Investing in value
High quality stocks, with higher return on equity and more stable earnings on average, tend to be more defensive and therefore perform well in times of rising uncertainty. This flight to quality often leads to a shift away from more value oriented securities. The behavior of the iShares Quality and Value ETFs over the first quarter reflected this phenomenon, with the iShares Quality Weighted Index Fund (QUAL) and the iShares Value Index Fund (VLUE) posting excess returns of 1.65% and -0.73% over the S&P 500 Index, respectively.
The take away?
Market Realist: How factor funds are useful
The graph compares the performance of the four factor funds with the S&P 500 (SPY) year-to-date, or YTD. The iShares MSCI USA Quality Factor ETF (QUAL) and the iShares MSCI USA Momentum Factor ETF (MTUM) have outperformed, while the iShares MSCI USA Value Factor ETF (VLUE) and the iShares MSCI USA Size Factor ETF (SIZE) have underperformed the S&P 500.
As discussed in Part 3 of this series, the American economy grew by only 0.2% in 1Q15. So why has QUAL outperformed VLUE?
QUAL has a ~35% allocation toward tech stocks (IYW) and a ~43% allocation toward the defensive sector. The tech stocks have outperformed the broader markets due to superior earnings growth. The defensive sector stocks, including consumer discretionary (XLY) and healthcare (XLV), have performed well. Defensive stocks tend to be low beta, which is why they were able to provide safety during the volatile first quarter.
Meanwhile, VLUE has a slight tilt toward cyclical sectors including the financials (XLF) and energy (XLE), as explained in Part 2. Cyclical stocks—which are relatively high beta—underperformed, as investors sought safety. Cyclical sectors make up ~62% of VLUE.
Meanwhile, SIZE has underperformed because of fears related to higher interest rates. Since SIZE invests in large- and mid-cap stocks with smaller market caps, they will be more affected by higher interest rates than stocks with larger market caps.
Factor funds allow you to get diversified exposure to sectors based on your outlook.
For more on these ETFs, read Weathering Market Volatility with Smart Beta.