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Waman Virgaonkar

Waman Virgaonkar
Vice President, MSCI Research

Hitendra D Varsani

Hitendra D Varsani
Executive Director, MSCI Research

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Factors in Focus: Go with the Flow?

  • Global equities were up in Q2 2021 for the fifth consecutive quarter with MSCI Quality Indexes leading performance among the MSCI Factor Indexes.
  • In the year to date, value and yield factor ETFs have seen the largest inflows. We looked at monthly inflows/outflows in factor ETFs and subsequent active returns and found a positive relationship over the last six years.
  • As economies reopen with increasing numbers of COVID-19 vaccinations “in arms,” MSCI’s adaptive multi-factor model pointed to an overweight to momentum and low size.

In the last Factor in Focus blog post, we saw how the value factor had dominated flows in the ETF space, as parts of the world slowly started to recover from the COVID-19 pandemic. In this post, we will look at flows into ETFs and whether it has been profitable, historically, to follow the money. Before we delve into that, however, we will do a quick roundup of factor and factor-index performance over the second quarter.

 

Profitability Was the Big Winner in Q2 2021

Global equity markets posted a positive return for the fifth consecutive quarter in Q2 2021. Progress on vaccinations around the globe and the reopening of economies were a strong impetus for the upward move. The MSCI ACWI Index was up 7.5% for the quarter, reaching an all-time end-of-day high on June 28. The exhibit below shows the pure-factor performance of the MSCI Global Equity Model over Q2 2021. Profitability was the best-performing factor, while earnings yield and dividend yield were the worst. Long-term reversal, low earnings variability and momentum also performed well.

 

Pure-Factor Performance in Q2

Factor performance of the MSCI Global Equity Model (GEM+ESG) pure factors from March 31, 2021, to June 30, 2021.

 

Quality Indexes Outperformed in Q2 2021

Quality indexes outperformed in all regions reflecting the strong underlying performance of the profitability and low earnings variability descriptors as seen above. Driven by the strong performance of the value factor and relative weakness in growth for more than the past six months, the MSCI Momentum Indexes recently rebalanced into securities with higher value and lower growth characteristics. In fact, the MSCI Momentum Indexes for the U.S., world and emerging-market equities rebalanced with a one-way turnover of 68%, 64% and 55% at MSCI’s May 2021 Semi-Annual Index Review compared to long-term historical averages ranging in the 40s. While the momentum indexes lagged the broad-market indexes (-1.4% active return versus the MSCI ACWI), the pattern was very different in emerging markets (+9.0% active return) and AC Asia ex Japan (+9.8% active return). A large part of this outperformance stemmed from momentum effects in China. 

 

Market Strength with Quality

 

 

The table shows regional variations of the MSCI Minimum Volatility Index (USD), MSCI High Dividend Yield Index, MSCI Quality Index, MSCI Momentum Index, MSCI Enhanced Value Index, MSCI Equal Weighted Index and MSCI Growth Target Index, from March 31, 2021, to June 30, 2021. The bar chart shows the active returns of the same indexes, by region, for each month in the quarter, as well as the full quarter.

 

Factor ETF Flows Were Strongest for Yield, Value and Low Size

The exhibit below shows the USD flows of globally listed ETFs from May 2020 to May 2021. More recently, yield, value and low-size ETFs saw the biggest inflows year to date, with a total of USD 50 billion flowing into these factor ETFs.

All data as of May 2021; Source: Refinitiv Lipper. Only primary listings, not cross-listings, are counted. MSCI does not guarantee the accuracy of third-party data.

 

Has it Paid to Go with the Flow?

In a similar spirit to price momentum, whereby investors associate active returns with previous winners, we analyzed the relationship between inflows/outflows in factor ETFs and subsequent active performance. One difference to note in terms of sourcing prices is that momentum portfolios have a long history (several decades), while factor ETFs are a relatively recent market development (our sample period covers January 2015 to May 2021).

To normalize against the general growth in ETF assets, we looked at the standardized monthly inflows/outflows relative to each factor ETF’s respective history and measured its active return over the next one-month period. As we can see in the exhibit below, during periods of outsized inflows into factor ETFs, active return over the next month has been positive (above +0.80%), whereas during periods of significant outflows, active return has been negative (below -0.50%).

 

Factor ETFs: Average Active Monthly Return vs. Standardized Inflows/Outflows

 

Average active monthly return of factor indexes based on time-series z-score of ETF flows. The z-scores of flows are calculated based on an expanding window of monthly flows in factor ETFs in the U.S. market. Period from January 2015 to April 2021.

 

MSCI’s Adaptive Multi-Factor Allocation Model

Our adaptive multi-factor framework is a model designed to analyze decisions about tilting toward factors. Our research has shown that factors were sensitive to changing market conditions and suggest there has been value in taking a holistic approach to factor assessment that encompasses not only the macroeconomic environment as shown above but also factor valuations, recent performance trends and risk sentiment.

As of June 30, 2021, our adaptive multi-factor model showed the following exposures across the four pillars:

  • The macro-cycle pillar indicated an overweight to quality, low volatility and momentum, based on mixed signals from the CFNAI, Federal Reserve Bank of Philadelphia’s ADS Index and PMI.
  • The valuation pillar overweighted value, momentum and yield, based on the valuation gap compared to an equal-weighted factor mix in the context of nearly 30 years of a factor’s history.
  • The momentum pillar selected quality, momentum and low size, based on the last three months’ relative performance. 
  • The market-sentiment pillar showed a risk-on environment, based on the Cboe Volatility Index® (VIX) term structure and credit spreads, resulting in an underweight to low volatility, yield and quality and an overweight to momentum, value and low size.

 

Exposures from MSCI’s Adaptive Multi-Factor Allocation Model

As of June 30, 2021. Positive exposures are denoted as + or ++, negative as - or --, neutral as N.

Overall, our adaptive multi-factor model showed an overweight to low size and momentum and an underweight to yield and low volatility, relative to an equally weighted factor mix.

 

 

Further Reading

Factors in Focus: Value Springs into Action

Reopening Economies and the Resurgence in Value

Factors in Focus: Val-Come Back.

Factors in Focus: Impact of Inflation on Style Factors

Adaptive Multi-Factor Allocation

Factors — Elements of Performance

Regulation