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Does a turbulent stock market support minimum volatility factor investing?

Nov 20, 2018

 

  • As investors sell tech stocks around the globe and benchmark indices in the US, Europe, and Asia decline, we take a look at factor investing through the last two years and discuss the advantages, disadvantages, and outlook for factor-specific investing. 
     
  • Our analysis today focuses on four factor-specific US investing strategies: momentum factor investing, as measured by the iShares USA Momentum Factor ETF (MTUM); low volatility factor investing, as measured by the iShares USA Minimum Volatility Factor ETF (USMV); value factor investing, as measured by the iShares USA Value Factor ETF (VLUE); and size factor investing, as measured by the iShares USA Size Factor ETF (SIZE).
     
  • Momentum factor investing has largely outperformed minimum volatility factor investing, value factor investing, and size factor investing by at least 12% over the last two years. Additionally, MTUM has generated returns of 37.2% through the last two years while the S&P 500 Index has returned only 22.4%.
     
  • Despite returns of 37.2% through the last two years, momentum factor investing is essentially flat in 2018, with MTUM yielding just 0.81% YTD. Momentum factor investing performs best in exaggerated bull markets. In these types of markets, herd investing often becomes more prominent, causing a disconnect between stock prices and their underlying values. Because momentum factor investing seeks to capitalize on the continuation of existing price trends, momentum ETFs like MTUM outperform in exaggerated bull markets -- in 2017 alone, MTUM returned 36.0%.
     
  • In 2018, the broad US stock market saw the return of volatility as market moving events like the US-Sino trade war, US Fed interest rates, and concerns of peak earning levels have taken center stage. With the S&P 500 nearly flat YTD, it is no surprise to see that momentum factor investing has performed poorly in 2018.
     
  • Minimum volatility factor investing has benefited from the renewal of turbulent markets in 2018 with USMV returning 5.46% YTD. Historically, minimum volatility factor investing has performed best in high-volatility markets, and 2018 has been no different.
     
  • Since October, where US markets have observed a large uptick in volatility, minimum volatility factor investing has returned –2.51% while momentum factor investing, value factor investing, and size factor investing have returned –12.63%, -7.68%, and –4.91%, respectively. Meanwhile, the S&P 500 Index has returned –7.66%.
     
  • If investors expect the recent trend of turbulent markets to continue through the end of 2018 and into 2019, it may be a good idea to consider a minimum volatility factor investing strategy. Value factor investing is also likely a safe option over the medium to long-term as investor demand for proven value stocks will likely increase as growth stocks become less favorable amid concerns of peak earnings growth in US stocks. 

 

Source: Capital IQ