Factor Investing Is Dead, Long Live Factor Investing!

Portfolio construction and implementation matters

April 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Market-neutral multi-factor products have reached all-time highs
  • However, long-only multi-factor products have consistently underperformed
  • Portfolio construction and implementation matters

INTRODUCTION

Investors have been style investing since the inception of stock markets. Some chase trends, while others focus on quality or cheap stocks. Factor investing is not new, but it did experience a significant boom after the global financial crisis in 2009 when asset managers like BlackRock made these strategies available to all investors via low-cost ETFs.

The popularity was supported by plenty of new research indicating that investors should look at their portfolios with a factor lens, where the influential paper from Andrew Ang, William Goetzmann, and Stephen Schaefer on analyzing the track record of the $350 billion Norwegian Government Pension Fund played a key role.

However, from 2017 onwards, the most popular factors like value and momentum started generating negative excess returns, which led to factor investing’s popularity waning and many funds being liquidated. Some market participants started calling this the factor investing winter, while others became more morbid and declared factor investing dead. One common narrative was that too many smart beta ETFs have arbitraged the factor premia away.

Jumping to 2024, it seems that these concerns have been overstated and factor investing is alive and well, but portfolio construction and implementation matter, which we will outline in this article.

FACTOR INVESTING RETURNS

We will use AQR’s Equity Market Neutral Fund (QMNIX) as a proxy for the state of factor investing as it constitutes a market-neutral multi-factor portfolio that is constructed in line with academic research. The fund selects stocks from a global universe based on value, quality, and momentum metrics. The long and short portfolios contain approximately 1,000 stocks each, and leverage is used to achieve beta-neutrality so that the returns are uncorrelated to the stock market.

The fund was launched in 2014 and had strong returns until 2017, when it gave up all gains over the next three years, and