Like any investment approach, factors present market participants with benefits as well as drawbacks. In terms of benefits, factor-based strategies have been shown to provide targeted access to factor exposures. Basically, this means that the ETF examples presented above (as well as many others) actually do what they say they do. If you are targeting dividend yield, ETFs that provide exposure to that factor will produce the desired results. The same holds true for momentum, low volatility or other factors not presented above.
During the height of the bull market in 2017-18, every factor except value was outperforming the market. However, factors such as momentum are hit-and-miss. Momentum was the best-performing factor in 2017, but it has offered no aggregate value over the previous ten years because of the financial crisis in 2008-09. As such, factor investing can be highly cyclical and prone to fluctuations.
Additionally, research from Robecco Institutional Asset Management found excess returns for low-beta, value and small-cap funds but no consistent returns for momentum and reversal funds.
In terms of other advantages, many factor-based strategies provide exposure to multiple factors within one vehicle, which gives investors a better shot at achieving their desired outcomes. Additionally, factor-based models represent a broad universe, which means diversification across many asset classes and factors is possible. Finally, advances in technology and data analysis allow investors to take advantage of factor-based models using more enhanced tools and processes.
On the opposite side of the spectrum, factor investing has a few notable drawbacks. For starters, no single factor works all the time. In fact, returns tend to be cyclical, which means extended periods of underperformance are possible and even likely. What’s more, the market for factor-based strategies has become more crowded in recent years, making it more difficult to pick out funds that will produce the desired results. Poorly constructed strategies can actually give you unintended exposures to factors you did not target initially. And because these strategies are actively managed, you can expect to pay more in terms of management fees.
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