Diversification benefits to factor investing
Stephen Tuttle

Instead of trying to “chase” performance by investing in what has performed well recently, seek multiple sources of return through a diversified portfolio.

History shows that investment asset classes, styles, sectors, and factors move in and out of favor over time. The table below tracks the annual returns of well-known investment factors. Each factor focuses on specific investment characteristics widely accepted as important exposure in a portfolio.

Single factor performance tends to be cyclical. No single factor works all the time. Note how factors move up and down year-to-year on the table.

The good news is that most factor returns generally are not highly correlated with one another. This indicates that investors may benefit from diversification by blending multiple factor exposures in a portfolio. The Multi-Factor box below seeks exposure to four common factors:  value, momentum, quality, and size.

In the last 15 years, the world endured multiple natural disasters, numerous geopolitical conflicts, and the deepest recession in the post-WWII era. Through it all, a portfolio that blends multiple factors produced solid returns with moderate risk, relative to single factors.

We believe diversification can help manage risk, while also maintaining exposure to market growth.

Annual Returns (in Percentages) of Factors

Source: FactSet, MSCI, Russell, Standard & Poor’s, J.P. Morgan Asset Management. The MSCI High Dividend Yield Index aims to offer a higher than average dividend yield relative to the parent index that passes dividend sustainability and persistence screens. The MSCI Minimum Volatility Index optimizes the MSCI USA Index using an estimated security co-variance matrix to produce low absolute volatility for a given set of constraints. The MSCI Defensive Sectors Index includes: Consumer Staples, Energy, Health Care and Utilities. The MSCI Cyclical Sectors Index contains: Consumer Discretionary, Communication Services, Financials, Industrials, Information Technology and Materials. Securities in the MSCI Momentum Index are selected based on a momentum value of 12-month and 6-month price performance. Constituents of the MSCI Sector Neutral Quality Index are selected based on stronger quality characteristics to their peers within the same GICS sector by using three main variables: high return-on-equity, low leverage and low earnings variability. Constituents of the MSCI Enhanced Value Index are based on three variables: price-to-book value, price-to-forward earnings and enterprise value-to-cash flow from operations. The Russell 2000 is used for small cap. The MSCI USA Diversified Multiple Factor Index aims to maximize exposure to four factors – Value, Momentum, Quality and Size. Annualized volatility is calculated as the standard deviation of quarterly returns multiplied by the square root of 4. Guide to the Markets U.S. Data are as of April 30, 2020.

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