Key Points:
- Factors are primary drivers of asset-class returns in the equity realm.
- Factor strategies provide exposure to rewarded risk factors in addition to market risk.
- The year 2022 saw a broad-based resurgence in factor performance.
- Factors such as Value, Momentum, and Low Investment outperformed their long-term averages.
- The energy sector played a significant role in driving factor performance.
- Macro factors have a significant influence on factor behavior in certain environments.
- Term spread, credit spread, and breakeven inflation factors explained a substantial portion of the Value factor’s variability in 2022.
- Investing across rewarded factors may be more advisable than relying on specific macroeconomic outcomes.
- Multi-factor strategies with well-balanced exposures to rewarded factors are likely to benefit from their long-term rewards.
Factors are the primary drivers of asset-class returns in the equity realm. These factors, including Value, Size, Momentum, Low Volatility, High Profitability, and Low Investment, compensate investors for the additional risk exposure they create in bad times. Factor strategies are appealing to investors as they provide exposure to rewarded risk factors in addition to market risk, potentially leading to superior risk-adjusted performance compared to cap-weighted benchmarks.
In 2022, factor performance experienced a broad-based resurgence. While the financial media focused on the outperformance of the Value factor, other factors also performed well. Factors such as Momentum, Low Investment, and Value beat their long-term averages, while factors like Low Volatility and Size had positive performance below their long-term averages. High Profitability was the only factor that posted negative performance in 2022.
The energy sector played a significant role in driving factor performance in 2022. It outperformed its cap-weighted counterpart, contributing to the positive performance of Value, Momentum, and Low Investment factors, while negatively impacting Low Volatility and High Profitability factors.
Macro factors can also have a significant influence on factor behavior in certain environments. In 2022, macro factors explained a significant portion of the variability of some US equity factors. Term spread, credit spread, and breakeven inflation factors were found to influence the variability of the Value factor. However, no macro factor had a significant impact on the variability of the Momentum factor.
Predicting how factors will behave in the future is challenging. While the macroeconomy, particularly monetary policy, is expected to continue influencing factors, investing based on specific macroeconomic outcomes may not be the best approach. Instead, investing across a set of rewarded factors is advisable. Empirical evidence suggests that rewarded factors can weather extreme market conditions and macro developments, providing investors with long-term rewards for the additional risks they are taking. Hence, multi-factor strategies with well-balanced exposures to the six rewarded factors are likely to continue benefiting from their long-term rewards in the future.
