Andrew’s Angle

Factors: A New Way

Jan 30, 2021

Factors did not do well in 2020.

During an extraordinary 2020, the S&P 500 ended up with a 18.4% return—an amazing result given the dramatic swings throughout the year and the striking bifurcations across industries and sectors. Four out of five factors underperformed the broader market. While momentum ended up by 8.2% above the market—putting to bed a myth that momentum only outperforms during late bull markets, value underperformed the market by 21.6% and minimum volatility by 15.6% (see chart below). This has prompted a lingering question among investors – is something broken about factor investing?

Cumulative Excess Factor Index Returns vs. MSCI USA

Excess factor Return

Source: BlackRock, Bloomberg. As of 31 December 2020. Factors based on the following indexes MSCI USA: MSCI USA Index USD; Value: MSCI USA Enhanced Value Index; Size: MSCI USA Low Size Index; Momentum: MSCI USA Momentum Index; Quality: MSCI USA Sector Neutral Quality Index. Excess returns are relative to the MSCI USA Index. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Absolutely not!

It is unusual, however, for three out of the four return-enhancing factors (momentum, value, size, and quality) to underperform the market. Looking at rolling 12-month returns since 1963 (June 30, 1963 – November 30, 2020) of Fama French generic factors in the chart below, three or more of these factors have underperformed just 8% of the time. Over the same time period, we have tended to see three out of the four return-enhancing factors outperform the broad market on average, with an equal weighted allocation to all four factors outperforming 82% of the time.

Percent of time the number of factors "exclusive" have underperformed the market over rolling 12-month periods

Factor Underperformance

Source: BlackRock, Fama French Data Library: Analysis over period 30 June 1963 - 30 November 2020. Factors based on the following Fama French factor definitions: Momentum: Mom; Size: SMB; Value: HML; Quality: RMW. Past performance is not indicative of future results.

Despite 2020 being an outlier in historical factor performance, we believe factors should evolve over time to better capture incremental returns and include near-term performance drivers. As we move forward into 2021 and beyond, there are three key ways we envision refining the measurement and implementation of factors.

More dynamic factors

The most difficult challenge factor investors face is the potential for any one factor to suffer extended cyclical underperformance (more recently the case for value). Becoming more dynamic with factors, incorporating factors (like value) along with their complements (“anti-factors” like growth) at appropriate times, can help mitigate these cyclical drawdowns. Broad and persistent, factors have demonstrated their ability to outperform the broader market over the long term. At the same time, factor portfolios can be taken to the next level by appropriately incorporating factors or their opposite complements in a tactical fashion over shorter time periods.

As an example, let’s look at how value and growth can be incorporated into a hypothetical dynamic factor portfolio. In the chart below, we use an unconstrained dynamic factor timing model to demonstrate how “anti-factors” can be viewed more favorably at times than their factor complements.1 Over the long run, we expect that the five long-run rewarded factors—value, momentum, quality, minimum volatility and size—would dominate. But, over the short run, our dynamic model might prefer to hold growth in place of value, or large or mega caps instead of small size. In this particular example, we forecast growth or value positions with profitability, research and development, earnings, and valuation indicators.

Factor + Anti-Factor Hypothetical Dynamic Portfolio Holdings

Anti Factor

Source: BlackRock, Bloomberg. As of 30 November 2020. Factors based on the following indexes (index inception dates included after the name): Value: MSCI USA Enhanced Value Index (12/12/14); Momentum: MSCI USA Momentum Index (2/15/13); Quality: MSCI USA Sector Neutral Quality Index (12/12/14); Growth: Russell 1000 Growth Index (1/1/87); Mega Caps: S&P 100 Index (6/15/83). This information should not be relied upon as research, investment advice or a recommendation regarding the Funds or any security in particular. This information is strictly for illustrative and educational purposes and is subject to change. This information does not represent the actual current, past or future holdings or portfolio of any BlackRock client.

The notion that growth is not rewarded over the long run does not mean that all growth rallies are unjustified; on the contrary, we believe some periods of growth outperformance are justified through record profitability, innovation, or attractive valuations. The chart above illustrates how dynamically holding growth and mega caps (the “anti-factors” to value and small size) was preferred over their factor complements in recent years due to their relative dominance in disruptive innovation alongside robust profitability. We can maintain a well-balanced portfolio by also holding positions in momentum, quality, and minimum volatility to capture exposure to historically rewarded factors.

Expanding the opportunity set in dynamic factor frameworks to include other investment styles or “anti-factors” during periods of cyclical strength has the potential to unlock additional benefits for portfolios and can help mitigate short-term weakness in traditional factors while still maintaining diversification.

Factors with themes

Themes, like the predominant work-from-home influences that occurred in 2020, are transitory, but they interact with factors in significant ways. Over 2020 much of the US workforce went into work-from-home and many in-person work and leisure activities were curtailed. Value suffered as social distancing themes went into effect—because often value stocks were overweight business models that needed a physical presence, like foot traffic in a store or in-person office interactions to generate business. Many growth companies benefited from the rise of connectivity technology. Social distancing also benefited large stocks with large financial cushions. During the worst months of February and March, minimum volatility outperformed the market by 4-6%.2

But, the pattern for minimum volatility reversed as the economy gradually re-opened over the last half of 2020. From the bottom of the market in late March, the market shot up, powered by the FAANGM (Facebook, Apple, Amazon, Netflix, Google or Alphabet, and Microsoft) and as market participants’ risk aversion decreased, strategies that minimized risk, like minimum volatility strategies, tended to lag. On the other hand, despite their overall disappointing performance in 2020, value and size outperformed the market in Q4 by 5.4% and 5.9%, respectively, as the economy reopened.3

All Eyes on Reopening

All Eyes on Reopening

Source: BlackRock, Bloomberg, JPMorgan, as of 9/30/2020. For illustrative purposes only. Social distancing winners and reopening winners are based on baskets constructed by JPMorgan of stocks likely to benefit or lag from extended social distancing (JPAMDISO and JPAMDISU, respectively). Each basket includes 30-50 stocks which are weighted by liquidity. The performance shown does not represent the performance of an investible product or portfolio and is not reflective of any investment opportunity available on BlackRock’s platform. Past performance does not guarantee future results. Holdings subject to change. Current ETF holdings can be found at

We need to account for these themes in factors—especially as existing themes evolve, and new themes emerge. A better understanding of the links between shifting market themes and style factors can empower us to monitor and mitigate or capitalize on these exposures. We can also incorporate this information into our systematic factor tilting framework, which tilts portfolios towards one factor vs. another based on each factor’s relative attractiveness.

New ways to measure factors

We are constantly evolving the way that we measure factors—continuing to find new ways to implement value, quality, and momentum, within and across asset classes. In our active factor funds, continued research and innovation have already led to the generation of new factor insights. These include better new measures of quality, the incorporation of supply chain and competitor data in momentum and improvement upon common measures of value incorporating intangible assets.

I believe the most exciting area is including ESG characteristics as important sources of returns that we can use in factor portfolio construction. We are leading the effort to better incorporate ESG measures into factor definitions themselves. Recent examples of this include measurements of carbon emissions intensity and corporate culture in our enhanced factor definitions of quality, as well as including green patents in our enhanced factor definitions of value. ESG will continue to be an exciting area of research that shapes the evolution in how we measure factors going forward.

A new way

Progress and innovation have always been central to successful factor investing. The first treatise on factor investing, Security Analysis by Benjamin Graham and David Dodd in 1932 showed investors how to systematically use accounting statements (which at the time were not standardized). In the 1980s and 1990s, factor investing applied extensive datasets of prices, company-level data, and risk statistics to define factors. And today, we evolve our factor research and portfolio construction to help investors pursue outcomes that factor investing can provide.

Andrew Ang
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 ...
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