Factor ETFs For Diversification & Return Improvement

Jun 18, 2024 | ETFs, Investing, Investment Portfolios, Investments, Newsletter

Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA, and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Monday, July 1, 2024. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Factor ETFs For Diversification & Return Improvement

Factor ETFs have matured significantly, attracting more investments. MyPlanIQ began covering factor ETFs around their inception roughly a decade ago. We also maintain some of the best investment model portfolios based on factor ETFs. Below are selected past articles on this topic:

In this article, we will examine the latest returns of these ETFs and portfolios.

Latest returns of most popular factor ETFs

The following table displays the latest returns for the factor ETFs we cover:

Factor ETF Performance Comparison (as of 6/14/2024):
Ticker/Portfolio Name YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 10Yr AR Since 7/18/2013
QUAL (iShares MSCI USA Quality Factor ETF) 16.8% 30.9% 10.8% 15.4% 13.3% 13.7%
VTV (Vanguard Value Index Fund ETF Shares) 7.8% 16.9% 7.3% 10.7% 9.9% 10.5%
MTUM (iShares MSCI USA Momentum Factor ETF) 24.3% 38.3% 6.0% 11.9% 13.5% 13.8%
USMV (iShares MSCI USA Min Vol Factor ETF) 7.1% 15.8% 5.9% 8.0% 10.5% 10.7%
SIZE (iShares MSCI USA Size Factor ETF) 4.0% 14.8% 3.5% 10.5% 10.1% 10.9%
SPGP (Invesco S&P 500 GARP ETF) 5.6% 17.3% 7.0% 15.1% 14.1% 14.7%
SPY (SPDR S&P 500 ETF Trust) 14.5% 26.0% 10.1% 15.3% 12.8% 13.3%

Observations: 

  • The Quality factor ETF (QUAL) has outperformed the S&P 500 ETF (SPY) over the past 1, 3, 5, 10 years, and since 7/18/2013, the earliest date when all of the above ETFs had data. This achievement is remarkable and underscores that investing in quality businesses is the optimal approach to achieving solid long-term returns.
  • The GARP (Growth At a Reasonable Price) ETF SPGP has also performed exceptionally well: it has outperformed SPY over the past 10 years and boasts the highest annualized return since 2013. We will discuss this further shortly.
  • The momentum factor ETF MTUM is also performing strongly. This factor has proven valuable in tactically enhancing portfolio returns over time.
  • Since the last major bear market in 2008 (with the bear market in 2020 viewed as a short-term blip due to rapid market recovery fueled by significant stimulus), Value, Size (small-cap stocks), and Minimum Volatility factor ETFs have lagged behind SPY by significant margins.
 

The secular trend since 2008 has been growth-oriented. It seems that such a trend will only change with a major market event, such as the next major bear market. Regardless, we would like to remind readers that no single trend lasts forever, and it is important to keep this perspective in mind when reviewing the above return data.

Quality ETF prevails

Let’s take a closer look at QUAL (iShares MSCI USA Quality Factor ETF) , which tracks the MSCI Quality Factor Index. The index selects stocks with the highest scores among three main variables: Return on Equity, Debt to Equity, and Earnings Variability. As of 6/13/2024, the ETF had 129 holdings, with the top 10 holdings being:

 

On the other hand, the top 10 holdings for the capitalization-weighted S&P 500 index were: 

 

We can see that due to the increased focus on return on equity and earnings variability, stocks like Eli Lilly have higher exposure in QUAL, contributing to QUAL’s return outperformance.

Long-term readers know that the investment philosophy of MyPlanIQ emphasizes solid business fundamentals, and quality factor ETFs are important candidates for our portfolio constructions. We will provide a more detailed review of these ETFs in a follow-up newsletter.

GARP SPGP ETF holdings

Moving on to SPGP (Invesco S&P 500 GARP ETF), its top holdings are more diverse: 

Its holdings are also less concentrated on mega-cap stocks. GARP (Growth at a Reasonable Price) can be viewed as a smart equity investment strategy that buys solid high-growth businesses that are reasonably priced while selling off either overvalued or poorly performing businesses. Such a sound strategy can be expected to deliver good long-term returns.

Factor ETF rotation portfolio

Each of the above factor ETFs (Quality, Momentum, Value, Min Volatility, Size, GARP) is designed to deliver better long-term returns than a general cap-weighted index like the S&P 500. Using a momentum-based strategy, such as MyPlanIQ’s, to rotate among these ETFs presents the possibility of outperforming the S&P 500 while reducing risk or interim volatility. This is exactly what the P Composite Momentum Scoring Factor ETFs (see Resources->Advanced Strategies) have delivered.

Portfolio Performance Comparison (as of 6/14/2024):
Ticker/Portfolio Name Max Drawdown 1Yr AR 3Yr AR 5Yr AR 10Yr AR 15Yr AR Since 1/2/2008 AR
P Composite Momentum Scoring Factor ETFs 34% 34.5% 14.2% 16.8% 15.3% 16.0% 14.8%
VFINX (VANGUARD 500 INDEX FUND INVESTOR SHARES) 55% 25.9% 10.0% 15.3% 12.8% 14.4% 10.4%

Furthermore, the 10-year and 15-year rolling returns clearly show that this portfolio has consistently outperformed VFINX or SPY (S&P 500 index funds).

Note that many people have some difficulty understanding the significance of the rolling return concept. The 10-year period rolling returns chart shows the trailing 10-year (annualized) returns from any past date. Therefore, if we see that the portfolio’s 10-year rolling return chart is always above the VFINX’s 10-year rolling return chart, it implies that an investor would always have achieved a better 10-year return regardless of when they started investing. This demonstrates that investing in this portfolio and holding it for 10 years at any point in the past would have yielded better returns than investing in VFINX.

Market Overview

Stocks reached all-time highs on four days last week. However, the rally seems very uneven. Here are some interesting stats:

  1. Three stocks (Microsoft, Apple, and Nvidia) make up 20% of the S&P 500 index, which is up almost 14% year-to-date.
  2. However, the equal-weighted S&P index is only up 3.4% and is still 4% below its March high. The equal-weighted index of the largest 1000 stocks in the Russell 1000 index is essentially flat this year.
  3. Worse still, investors seem to have given up hope on small-cap stocks. The Russell 2000 index ETF (IWM) is down 0.5% year-to-date and is still about 20% below its all-time high from November 2021.

It is possible that stocks are climbing a wall of worry, or that the high-flying mega-tech stocks will revert to their strength, eventually either continuing their rise or correcting. As always, we claim no crystal ball and we call for staying the course which is guided by well-defined and sound strategic and tactical strategies:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as we have emphasized numerous times when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years, preferably much longer, given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. If you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Also, you should follow your strategy rigorously, especially during this time. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This is true time and time again.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of market is through dollar cost average (DCA), i.e., invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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