Smart Beta In Correction: Momentum, Low Volatility And Quality Continue To Outperform

by: Left Banker


I look at the relative performance of five iShares single-factor, smart-beta ETFs, alone and in combined portfolios.

Funds emphasizing low-volatility, momentum and high quality have outperformed, even through the market's correction.

Funds emphasizing small size and value had underperformed.

Smart Beta In Correction

In previous articles on the iShares, single-factor, smart-beta ETFs (A Quest for the Smartest Beta and Expanding the Smart Beta Filter: Does It Help?) I concluded that three of these funds -- those focused on low volatility (iShares MSCI USA Minimum Volatility ETF (NYSEARCA:USMV)), momentum (iShares MSCI USA Momentum Factor Index ETF (NYSEARCA:MTUM)) and quality (iShares MSCI USA Quality Factor ETF (NYSEARCA:QUAL)) -- have been consistently generating alpha. Two others, which emphasize size (iShares MSCI USA Size Factor ETF (NYSEARCA:SIZE)) and value (iShares MSCI USA Value Factor ETF (NYSEARCA:VLUE)), were less effective. I further showed that an equal-weighted portfolio of USMV, MTUM and QUAL solidly outperformed SPY.

Since that time the market has been in a steady downtrend. These market conditions provide an opportunity to ask how the single-factor, smart-beta funds have handled the correction to date.

Performance for the Full Record

First, let's look at the performance records1 of the funds since the inception of the most recent in July 2013.

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As we see in the table, for the full 30 months under consideration MTUM, QUAL and USMV beat the broader market as represented by SPY while VLUE and SIZE fell short.

Previously, I considered how the funds behave when combined in two equal-weighted portfolios, one comprising MTUM, QUAL and USMV and the other comprising all five of the factor ETFs. As in the past, the current results demonstrate that each of those portfolios has outperformed SPY, providing greater returns, lower volatility and reduced maximum drawdowns. The MTUM-QUAL-USMV portfolio (shown as "MQV" in the tables) outperformed the portfolio that included all five funds.

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Most Recent 12 Months

As we know, recent months have not been kind to investors with long equity positions. The results seen in these tables, especially the maximum drawdown numbers, suggest that the single-factor funds may have outperformed during the downward moving market as well over the longer term considered.

ETF performance for the 12 months beginning February 2015 through the end of January 2016 looks like this.

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Here again we see MTUM, QUAL and USMV beating SPY on all metrics, and VLUE and SIZE lagging on CAGR, Sharpe and Sortino Ratios. MTUM once again generated the highest returns but at the cost of higher volatility than the runner-up, USMV. Interestingly, SIZE shows a lesser maximum drawdown than VLUE and lower volatility than all but USMV.

The combined portfolios turned in the results one would expect from the performances of the individual funds.

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The MQV portfolio was up 4.16% for the period. The performances of its components were sufficient to keep the five smart-beta funds portfolio just better than even for the 12 months as SPY fell into negative territory.

Most Recent Six Months

The even more dismal market of the past six months shows the same trends continued to hold.

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MTUM, QUAL, USMV have each outperformed SPY. USMV is particularly impressive with CAGR of -1.1% during the period when SPY gave up over -13% on an annualized basis. VLUE and SIZE continued their underperforming ways with both lagging SPY, VLUE by a substantial margin.

As for the combined portfolios, clearly the MQV portfolio topped the results. And here again, the returns of MTUM, QUAL and USMV were sufficient to keep a portfolio of all five funds ahead of SPY for the period.

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Volatility-Adjusted Results Relative to SPY

We can look at the CAGR returns relative to the funds' volatilities to get a picture of risk-adjusted returns. The following charts show the same periods (full record since inception, one year and six months) with CAGRs plotted against the standard deviations. The funds are shown individually and in the two combined portfolios (labeled MQLv for the three single-factor funds equally-weighted, and MQLvSV for all five, equally-weighted). In each chart the line runs from the zero intercepts through SPY. Points above the line show outperformance relative to SPY on a volatility-adjusted basis.

Since inception of the youngest fund:

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Full year through Jan 2016:

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Six months through Jan 2016:

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As we see, when considered along with volatility, the same general conclusions hold. Those single-factor funds that are driven by algorithms designed to select stocks with high momentum, high quality, or low volatility consistently outperformed SPY even in down markets. And a portfolio of these funds solidly outperforms SPY when adjusted for volatility, showing both greater returns and lower volatility.

The funds based on market cap and value have just as consistently underperformed. When the funds are combined in equal-weighted portfolios, the favorable record of the three single-factor funds vs. SPY becomes even more pronounced. Futhermore, their outperformance is sufficient to bring the portfolio comprising all five of the single-factor funds above the line in all but the case of the last six months where the full portfolio falls on the line.


It is well established that the size and value factors have, over time, led to outperformance over the broader market. Indeed, the case for these factors may be stronger than that for momentum, low volatility, or the hardest-to-define factor, quality. Why then, one is inclined to ask, have SIZE and VLUE done so poorly relative to QUAL, MTUM and USMV? As always, the devil is in the details. The implementations of the size and value factors for these ETFs is, in my view, neither sufficiently innovative nor astute for them to stand out in what are very crowed fields. One can select among dozens of funds emphasizing value or size. On the other hand, there are few other funds that attempt to emphasize either momentum or quality as single-factor investment criteria. A close look at the algorithms behind QUAL and MTUM does show, in my view, particularly thoughtful implementations of these factors, much more so than than the implementations of the size and value factors. These are described in more detail in my previous articles on the topic which are cited above, so I'll not repeat it here.

It should also be noted that the periods under consideration have not favored either value or smaller cap stocks. It is possible that VLUE and SIZE have been as much affected by those market conditions as by shortcomings in the algorithms driving the funds' indexes. It would be informative on this count to examine these two ETFs in relation to the broader spectrum of value and small- to mid-cap ETFs. Informative perhaps, but not particularly useful; it is sufficient for my purposes to see that these funds are consistent underperformers without needing to understand the details of why that is the case.

In conclusion, the results for the recent down market environment support previous observations that QUAL, MTUM and USMV offer attractive single-factor investing opportunities. Alone or in a combined portfolio, their solid outperformance of the broader market has continued in a down trending equity environment. By contrast, the iShares implementations of the size and value factors have a history that leaves little to recommend them.


  1. Performance data in tables are from and portfolios were rebalanced monthly.

Disclosure: I am/we are long MTUM, QUAL, USMV.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article does not constitute investment advice. I am passing along the results of my research on the subject. Any investor who finds these results intriguing will certainly want to do all due diligence to determine if any security mentioned here is suitable for his or her portfolio.