Market-Neutral versus Smart Beta Factor Investing

Don´t drop your shorts.

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

SUMMARY

  • Smart beta multi-factor ETFs in the U.S. have consistently generated negative returns over the last 10 years
  • In contrast, market-neutral multi-factor funds are at record highs
  • The discrepancy can be explained by the short side contributing almost all positive returns

INTRODUCTION

Quants have been calling the period between 2017 and 2020 the Factor Investing Winter as popular equity factors like value and momentum generated consistently negative returns. Funds like AQR`s Equity Market Neutral Fund (QMNIX), which provides exposure to these factors in a long-short format, lost more than 90% of their assets under management as investors lost their faith in the strategy (read Factor Investing Is Dead, Long Live Factor Investing!).

Since then, the trend reversed as QMNIX and similar funds like Vanguard`s Market Neutral Fund (VMNIX) have reached all-time highs in 2024, proving critics wrong. However, the same can not be said about long-only smart beta multi-factor products as these have continued to produce poor performance. Somewhat ironically, investors have allocated only a few billion dollars to funds like QMNIX, but close to one trillion dollars to smart beta ETFs.

In this research article, we will compare market-neutral versus long-only multi-factor investing in the U.S. stock market.

SMART BETA EXCESS RETURNS

First, we compute the outperformance of five multi-factor ETFs trading in the U.S. that have a track record of almost 10 years and primarily provide exposure to value, momentum, and quality.

We observe that all five generated consistently negative excess returns since 2015. RTDYX and JHML were less volatile than ROUS and DEUS, but the trends in performance were identical, which confirms similar factor exposures. GSLC is the largest multi-factor ETF with close to $12 billion of assets under management, but it has very low factor exposures and can be considered an index tracker (read Multi-Factor Smart Beta ETFs).