Factors are the important thing market drivers of an asset class’s return. In the equity space, there are only a limited variety of rewarded aspects supported by academic consensus: value, size, momentum, low volatility, high profitability and low investment. These aspects compensate investors for the extra risk they bring about during bad times. Therefore, factor strategies are attractive to investors because they supply exposure to rewarding risk aspects along with market risk and is usually a source of higher risk-adjusted performance over the long run in comparison with capitalization-weighted benchmarks.
The 12 months 2022 was a memorable 12 months for investors, but for reasons that weren’t entirely positive. However, one vivid spot was the relative outperformance of equity risk aspects in comparison with other popular equity investment styles. While the financial media has attributed recent strong factor performance almost entirely to the worth factor, the resurgence in factor performance has actually been much broader.
Factor Performance’s comeback was broad-based
Here, “factor performance” refers back to the performance of long/short factor portfolios that take long positions on a subset of stocks with the strongest positive exposure to a specific factor and a subset of stocks with the strongest negative exposure take short positions on the identical factor. In fact, within the United States, just about all aspects performed positively in 2022, with a median return of 6.9%, according to their long-term average, as shown within the chart below. The Momentum, Low Investment and Value aspects outperform their long-term averages, although not their best annual rolling 5% returns. The Low Volatility and Size aspects also performed positively, although below their long-term averages. High Profitability was an outlier and had the one negative performance. In fact, the factor performed so poorly that it beat its worst rolling return of 5% between December 31, 1974 and December 31, 2021.
US factor performance in 2022
| US aspects | Size | Value | mummy | Low Vol | High Pro | Low inv | 6-F EW |
| 2022 | 3.5% | 8.4% | 19.9% | 4.3% | -10.1% | 15.4% | 6.9% |
| Avg. roll Annual return |
8.8% | -1.7% | 3.9% | 8.5% | 3.8% | 4.1% | 4.1% |
| The worst 5% Rolling return |
-22.0% | -20.5% | -20.9% | -17.4% | -9.1% | -9.2% | -3.9% |
| Top 5% Rolling return |
53.8% | 14.4% | 27.9% | 36.9% | 22.5% | 21.3% | 18.7% |
The ends in the chart above contradict two popular media myths: that the factor performance story is just a price story and that a highly profitable company will outperform in a rising rate of interest environment.
The factor story was an industry story
Which sectors drove factor performance in 2022? The energy sector played an impressive role. It outperformed its broad equity-weighted counterpart by 84.5% and, as shown within the figure below, helped boost performance, momentum and Low Investment aspects and negatively impacted Low Volatility and High Profitability aspects. out of.
Sector Performance Mapping: US Factors, 2022
When it involves international stocks and global stocks, the story is basically consistent with the US market.
Factor performance through a macro lens
While macro aspects are usually not the first drivers of stock performance, they’ll have a big impact on factor behavior in certain environments. In examining how the macro environment influences factor performance, we use a macro framework developed by Noël Amenc, Mikheil Esakia, Felix Goltz, and Ben Luyten. Our 4 macro variables, shown within the chart below, are short-term rates of interest (three-month Treasury bills); maturity range (10-year minus 1-year government bonds); Standard range (Baa minus Aaa corporate bonds); and breakeven inflation (10-year breakeven inflation). For each macro variable, we construct a protracted/short macro portfolio consisting of stocks with the strongest and weakest sensitivity to macro innovations (surprises). We take long positions on stocks with the best sensitivity to weekly macro innovations and short positions on stocks with the least sensitivity to weekly macro innovations.
In 2022, macro aspects explained much of the variability in some US equity aspects. For example, the term spread, credit spread, and breakeven inflation aspects explained 27%, 33.7%, and 45.3% of the variability in the worth factor over the period, respectively. Breakeven inflation was one in every of the strongest macro aspects because it explained a big portion of the fluctuations in Value, High Profitability and Momentum returns. No macro factor had an actual impact on the variability of the momentum factor.
Percentage of US equity factor performance in 2022 explained by macro aspects
| USA 2022 R-squared |
Size | Value | Momentum | Low volatility |
High profitability |
Low investment |
| Short tariff | 6.1% | 0.4% | 0.6% | 46.7% | 8.0% | 1.0% |
| Runtime distribution | 8.6% | 27.0% | 1.2% | 36.3% | 36.5% | 11.7% |
| Credit spread | 11.4% | 33.7% | 5.3% | 20.5% | 47.1% | 22.4% |
| Break even inflation |
12.5% | 45.3% | 7.1% | 19.6% | 67.0% | 29.7% |
The results above contrast with the longer-term impact of macro aspects on equity aspects, shown within the chart below. While macroeconomic aspects won’t have the best impact in the long run given the transition to a more normalized rate of interest environment, they’ll have a stronger influence on factor performance in 2022. This is consistent with scientific findings. As a matter of fact, Short-term fluctuations in factor risk premiums are related to the business cycle or macroeconomic conditions.
US Stock Factor Percentage. Longer-term performance explained by macro aspects
| USA long run R-squared |
Size | Value | Momentum | Low volatility |
High profitability |
Low investment |
| Short tariff | 0.9% | 5.9% | 6.0% | 29.4% | 1.2% | 14.5% |
| Runtime distribution | 1.9% | 1.2% | 0.0% | 14.9% | 3.7% | 0.8% |
| Credit spread | 4.7% | 0.3% | 0.0% | 21.7% | 0.0% | 7.1% |
| Expected inflation | 0.4% | 3.2% | 0.2% | 4.9% | 10.3% | 0.8% |
How did macro aspects impact equity aspects? The chart below shows that Value and Low Investment had positive sensitivity and High Profitability and Low Volatility had negative sensitivity to breakeven inflation. Similarly, Value and Low Investment had negative sensitivity and Low Volatility and High Profitability had positive sensitivity to the credit spread factor.
2022 US equity factor sensitivities to macro aspects
| USA 2022 Betas |
Size | Value | Momentum | Low volatility |
High profitability |
Low investment |
| Short tariff | 0.22 | 0.05 | -0.04 | -1.11 | -0.25 | -0.08 |
| Runtime distribution | 0.16 | 0.33 | 0.07 | -0.62 | -0.35 | 0.23 |
| Credit spread | -0.33 | -0.65 | -0.34 | 0.83 | 0.71 | -0.57 |
| Break even inflation |
0.25 | 0.54 | 0.28 | -0.58 | -0.60 | 0.46 |
What aspects come next?
While it’s not possible to predict how aspects will behave in 2023 and beyond, to date it seems that macroeconomics, particularly monetary policy, will remain on the forefront of investors’ minds. How this impacts sectors and aspects is a fair tougher query, and investing based on a particular macroeconomic end result might not be the most effective plan of action for many investors. Rather, it is perhaps more advisable to speculate across all rewarded aspects. As empirical evidence shows, the common historical premiums of the aspects are likely to resist all possible extreme market conditions and macroeconomic developments. The long-term reward The variety of risk aspects won’t disappear, as they represent compensation for added risks that investors take. Therefore, multi-factor strategies with balanced exposure to the six rewarded aspects should proceed to reap their long-term advantages in the long run.
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Photo credit: ©Getty Images / baona
