Factors are the primary market drivers of asset class returns. In equities, only a limited set of rewarding factors are supported by academic consensus: value, size, momentum, low volatility, high profitability, and low investment. These factors compensate investors for the additional risk exposure they create in times of crisis. Therefore, factor strategies are attractive to investors as they provide exposure to rewarding risk factors in addition to market risk and can be a source of superior risk-adjusted performance over the long term compared to weighted benchmarks. depending on capitalization.
2022 has been a momentous year for investors, but for not-all-good reasons. The relative outperformance of equity risk factors compared to other popular equity investment styles was a bright spot, however. While the financial media has attributed recent strong factor performance almost entirely to the value factor, the resurgence in factor performance has actually been much broader.
The return of Factor Performance has been widespread
Here, “factor performance” refers to the performance of long/short factor portfolios that buy a subset of stocks with the highest positive exposure to a given factor and sell a subset of stocks with the highest negative exposure to the same factor. Indeed, in the United States, almost all factors recorded positive performances in 2022, with an average return of 6.9%, which is in line with their long-term average, as illustrated in the graph below. -below. The Momentum, Low Investment and Value factors beat their long-term average, but not their best rolling 5% annual returns. The Low Volatility and Size factors also performed positively, albeit below their long-term average. High profitability was an outlier, posting the only negative performance. Indeed, the factor performed so poorly that it eclipsed its worst rolling return of 5% between December 31, 1974 and December 31, 2021.
Performance of US factors in 2022
| American Factors | Size | Value | Mom | Low volume | Top Pro | Low Rev | 6-F SO |
| 2022 | 3.5% | 8.4% | 19.9% | 4.3% | -10.1% | 15.4% | 6.9% |
| Avg. Rolling Annual return |
8.8% | -1.7% | 3.9% | 8.5% | 3.8% | 4.1% | 4.1% |
| Worst 5% Rolling return |
-22.0% | -20.5% | -20.9% | -17.4% | -9.1% | -9.2% | -3.9% |
| Top 5% Rolling return |
53.8% | 14.4% | 27.9% | 36.9% | 22.5% | 21.3% | 18.7% |
The results in the chart above contradict two popular media narratives: that the factor performance story is only a value story and that any highly profitable company will outperform in a rising rate environment.
Factor’s story has been a sector story
Which sectors drove factor performance in 2022? The energy sector has played an outsized role. It outperformed its broadly cap-weighted peer by 84.5% and, as illustrated below, helped boost performance in the Value, Momentum and Low Investment factors and had a negative impact on low volatility and high profitability.
Sector performance attribution: US factors, 2022
For international equities and global equities, the story is largely in line with the US market.
Performance factor through a macro lens
Although macro factors are not the main drivers of stock performance, they can have a significant influence on the behavior of factors in certain environments. To examine how the macro environment influences factor performance, we use a macro framework developed by Noël Amenc, Mikheil Esakia, Felix Goltz and Ben Luyten. Our four macro variables, shown in the chart below, are short rates (three-month Treasury bills); forward spread (10-year minus 1-year Treasury bills); default spread (Baa minus Aaa Corporate Bonds); and breakeven inflation (breakeven inflation over 10 years). For each macro variable, we construct a long/short macro portfolio made up of the stocks most and least sensitive to macro innovations (surprises). We go for long stocks with the highest sensitivity to weekly macro innovations and short stocks with the lowest sensitivity to weekly macro innovations.
In 2022, macro factors explained much of the variability in some factors related to US equities. For example, the duration gap, credit spread, and breakeven inflation factors explained 27%, 33.7%, and 45.3%, respectively, of the variability in the value factor over the period. Break-even inflation was one of the most powerful macro factors, as it explained much of the variability in returns from value, high profitability and momentum. No macro factor had a real impact on the variability of the Momentum factor.
Percentage of US equity factor performance in 2022 explained by macroeconomic factors
| USA 2022 R squared |
Size | Value | Momentum | Weak Volatility |
High Profitability |
Weak Investment |
| Short rate | 6.1% | 0.4% | 0.6% | 46.7% | 8.0% | 1.0% |
| Term gap | 8.6% | 27.0% | 1.2% | 36.3% | 36.5% | 11.7% |
| credit spread | 11.4% | 33.7% | 5.3% | 20.5% | 47.1% | 22.4% |
| Break even Inflation |
12.5% | 45.3% | 7.1% | 19.6% | 67.0% | 29.7% |
The results above contrast with the longer-term impact of macro factors on equity-related factors, illustrated in the following chart. Although macroeconomic factors do not have the most significant long-term impact, given the transition to a more normalized interest rate environment, they exert a more pronounced effect on factor performance in 2022. This is consistent with academic findings. In effect, short-term variations in factor risk premia are related to the business cycle or macroeconomic conditions.
Percentage of long-term U.S. equity factor return explained by macroeconomic factors
| long term usa R squared |
Size | Value | Momentum | Weak Volatility |
High Profitability |
Weak Investment |
| Short rate | 0.9% | 5.9% | 6.0% | 29.4% | 1.2% | 14.5% |
| Term gap | 1.9% | 1.2% | 0.0% | 14.9% | 3.7% | 0.8% |
| credit spread | 4.7% | 0.3% | 0.0% | 21.7% | 0.0% | 7.1% |
| Expected inflation | 0.4% | 3.2% | 0.2% | 4.9% | 10.3% | 0.8% |
How have macro factors affected equity factors? The chart below shows that value and low investment had a positive sensitivity and a negative sensitivity of high profitability and low volatility to breakeven inflation. Similarly, Value and Low Investment had a negative sensitivity and Low Volatility and High Profitability a positive sensitivity to the credit spread factor.
Factor Sensitivities of US Equities in 2022 to Macroeconomic Factors
| USA 2022 Betas |
Size | Value | Momentum | Weak Volatility |
High Profitability |
Weak Investment |
| Short rate | 0.22 | 0.05 | -0.04 | -1.11 | -0.25 | -0.08 |
| Term gap | 0.16 | 0.33 | 0.07 | -0.62 | -0.35 | 0.23 |
| credit spread | -0.33 | -0.65 | -0.34 | 0.83 | 0.71 | -0.57 |
| Break even Inflation |
0.25 | 0.54 | 0.28 | -0.58 | -0.60 | 0.46 |
What’s next for Factors?
While it’s impossible to predict how the factors will behave in 2023 and beyond, so far it looks like macroeconomics, especially monetary policy, will always be at the forefront of investors’ minds. How this will influence sectors and factors is an even more difficult question, and investing based on a specific macroeconomic outcome may not be the best course of action for most investors. On the contrary, investing in all of the rewarded factors may be more judicious. As empirical evidence shows, average historical factor premiums are likely to be resilient to all sorts of extreme market conditions and macroeconomic developments. The long term reward risk factors will not disappear because they compensate for the additional risks taken by investors. Therefore, multi-factor strategies with well-balanced exposures to the six rewarded factors should continue to benefit from their long-term reward in the future.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
Image credit: ©Getty Images / baona
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