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Index Research

How to Play the Factor Game?

Smart Beta Strategies, which offer benefits of both passive and active investing, have gained in popularity. Now find out which factors are performing better, and why.

  • By Richard Lin, CFA, Nasdaq Global Information Services 

Smart Beta strategies, which combine the benefits of passive investing and the advantages of active investing, have gained in popularity over the past decade.

Nasdaq is one of the world’s largest Smart Beta index providers. As of September 2019, there was more than $90 billion in ETF AUM benchmarked to Nasdaq Smart Beta indexes.

Nasdaq offers full suites of single and multi-factor based Smart Beta indexes, such as the Nasdaq Dorsey Wright Indexes, Nasdaq Victory Indexes, Nasdaq Dividend & Buyback Achievers Indexes, Nasdaq AlphaDEX Indexes, and Nasdaq Smart Sectors Indexes. Performance history for Nasdaq Smart Beta indexes dates back as early as March 2001.

In this article, we will focus on reviewing single factors and how they have performed over time. The question always comes up: which factor has performed better and the follow-up question, why? We will answer these questions using the 18+ years of available Smart Beta factor returns. Below are the Smart Beta single factor indexes covered in the following analysis:

Smart Beta Chart 1

How Did the Factors Perform Over Time?

Similar to what the majority of industry practitioners and academic researchers have discussed, no single factor dominated throughout the entirety of the study period from 2001 to 2019. Factor rotation is a common phenomenon.

Still, we are able to observe certain trends on the aggregate level. The momentum factor did well in the first half of our look back history from 2001 to 2010, however, it became less consistent in the second half of the study period. On the other hand, we found that while the growth factor didn’t do as well in the study’s early years from 2001 to 2004 following the tech bubble, it is recovering and has regained popularity in recent years.

Smart Beta Chart 2

Which Factor is the Winner After All?

From the buy and hold investors’ perspective, different investment horizons give different factor champions depending on how long investors intend to hold their investments.

For example, the momentum factor performed the best on a year-to-date basis (through 9/30/2019), but didn’t do as well when investors held it over the last ten years. Instead, the quality factor topped the list (in the last ten years).

Throughout the entirety of our study period from 2001 to 2019, momentum was the best performing factor on a cumulative basis. That result, however, may largely be due to momentum’s stunning performance in the years prior to 2011. Overall, the momentum, quality, volatility, and valuation factors outperformed the benchmark throughout the entire history. Surprisingly, the dividend and growth factors were the two factors that underperformed the benchmark on a cumulative basis in the study.

Smart Beta Chart 3

Factor Performance on a Relative Basis

If investors were only interested in beating the benchmark, which factor has a higher chance to win? Chart 1 shows that the quality factor won 15 out of the past 18 years. It is followed by volatility, value, and momentum.

Dividend and growth had only equal or fewer chances to outperform the benchmark. This observation confirms our previous finding that dividend and growth were the worst-performing factors throughout the entire history studied.

Smart Beta Chart 4

On the other hand, the momentum factor may be the best active factor in terms of profitability. On average, momentum returned an active annual return of 11.9% when outperforming and -3% when underperforming. In comparison, the quality factor only produced a return of 5.3% outperformance and -2.7% underperformance relative to the benchmark.

Let’s turn to dividend and growth again. Although the dividend factor was still quite profitable when outperforming (8.6% annual active return), those gains were almost completely offset by the loss when underperforming (-8.3% annual active return). Ultimately, the growth factor was the worst performing factor as it returned merely 2% outperformance but -3.3% underperformance.

Smart Beta Chart 5

Factor Active Risk

Benchmark-constrained investors may also be interested in finding ways to improve portfolio returns without taking on too much active risk (i.e. tracking error). In this case, investors should consider growth, volatility, value or quality more than dividend and momentum as dividend and momentum generated higher tracking errors over time. We have illustrated the case of three years, ten years, and since inception. Momentum and dividend are consistently more volatile (relative to the benchmark as measured by tracking error) than all other factors.

Smart Beta Chart 6

On the flip side, the momentum and dividend factors may be the darlings for active traders as “the higher the risk the higher the return”. However, these two still behaved very differently. In the following chart that shows a rolling one-year active return and risk matrix, we see that while both were the most active factors, momentum has historically had relatively lower tracking errors than dividend. The potential explanation behind that phenomenon is that momentum is more alpha-focused in nature given its strategy design, while dividend is more vulnerable to macro environment changes such as interest rates. Nevertheless, both factors create plenty of opportunities for smart traders to capitalize on due to factor alpha dispersion.

Smart Beta Chart 7


In short, this article provided a detailed performance review of six popular Smart Beta factors: growth, value, quality, volatility, dividend, and momentum.

Our investigation showed that none of the factors consistently outperformed throughout the entire history from 2001 to 2019. This paves the way for why rotation amongst factors is a common phenomenon.

We are still trying to summarize some trends on the aggregate level. For example, we have observed that momentum has turned from the super-star in early years prior to 2011, to a a lower performing factor in recent years. Contrarily, growth seems to have regained popularity in the current market environment. On a cumulative basis, quality was the best-performing factor in the last 10 years; but momentum outpaced quality over the entire study period. Using the Nasdaq US 500 Large Cap index as our benchmark, quality had the highest chance to win (15-to-3) on a relative basis year over year from 2001-2018. Momentum is the best active factor with the highest average active return when outperforming. Finally, momentum and dividend are the two types of factors that consistently generate higher tracking errors, so benchmark-constrained investors should pay special attention to integrating them into current portfolios, while active traders may find ways to monetize from the factor alpha dispersion.

Smart Beta Appendix


1. Since Dorsey Wright Technical Leaders Index history starts from 2007, we used another similar Dorsey Wright Index, Dorsey Wright Dynamic Focus Five Total Return Index (DWANQDFFT), to extend the return history.

Nasdaq® is a registered trademark of Nasdaq, Inc. The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing.


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