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Factor Box in 360 Evaluator Methodology

Introduction

Investors have increasingly moved beyond traditional sector, size, and value-growth style views to factor-based considerations of their portfolios. The Equity Factor Box in 360 Evaluator is designed to help investors understand the equity portion of their portfolio’s factor exposures by displaying the strength of their portfolio’s exposure to six different factors – value, low size, momentum, quality, dividend yield and low volatility. These six factors are broad, persistent drivers of returns over time and reflect the characteristics that managers often consider when constructing portfolios. 

Defining the Factors

A definition of each factor is outlined below:

 

Factor
Definition
Value Stocks that are inexpensive relative to their fundamentals
Low Size Smaller, more nimble companies
Momentum Stocks in an upswing
Quality Companies with healthy balance sheets and stable earnings
Dividend Yield Higher yielding companies
Low Volatility Securities with low historical price volatility

Investors can use the Equity Factor Box to understand portfolio factor exposure and to aid in portfolio construction and risk management.

 

Methodology

The Equity Factor Box in 360 Evaluator scores custom portfolios uploaded into 360 Evaluator across the six different factors identified above by assigning the portfolio a percentile rank from 0 to 100 for each factor. A portfolio falling above the 50th percentile for a specific factor has a higher exposure to the factor as compared to the median exposure of the estimation universe. A portfolio falling below the 50th percentile for a specific factor has a lower exposure to the factor as compared to the median exposure of the estimation universe. A portfolio at the 50th percentile for a specific factor has a similar exposure to the factor as compared to the median exposure of the estimation universe.

Equity Factor Box Scale

Defining the Estimation Universe

The estimation universe includes open-ended mutual funds and ETFs meeting the following criteria:

  • Equity funds denominated in USD that are registered under the Investment Company Act of 1940, as amended;
  • Minimum AUM of $25MM;
  • Have at least 90% of its assets covered within the BlackRock BFRE World Risk Model1; and
  • For funds with multiple share classes, the largest share class is used.

Calculating Factor Exposures and Developing the Mapping Table

Style exposures for funds meeting the above criteria are then calculated based on the BFRE World Risk Model:

(1) For each fund within the estimation universe, a raw factor score is determined across each of the six factors using BlackRock’s BFRE World Risk Model and fund holdings.

The Equity Factor Box first leverages raw factor scores from the BFRE World Risk Model to determine exposures to the six Equity Factor Box style factors.  In some instances, BFRE Risk Model exposures are combined or reversed to accurately reflect the desired style factors within the Equity Factor Box. For example, we take the inverse of the exposures to the Volatility factor in order to reflect the desired output of exposure to the Low Volatility factor. These BFRE World Risk Model risk factors are z-scores2 and are mapped to the respective Equity Factor Box factor as listed below:

Factor
Definition
Value Value + Earnings Yield
Low Size Inverse Size + Small Cap
Momentum Momentum - Reversal
Quality Profit - Leverage
Dividend Yield Dividend Yield
Low Volatility Inverse Volatility

(2) To facilitate comparisons of factor scores between funds and to better demonstrate relative strength of a fund’s exposure, these raw factors z-scores are then converted into percentile rankings within the estimation universe. To determine the percentile ranks, raw factor scores are put through a process of repeated Winsorization3 and smoothing. Rank cutoffs are determined and every fund within the estimation universe is assigned an Equity Factor Box percentile rank between 1 and 100 for each factor.

(3) The output of this process is an Equity Factor Box mapping table that allows the translation of Winsorized factor scores to percentile ranks for portfolios. The Equity Factor Box within 360 Evaluator leverages this mapping table to score portfolios uploaded into 360 Evaluator. The portfolio’s raw factor z-scores are determined through Aladdin. These raw factor z-scores are then translated into percentile ranks based on the process and fund mapping table described above. Note, while the funds modeling process uses data to represent holdings and/or factor exposures, there is no guarantee that it is perfect representation of the fund. The holdings used to model the funds are often lagged up to several months, due to the availability of data.

Displaying the Exposure

Portfolio exposures to each factor are displayed in the Equity Factor Box visual by a horizontal bar. The length of the horizontal bar indicates the percentile of the portfolio’s exposure to that specific factor. The longer the horizontal bar, the greater the portfolio’s exposure to that factor.

  • Higher Exposure - A portfolio falling above the 50th percentile has a higher or stronger exposure to the factor as compared to the median exposure of the estimation universe
  • Lower Exposure - A portfolio falling below the 50th percentile has a lower exposure to the factor as compared to the median exposure of the estimation universe
  • Neutral Exposure - A portfolio at the 50th percentile has a similar exposure to the factor as compared to the median exposure of the estimation universe

In addition, the Equity Factor Box visual displays the factor exposures of two broad market reference benchmarks. Selecting either the US Equities or Global Equities button will plot the iShares Core S&P 500 ETF or the iShares MSCI ACWI ETF’s exposures to the six different factors respectively. The reference benchmark exposures are indicated by an orange dash on the Equity Factor Box visual. If the portfolio’s exposure to a specific factor is greater than the reference benchmark, the portfolio’s exposure, as indicated by the length of the horizontal bar, will plot further to the right (higher percentile). If the portfolio’s exposure to a specific factor is less than the reference benchmark, the portfolio’s exposure, as indicated by the length of the horizontal bar, will plot to the left (lower percentile).

1 BFRE World Risk Model is a global fundamental equity risk model estimated and maintained by BlackRock to describe the structure and sources of equity portfolio risk. 2 The z-score is a statistical measure showing how many standard deviations the fund’s exposure is away from the average exposure of the estimation universe to each factor. 3 Winsorization is the transformation of data through limiting extreme values to reduce the effect of outliers while preserving information. We use this procedure to transform the style factors to a common standardized scale.

Glossary

BFRE World Risk Model: Fundamental equity risk model estimated and maintained by BlackRock. BFRE World Risk Model is the global equity model.

Dividend Yield: A measure of a company’s dividend relative to its underlying price.

Estimation Universe: A sample set of equity mutual funds and ETFs used to form the percentile rankings.

Factors: Fundamental historical drivers of security risk and returns such as value or momentum. 

Higher exposure: Exposure above the 50th percentile.

Lower exposure: Exposure below the 50th percentile.

Low Size: A measure of the market capitalization of a company relative to companies in a given universe of stocks.

Low Volatility: The inverse of volatility, a measure of the risk of an asset measured by the standard deviation of returns over a particular interval of time.

Momentum:  A measure of recent strength in stock price behavior. Stocks that had positive excess returns in the recent past are grouped separately from those that displayed negative excess returns.

Neutral exposure: Exposure at the 50th percentile.

Percentile Ranking: A value from 0-100 assigned to the portfolio across each factor.  Indicates the portfolio’s percentile ranking to the factor within the estimation universe

Quality: A measure of balance sheet strength and earnings stability

Raw Factor Scores or Z-score:  The z-score is a statistical measure showing how many standard deviations the fund’s exposure is away from the average exposure of the estimation universe to each factor.

Standard Deviation: A statistical measure showing how dispersed returns are around the average.

Value: A measure of how inexpensive a stock is relative to its fundamentals.

FAQ

(1) What is the Equity Factor Box in 360 Evaluator?

The Equity Factor Box is a tool and visual within 360 Evaluator. Investors can use the Equity Factor Box to understand the equity factor exposures of their portfolios, and to aid in portfolio construction and risk management. The Equity Factor Box analyzes and depicts portfolio exposures across six different factors – quality, value, low size, momentum, yield and low volatility.

(2) How is the Equity Factor Box different from the Morningstar Style Box?

In 1992, Morningstar introduced the Style Box, which provided a simple way for investors to construct portfolios by viewing securities, funds, and portfolios across two dimensions or exposures – market cap/size (large versus small) and fundamentals/style (value vs growth). Size and Value are among the earliest understood rewarded drivers of risk and return to be adopted broadly. More recently, academic research, empirical data, and investor experiences indicate additional persistent drivers of risk and return (momentum, quality, volatility) and important dimensions of portfolio construction (yield). The Equity Factor Box in 360 Evaluator provides the opportunity to evaluate portfolios across all of these important factors as opposed to focusing solely on value and size.

(3) How can the Equity Factor Box be used?

The Equity Factor Box can be used in a variety of ways to manage risk and diversification. We find the most common applications are to help investors: 

  • Understand and evaluate the factor exposures of a portfolio and compare exposures to those of an index or another portfolio
  • Identify gaps in exposures across a portfolio
  • Identify ways to achieve similar factor exposures with lower cost alternatives

(4) What factors are included in the box?

Factors are fundamental historical drivers of investment returns. While there are hundreds of factors, only a few are known to be broad (exist across asset classes), persistent (work across market cycles), historically rewarded, and well documented by academic research. For this reason, the Equity Factor Box includes six different factors - value, low size, momentum, quality, dividend yield and low volatility. These six factors are proven, persistent drivers of risk and return over time and reflect the factors that managers often consider when constructing portfolios. All six factors are intuitive and can help explain the commonalities of return across and within asset classes. These factors have been observed for decades and because of their economic foundation, we believe that they may persist for decades to come. 

(5) How are the factors defined broadly?

Factor
Definition
Value Stocks that are inexpensive relative to their fundamentals
Low Size Smaller, more nimble companies
Momentum Stocks in an upswing
Quality Companies with healthy balance sheets and stable earnings
Dividend Yield Higher yielding companies
Low Volatility Securities with low historical price volatility

(6) Why isn’t growth included as one of the factors?

Growth has historically not been a rewarded factor. The Equity Factor Box focused only on those investment factors that are broad and persistent drivers or risk and return.

(7) What risk model is used and how are the factors defined within the model?

BlackRock’s multifactor equity risk model, BFRE World Risk Model, powers the exposure data for the Equity Factor Box in 360 Evaluator. BFRE World Risk Model exposures are combined or reversed to accurately reflect the desired style factors within the Equity Factor Box. These BFRE World Risk Model risk factors are mapped to the respective Equity Factor Box factor as listed below:

Factor
Definition
Value Value + Earnings Yield
Low Size Inverse Size + Small Cap
Momentum Momentum - Reversal
Quality Profit - Leverage
Dividend Yield Dividend Yield
Low Volatility Inverse Volatility

(8) What does the Equity Factor Box visual show?

The Equity Factor Box displays the strength of the selected fund’s exposure to the six different factors – value, low size, momentum, quality, yield and low volatility - relative to the exposures of the estimation universe.

(9) What are the bars within the graph displaying?

The bars represent the factor exposures of the portfolio relative an estimation universe of equity funds. All bars start on the left axis and extend to the right. The length of the each bar represents the portfolio’s Equity Factor Box percentile score to each factor. The longer the horizontal bar, the greater the portfolio’s exposure to that factor.

(10) How do I interpret the Equity Factor Box Score?

The Equity Factor Box provides the portfolio’s factor exposure through a percentile score. The percentile score is a number from 0 to 100 that indicates the strength of the portfolio’s exposure to the factor. The higher the percentile score the greater the exposure of the portfolio to that factor.

(11) Why do the percentile scores not add up to 100% across all the factors?

The portfolio’s factor exposures are displayed through a percentile score. Percentile scores are assigned for each of the six factors. The portfolio’s exposure to each factor will range from 0 to 100. The percentiles, unlike sector or country weights, are not able to be summed across factors. 

(12) What are the orange dashes within the graph displaying?

In addition to the selected portfolios, the Equity Factor Box displays the factor exposures of two broad market reference benchmarks. The factor exposures of the reference benchmarks are indicated by an orange dash on the Equity Factor Box visual. Selecting either the US Equities or Global Equities button will plot the iShares Core S&P 500 ETF or the iShares MSCI ACWI ETF’s exposures to the six different factors respectively.

(13) How are the “higher exposures” and “lower exposures” defined?

A portfolio falling above the 50th percentile has a higher or stronger exposure to the factor as compared to the median exposure of the estimation universe. A portfolio falling below the 50th percentile has a lower exposure to the factor as compared to the median exposure of the estimation universe. A portfolio at the 50th percentile has a similar exposure to the factor as compared to the median exposure of the estimation universe.

(14) If I have higher (lower) exposure to a specific factor, is that good?

It depends - factors are the long-term drivers of returns. Above-average exposure to certain return-enhancing factors such as Quality, Value, Low Size, and Momentum can lead to outperformance over the broad market in the longer-term. Other factors such low volatility and yield can be used to reduce portfolio risk and provide consistent income respectively. The appropriate exposure to a particular factor will ultimately depend on your investment objectives and economic views.

(15) Can I see what holdings are causing my portfolio’s factor exposure?

The Equity Factor Box in 360 Evaluator displays the overall portfolio exposure to the six different factors. The tool does not currently allow for viewing factor exposures of individual funds or holdings within the portfolio. To view the factor exposure of individual U.S. equity funds, use the Factor Box web tool.  

 

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