Level 0 Investing & ETF Basics · Part 13/16

Factor ETFs: Value, Quality, Growth & Small Cap

By Alexander Bock, founder and data analyst

Factor ETFs reweight a broad index toward a specific style. The funds in the catalog with their current holdings:

Schematic line of a factor's relative performance against the overall market with multi-year phases above and below zero
Schematic, not measured data: this is how factor premiums typically behave. (1) Multi-year phases in which a factor leads the market alternate with (2) long dry spells. Looking only at short periods, the picture can be the opposite depending on the starting point.

The fund pages show top holdings, sectors and countries, and how differently the same “world” is composed depending on the factor. Any two can be set side by side in the ETF comparison.

In Context

Factors change diversification and risk profile relative to the market index. Their out- or underperformance runs in cycles that can last many years. In portfolios, they are therefore usually used as an addition to a broad core.

Where Factors Come From

The research starts with Eugene Fama and Kenneth French (1992, 1993). Besides the overall market, company size and valuation explained part of the differences in returns between stocks. Mark Carhart added momentum in 1997, Robert Novy-Marx profitability in 2013. Factor ETFs turn such traits into fixed rules.

How the Indices Measure a Factor

  • Value: valuation ratios such as price-to-book, price-to-earnings based on expected earnings, and enterprise value to operating cash flow.
  • Quality: high return on equity, low debt and stable earnings.
  • Momentum: price performance over the past six and twelve months, relative to its volatility.
  • Minimum volatility: a selection that, by calculation, gives the lowest volatility for the portfolio as a whole.

What a Factor Costs

Factor ETFs trade more often than a broad market fund, because valuations and ratios keep shifting. Their ongoing costs are usually higher than those of a world ETF. Both eat into any extra return. The ETF overlap check shows, holding by holding, how much a factor fund differs from the overall market.

Information only, not investment advice.

Updated · Content and figures checked