What’s in a Factor? Breakdown by Sectors
Structural Sector Exposure vs Frequent Sector Rotation
February 2018. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Some factors show structural sector exposure while others rotate sectors frequently
- Sector concentrations explain factor performance and may represent concentration risks
- Value is currently long Financials, Low Volatility is short Health Care, and Growth is short Energy
INTRODUCTION
Despite all the hustle and bustle surrounding factor investing, considerable uncertainty remains about what factors and their related products represent and contain. For example, there is a large discrepancy between the excess returns of long-short factor portfolios and investable smart beta products. Taking a step further back to the factor construction level, it’s illuminating to examine what stocks compose the building blocks of factors.
By analyzing how the factors break down by sector, we can gain valuable insights into factor performance and concentration risks.
With that goal in mind, we explore the six well-known factors – Value, Size, Momentum, Low Volatility, Quality, and Growth – using definitions in line with academic and industry standards and focusing our analysis on the United States. We construct the long and short portfolios using the top and bottom 10% of the stock universe.
THE VALUE FACTOR
The chart below shows the long and short value factor portfolios by sector, with the average portfolios covering the years 2000 to 2017. Financials make up more of the current long portfolio than the average portfolios, indicating that banks, insurance, and other financial services companies are cheaper today than their historical average. Interestingly, the Technology sector does not compose a larger share of the current short portfolio despite concerns about the high valuations of tech companies like Amazon and Facebook (read Value Factor – Intra vs Cross-Sector).
