How did factors perform during a roller coaster first quarter?

Growth, momentum factors prevail after a volatile start to the year

Nick KalivasTime to read: 5 min

Equities experienced heightened volatility during the first quarter of 2018, with the S&P 500 Index surging 7.55% from Dec. 31 2017, through Jan. 26, 2018, before dropping nearly 8% through quarter-end.1 Early in the quarter, market activity was buoyed by upward revisions to corporate profit outlooks following federal tax cuts in December, coupled with a squeeze on short volatility positions.

However, this momentum eased in the final two months of the quarter as investors became uneasy over a number of developments:

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Examining factor performance during a year of concentrated gains

Market trends sparked big wins for growth and momentum in 2017

Nick KalivasTime to read: 3 min

The books are closed for 2017. It was another strong year for the equity market, with the S&P 500 Index up 21.8%. Performance was highly concentrated, with more than one-third of the S&P 500’s gains linked to technology stocks and roughly 15% of the gains coming from the financials sector. Health care came in a close third to financials, representing 14.2% of the S&P 500’s total return. Together, these three sectors accounted for more than two-thirds of the S&P 500’s gains. Conversely, energy and telecommunication services were the only two sectors with negative performance. The table below highlights each sector’s contribution to the total return of the S&P 500 Index in 2017.

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Do valuations affect the performance of the low volatility factor?

A closer look reveals that market conditions may be a more accurate indicator of low volatility performance

Nick KalivasTime to read: 3 min

In my last blog, I outlined the difficulty of valuing factors by traditional price metrics such as price-to-earnings and price-to-book ratios. Part of the problem in valuing factors is that factor-based portfolio holdings change so often and can be influenced by market conditions. I would like to expand on that idea by suggesting that market conditions can actually be a predictor of factor performance. In this case, I’d like to examine the low volatility factor.

Low volatility doesn’t adhere to traditional valuation theories

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How do you place a value on factors?

Using traditional methods can be difficult, but long-term trends can provide valuable insights

Nick KalivasTime to read: 4 min

In my interactions with clients, I have noticed a desire to examine the valuation of investment factors such as low volatility, quality, dividend yield and momentum. Many investors look at investment factors as they would a stock, with the belief that factors have intrinsic value and can be analyzed using price ratios such as price-to-sales or price-to-book. However, there are problems with applying traditional valuation analysis to factors.

Why are factors so difficult to value?

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Small-cap stocks deliver big performance in the third quarter of 2017

Growth and momentum strategies also outperform, while value shares gain late in the quarter

Nick KalivasTime to read: 4 min

Small-size, momentum and growth strategies paced factor performance during the third quarter of 2017. By contrast, low volatility, low beta and value struggled as standalone factors during this time — although a late spike in 10-year Treasury yields helped value shares reverse some of their losses earlier in September.

As has been the case so far this year, factor dispersion was significant in the third quarter. The spread between the best- and worst-performing factors was 8.77% for the quarter and 29.17% year to date. This dispersion in returns highlights the differentiated risk and return profiles present in investment factors, and underscores the benefits of factor diversification.

Factor performance: Q3 2017 and year-to-date 2017

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