Rewarded risk factors are recognized as a fundamental component of equity returns. Envestnet | PMC believes that the most robust among the studied risk factors are value, momentum, quality, low volatility, and size. Like all return components, factors are cyclical in nature. Below, we take a look at the performance of these factors in the current market environment.
How factors have fared: Q1 2022
As of 3.31.22. Source: Morningstar Direct, MSCI Inc. U.S. factor returns are represented by the MSCI USA Momentum, MSCI USA Enhanced Value, MSCI USA Quality, MSCI USA Small Cap and MSCI USA Minimum Volatility indices, respectively, and excess returns are relative to the MSCI USA index. World Ex-USA factor returns are represented by the MSCI World ex USA Momentum, MSCI World ex USA Enhanced Value, MSCI World ex USA Quality, MSCI World ex USA Small Cap and MSCI World ex USA Minimum Volatility indices, respectively, and excess returns are relative to the MSCI World ex USA index. These are long-only indices.
The data shows that risk factors performed similarly here and abroad for the first quarter of 2022. Some key takeaways to note:
Value investors around the globe enjoyed a sigh of relief as this factor posted gains in a favorable market environment. Tailwinds for the value factor include rising rates, high inflation, and the continued reopening of the economy.
Quality’s underperformance this quarter is somewhat surprising, as higher volatility and falling markets tend to be a boon for this factor. The rotation out of highly valued, profitable growth equities may have been a drag on the quality factor by extension, as quality and growth tend to have modestly positive correlation.
The minimum volatility factor performed as expected in the first quarter, as its lower beta tendencies were attractive in a volatile and uncertain market environment.
Style factors in general have lagged over intermediate-term trailing periods. Trailing one-year underperformance of the small cap factor belies the wild ride it had throughout the year. Until the last quarter of 2021, it had handily outperformed the broader domestic equity benchmark. However, small cap growth stocks were particularly susceptible to the looming rise in interest rates and slower growth expectations that emerged toward the end of the year. As a result, they have underperformed both small cap value and large cap stocks by double-digit margins and have been a heavy weight on the small cap factor in general. Inflation has returned with a vengeance and all corners of the market are bracing for the fallout. Factor premia are likewise affected by the inflationary environment, and history may have some insight into what to expect from factors as inflation heats up. Check out our deeper dive HERE.