Are Factors Losing Their Edge?


Several articles from a variety of sources recently caught my eye. The common thread of these articles was that return factors—those that have shown a propensity to outperform the market over time—have been losing their ability to outperform.

Most of these articles posit that as factors have gained in prominence in financial circles, the potential for future outperformance has been arbitraged away. Since so much money has been funneled into smart beta exchange-traded funds (ETFs) aimed at exploiting these exact factors, less of an edge will exist going forward. A bold claim, to be sure, but does the data back it up?

Using data from Professor Kenneth French’s website, we can isolate several U.S. equity factors and compare them to the market’s returns. We took the four most oft-cited factors—size, value, quality and momentum—and analyzed them over rolling 10-year periods to view the effectiveness of these factors over the entirety of market cycles. Has there been a drop-off in performance in recent years?

Rolling 10-Year Annualized Excess Return vs. S&P 500

Rolling 10-Year Annualized Excess Return v. S&P 500

Reduced Outperformance, but Not Eliminated Outperformance

Looking at the data, a few takeaways emerge:

  • It does appear that starting in 2011, the excess return for all four factors versus the S&P 500 has been coming down, to varying degrees.
  • The last decade for the size factor, which can see its relative performance ebb and flow over long stretches of time, is one of the worst periods of relative performance since the tech bubble of the late 1990s.
  • Value is in the midst of its worst stretch of relative performance in history.
  • Momentum and quality have remained consistent outperformers, with quality of note for its stability of excess returns. In fact, there has not been a rolling 10-year period where quality didn’t outperform the S&P 500 since 1990, with all annualized excess returns between .25% and 3.55%.
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