Monday, May 20, 2024

The ‘factor’ funds keeping up with the US tech rally

Must read

We recently touched on the idea of pairing active funds that use different investment styles as a way of navigating the ups and downs of markets. That’s something that, much as it can come with mixed results, remains pretty compelling when markets can also turn one way or another.

But other options do exist, too. Investors can, for one, use passive funds that track established markets as a rough proxy for investment styles, with the S&P 500 as a growth play and the FTSE 100 as a source of value exposure, to give two examples. That approach isn’t exactly perfect due to the many nuances of broad market exposures: note, for example, that Europe – sometimes viewed as a value market – is home to plenty of market darlings with big structural growth narratives.

Alternatively, one option is to make use of the various factor exchange-traded funds (ETFs) out there. We do include a couple of these in our 2023 Top 50 ETFs list, with the idea that investors can achieve a little more nuance than using regular trackers focused on markets, such as the S&P 500 or MSCI Emerging Markets, that are heavily skewed to specific sectors or geographies.

But how do such funds hold up in unusual conditions? The outperformance of a handful of US tech majors reinforced concerns last year that US and global indices were both distorted and difficult to beat, or even just keep up with. US factor ETFs have had some mixed outcomes here.

To start with a winner, the iShares Edge MSCI USA Quality Factor ETF (IUQF), which has a 6.6 per cent allocation to Nvidia (US:NVDA) and a little over 30 per cent in information technology names, delivered a monster sterling total return of 23.1 per cent in 2023 versus 17.2 per cent from the S&P 500 and 19.6 per cent from the MSCI USA index. By contrast, the iShares Edge MSCI USA Value Factor ETF (IUVF), which does have a high allocation to the information technology sector but doesn’t hold Nvidia, managed a solid but much lower 7.3 per cent return.

These outcomes might seem predictable enough, but there are still some surprises to be had, as is often the case when we try to put factor investing into practice. The iShares Edge MSCI USA Momentum Factor ETF (IUMF) might seem like an obvious choice for investors who want to back the market leaders, but it actually managed an underwhelming 2.9 per cent return last year once its performance is taken in sterling terms.

That seems surprising from a glance at the portfolio itself: the fund has a 7 per cent allocation to Nvidia, 5.9 per cent in Meta (US:META), 5.6 per cent in semiconductor play and strong performer Broadcom (US:AVGO) and 4.8 per cent in Microsoft (US:MSFT), as well as a 42 per cent allocation to the information technology sector. As can be the case, the fund may have been caught out by timing, with semi-annual rebalancing meaning it can belatedly load up on exposure to the market leaders. The fund also looks worse than it should thanks to currency effects: it managed a 9 per cent return in US dollar terms, although this is well behind the 26.7 per cent generated by a standard MSCI USA ETF.

Latest article