexes were effectively exposed to only two or three factors.2 In particular, the S&P 500 has historically been dominated by three factors: value, quality and momentum. And the market’s factor exposures change over time — just as the market’s sector, industry and country exposures change over time.

Try it yourself!
This interactive tool lets you graph factors in select global indexes.
Analyze indexes Analyze indexes

Going beyond average

What does this mean for an investor? It turns out that the collection of exposures delivered by a broad market index may not be the right fit for everyone’s needs. Investors might consider adding additional factors to create a different mix.

For example, these charts show that there was virtually no exposure to minimum volatility in the S&P 500 Index between 2010 and 2013. Armed with information like this, investors could choose to:

  • Add a minimum volatility fund for enhanced diversification and potential downside risk protection
  • Add a multifactor fund to bring balance to the market’s longer-term factor exposures
  • Add an additional factor as a moderate tilt to express a bullish view, for example

Know what’s in your index!

Market indexes have factors, too. The first step is knowing the factors already in those indexes. Then, it’s simple to build portfolios seeking enhanced returns, reduced risk or better diversification by deliberately adding the appropriate factors. Indeed, we find that the proportion of index movements that can be explained by factors has been increasing lately, making factor analysis and allocation even more critical.

Now I just wish there was a way to add more of that height factor so I can buy a jacket off the rack.

Andrew Ang
Head of Factor Investing Strategies
Andrew Ang, PhD, Managing Director, coordinates BlackRock’s efforts in factor investing. He leads BlackRock’s Factor-Based Strategies Group which manages macro and style ...