Smart beta ETFs delivered the best performance in over a decade with all but one factor beating global equity benchmarks in 2022.

According to data from Finominal, only growth underperformed global equities while value, size, momentum, low volatility, quality and multi-factor strategies outperformed market beta.

Value ETFs led the way with 4.4% outperformance as high interest rates prompted a reality check for pricey growth names in tech and communications sectors while profitable companies proved more resilient. Similarly, an overweight to energy was beneficial as fossil fuel prices hit 15-year highs.

Low volatility ETFs also had an edge with 3.1% outperformance owing to their outsized allocations to healthcare, consumer staples and utilities stocks which tend to be more defensive, with more stable balance sheets to weather market volatility.

Smart beta excess returns

Source: Finominal

Nicolas Rabener, founder and CEO of Finominal, commented: “2022 is the best year for factor investing over the last decade.”

Examining how factor portfolios behaved during the year, Finominal found while size and quality yielded lower returns, they were less volatile through 2022 than value, momentum and – paradoxically – low volatility strategies.

Another interesting trend is how unlike previous years, value and low volatility were positively correlated while the correlation between value and size turned negative – a pattern which “is reminiscent of the tech bubble in 2000”, the research said.

long-short factor performance

Source: Finominal

Rabener also argued investors might be better-served investing in beta neutral – equal-weight long-short – factor strategies rather than smart beta ETFs which tend to be long-only and market cap-weighted, given the former offers a better tool for diversification.

“An equal-weighted portfolio of beta-neutral factors produced a return of 7.5%, which would have generated attractive diversification benefits for a traditional equity-bond portfolio, given that this was substantially down in 2022”, he added.

Rabener concluded by stating the past decade has been a difficult period for factors, with the tech mainstays of most investor portfolios often found in the short positions of value, quality and low volatility beta neutral portfolios.

“In 2022, investors’ preferences changed with rising interest rates which led to the best year for evidence-based investors over the last decade as all of the well-known factors generated positive returns.”

However, he said investor flows were slow to react to good news in factor outperformance.

“Evidence-based fund managers rejoice about the strong performance of traditional factors like value in 2022, but investors were not too enthusiastic in terms of capital allocations to factor investing products.” 

Interestingly, the opposite trend played out in ESG-tilted factor ETFs in 2022, with the iShares MSCI USA Momentum Factor UCITS ETF (IUME) and iShares MSCI USA Value Factor UCITS ETF (IUVE) seeing $2.3bn combined outflows as investors quickly pulled money from strategies with baked-in energy underweights.

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