How Have Factors Responded To Investors' Newfound Optimism?

by: Invesco PowerShares


Factor outperformance has varied since the Nov. 8 elections, with the value and size factors doing especially well.

Momentum and low volatility stocks have not fared as well in light of newfound investor optimism.

Investors wary of market volatility may wish to pair factors, which can have important implications for diversification.

Pairing factors can help capitalize on market trends, while providing a potential hedge

Posted by Nick Kalivas, Senior Equity Product Strategist

Although investment factors have shown the ability to outperform market-cap-weighted benchmarks over time, factors are cyclical by nature - falling in and out of favor depending on market conditions. In my view, a particularly useful way to assess performance and grasp shorter-term cyclical factor movements is by considering excess returns on a 12-month rolling basis.

Excess return is defined as the difference in return between a factor index or exchange-traded fund (ETF) and a benchmark index, such as the S&P 500 Index. Assessing excess returns on a rolling basis captures performance in overlapping 12-month periods - allowing investors to gauge the consistency of returns over time.

With that in mind, let's take a look at rolling 12-month excess returns for a small sample of investment factors versus the S&P 500 Index. The chart below begins in April 2012, based on the inception date for the longest-tenured of these factor indices.

investment factors versus the S&P 500 Index

Source: Bloomberg L.P., Jan. 31, 2017. Total returns for the period covering April 30, 2012, through Jan. 31, 2017. Low volatility represented by the S&P 500 Low Volatility Index (12.66%), value represented by the Dynamic Large Cap Value Intellidex Index (14.18%), momentum represented by the Dorsey Wright Technical Leaders Index (9.72%), dividend represented by the NASDAQ US Dividend Achievers 50 Index (18.15%), small-cap size represented by the FTSE RAFI US 1500 Small-Mid Index (14.18%). Performance data reflect monthly rolling returns relative to the S&P 500 Index. Past performance is no guarantee of future results.

Value, size factors have outperformed

If you focus on the right-hand side of the chart, you'll see that the small-cap size factor (represented in turquoise by the FTSE RAFI US 1500 Small-Mid Index) and the value factor (represented in green by the Dynamic Large Cap Value Intellidex Index) have seen their excess returns move higher in recent months after a period of underperformance.

The recovery in the value and size was likely driven by an improved outlook for economic and profit growth, as well as rising interest rates. The ISM Manufacturing Index reached 56.0 in January 2017 after dipping to 49.4 in August 2016.1 Strength in the size and value factors since mid-2016 is also consistent with the rise in the 10-year Treasury yield, which increased from a low of 1.36% in July 2016 to 2.45% as of Jan. 31, 2017.1

Changing market leadership has hindered momentum factor

Conversely, the momentum factor, as defined by the Dorsey Wright Technical Leaders Index, has shown relative weakness of late. Changing and unstable market leadership has created headwinds to momentum, but momentum may be attempting to revert back to mean, which could drive its excess return into positive territory. That could be good news for contrarian investors, who may be attracted to the momentum factor given its recent underperformance.

Low volatility shares have underperformed in reaction to positive macro fundamentals

After posting outsized returns in the first half of 2016, the low volatility factor, as defined by the S&P 500 Low Volatility Index, has underperformed the S&P 500 Index since early November. The weak relative performance of low volatility is likely a function of stronger economic growth, elevated stock valuations following the Nov. 8, 2016, presidential election, and rising interest rates. It comes as no surprise that low volatility's weakness has coincided with improvement in the value and size factors, as low volatility strategies are designed to perform best in bear markets.

Dividend stocks have outperformed, despite weakness

Excess returns for the dividend factor, as defined by the NASDAQ US Dividend Achievers 50 Index, have retreated in recent months, but dividend-paying stocks have still outperformed the market in a low-yield environment. While US Treasury yields have climbed in recent months, inflation-adjusted interest rates still remain low from a historical perspective, with the 10-year Treasury yield near 2.50% and the core consumer price index rising 2.20% in December.1 This makes dividend-paying stocks attractive, in my view. At the end of January, the dividend yield on the NASDAQ US Dividend Achievers 50 Index was 3.59%, which is competitive, in my view.1 Moreover, a byproduct of the NASDAQ US Dividend Achievers 50 Index methodology has been exposure to smaller-cap stocks relative to the S&P 500 Index. This is significant, as small caps have rallied sharply since the November elections, with the S&P SmallCap 600 Index up 15.20% between Nov. 8, 2016, and Jan. 31, 2017.1

Want to diversify? Pay attention to factor excess return correlations

The graphic below highlights low (and sometimes even negative) correlations between the various factors' excess returns. Put another way, when some factors show relative strength to the S&P 500 Index, others show relative weakness. The correlation table not only puts a number on this relationship, but also provides insight into which factors could pair well for investors looking to enhance their portfolios' diversification.2 Factors have the potential to enhance portfolio returns over longer periods of time. Although short-term results can vary, pairing factors with low or negative excess return correlations can have important implications for longer-term portfolio diversification.

12-month rolling excess return correlation to the S&P 5oo Index - April 2012 to January 2017

correlations between the various factors

Source: Bloomberg L.P., Jan. 31, 2017. Low volatility represented by the S&P 500 Low Volatility Index, value represented by the Dynamic Large Cap Value Intellidex Index, momentum represented by the Dorsey Wright Technical Leaders Index, dividend represented by the NASDAQ US Dividend Achievers 50 Index, small-cap size represented by the FTSE RAFI US 1500 Small-Mid Index. Performance data reflect monthly rolling returns relative to the S&P 500 Index.

In the table above, note the low correlation figures - those with low positive and, in some cases, negative values. These indicate that factors behave differently given the same market conditions. As you can see from the negative correlations, low volatility pairs well with momentum and value, while momentum pairs well with a number of different factors - particularly value and low volatility, which is also borne out in academic research. By contrast, higher correlation numbers suggest that dividend and low volatility do not provide much diversification benefit when paired (at least that has been the case during the roughly five-year period measured here).

Putting it all together

The economy has shown firmer footing in recent months. Beyond the cyclical upswing, investors appear optimistic about the potential for tax cuts and less regulation under the Trump administration. If current optimism continues, it would not surprise me to see the value and small-cap size factors continue to flourish. Nonetheless, market risks remain, and risk-averse investors may wish to diversify their portfolios with low volatility exposure as a hedge against potential market turbulence. More aggressive investors might be better served pairing the value and momentum factors, with the hope that momentum stocks revert back to mean, which could provide a boost to their overall performance.

PowerShares by Invesco offers a wide range of factor-based ETFs, including both single- and multi-factor options.


  1. Bloomberg L.P., Jan. 31, 2017
  2. Diversification does not guarantee a profit or eliminate the risk of loss.

Important information

Blog header image: Billion Photos/

Correlation is the degree to which two investments have historically moved in relation to each other.

The consumer price index measures change in consumer prices as determined by the US Bureau of Labor Statistics.

The FTSE RAFI US 1500 Small-Mid Index is designed to track the performance of small and medium-sized US companies selected based on four fundamental measures of size: book value, cash flow, sales and dividends.

The Dynamic Large Cap Value Intellidex Index is designed to provide capital appreciation while maintaining consistent stylistically accurate exposure.

The ISM Manufacturing Index, which is based on Institute of Supply Management surveys of more than 300 manufacturing firms, monitors employment, production inventories, new orders and supplier deliveries.

The Dorsey Wright Technical Leaders Index includes approximately 100 US mid- and large-capitalization companies selected by Dorsey, Wright & Associates LLC's proprietary methodology, designed to identify companies that demonstrate powerful relative strength characteristics.

The NASDAQ US Dividend Achievers 50 Index comprises 50 stocks selected principally on the basis of dividend yield and consistent growth in dividends.

The S&P 500 Index is an unmanaged index considered representative of the US stock market.

The S&P 500 Low Volatility Index consists of the 100 stocks from the S&P 500® Index with the lowest realized volatility over the past 12 months.

The S&P SmallCap 600 Index is a market-value weighted index that consists of 600 small-cap US stocks chosen for market size, liquidity and industry group representation.

Factor investing is an investment strategy in which securities are chosen based on certain characteristics and attributes.

Momentum style of investing is subject to the risk that the securities may be more volatile than the market as a whole or returns on securities that have previously exhibited price momentum are less than returns on other styles of investing.

There is no guarantee that low volatility stocks will provide low volatility.

A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.

Investing in securities of large-cap companies may involve less risk than is customarily associated with investing in stocks of smaller companies.

Stocks of small-capitalization companies tend to be more vulnerable to adverse developments, may be more volatile, and may be more illiquid or restricted as to resale than large companies.

Treasury securities are backed by the full faith and credit of the US government as to the timely payment of principal and interest.

Securities that pay high dividends as a group can fall out of favor with the market, causing such companies to underperform companies that do not pay high dividends. Also, changes in the dividend policies of the companies and the capital resources available for such companies' dividend payments may be affected.

Before investing, investors should carefully read the prospectus/summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the funds visit for a prospectus/summary prospectus.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.


All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.'s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC, investment adviser. Invesco PowerShares Capital Management LLC (PowerShares) and Invesco Distributors, Inc., ETF distributor, are indirect, wholly owned subsidiaries of Invesco Ltd.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was posted on the Invesco PowerShares' blog by an Invesco PowerShares' employee on February 23, 2017: