‘Tesla is an ideal poster boy’: Why 2020 was a 'poor year' for factor investing

Value, size and low volatility significantly underperformed the market while momentum delivered double-digit returns

Tom Eckett

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It was a torrid time for traditional factors in 2020 as large-cap tech stocks such as Tesla and Apple dominated market performance following the extreme volatility in March.

According to research conducted by FactorResearch, which constructed long-short beta-neutral factor portfolios, value suffered the worst performance falling 19.2% last year, meaning it has been the worst performing factor every year over the past decade barring 2013 and 2015.

Unlike during the Global Financial Crisis in 2008, low volatility failed to offer investors protection during the coronavirus volatility and finished the year 10.5% down.

Nicolas Rabener, founder and CEO of FactorResearch, said the poor returns were driven by certain sector biases such as overweight real estate while underweight tech.

“Being short Tesla or Netflix while long shopping centre REITs was not helpful positioning for a pandemic, although that just reflects the nature of the portfolio construction,” he added.


Source: FactorResearch

At the other end of the spectrum, momentum was the best performing factor by some distance last year delivering returns of 16.6%.

The rally in tech stocks following the coronavirus turmoil was the key reason why momentum has delivered significant outperformance over the past 12 months.

Taking the iShares Edge MSCI World Momentum Factor UCITS ETF (IWMO) as an example, its top 10 holdings include the likes of Tesla, Apple, Microsoft, Amazon, Facebook, Google and PayPal.

Exposure to tech stocks, Pierre Debru, director of research at WisdomTree, said has been the key driver of outperformance last year resulting in momentum and growth posting strong returns.

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“Growth and momentum benefitted from strong overweights in tech stocks to deliver double-digit outperformance, reminiscent of the ‘dot-com’ tech bubble in 2000.

“If 2020 has taught us anything, it is that investors and their portfolios need to be ready for everything and anything,” Debru continued. “Tech companies could continue to benefit from the new working and living habits that we all picked up this year.”


Source: FactorResearch

Elsewhere, size struggled in this market environment falling 4.7% over the past 12 months while quality delivered positive returns of 3.7%.

With the pandemic accelerating the adoption of digital technologies, companies involved in technological disruption have been the big winners.

According to Rabener, Tesla is the ideal “poster boy” for understanding why traditional factors have had such a poor year.

With the large-cap electric car manufacturer trading at an extortionate valuation, exhibiting extreme volatility and featuring low profitability, it has a negative exposure to size, value, low volatility and quality factors.

“Tesla was up close to 600% in 2020 and a few other stocks with similar characteristics had equally impressive returns,” Rabener continued. “Although these stocks contributed to the strong performance of momentum, investors’ current infatuation with technology and growth also explains the pain in the other classic equity factors.”


Source: FactorResearch

Furthermore, new evidence released last year warned smart beta ETFs were relying on data mining and backtesting to attract assets.

The academic study, entitled The Smart Beta Mirage, found smart beta ETFs delivered above-average market returns of 2.77% a year prior to listing but once they go live this drops to a yearly underperformance of 0.44%.

“Our results caution the risk of data mining in the proliferation of ETF offerings,” the authors stressed. “In fact, ETF issuers have strong incentives to present investors stellar backtested returns, as investors often pay attention to past performance, and stellar backtested performance could help ETF issuers attract investment flows.”

With smart beta ETFs now beginning to display over three-year live track records, 2021 could be the year that determines which strategies stand the test of time and which are left behind.

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