While 2022 left a lot to be desired, the fourth quarter seemed like it tried to make up for the previous three, at least until the very end of the year. The SPDR S&P 500 ETF Trust (SPY) returned 7.07% (not including any dividends) which, given the full-year's negative 19.48% return, helped make 2022 only the worst year since 2008 and not any further back in history. As we transition from the Fed-induced, everyone-is-a-genius rally of the last few years, I thought it would be interesting to take a look at some fund strategies that go a step beyond providing passive beta, or broad market exposure.
Before everyone went Fed-free-money crazy, "Smart Beta" funds were all the rage. These are strategies that are driven by various factors. Some had very complicated models like the First Trust suite of AlphaDex products and some focused on very simple factors, like low volatility, momentum, and stocks with "value" attributes.
In running some screens on fourth-quarter returns, I found funds in each of these categories that showed promise. In an effort to keep my comparisons in the apples-to-apples camp, I selected funds that used the S&P 500 as their base and applied their screens on that same starting point. I say this, because there are higher returning funds in each of these categories, but again, I'm trying to isolate the efficacy of the approach given the same starting point.
Source for all charts: Factset, All You Can ETF
The Funds
In each category, I selected the best performing S&P 500-based fund and it turns out that all three of these factor funds are issued by Invesco. It wasn't my intent to showcase Invesco, but here we are:
The Invesco S&P 500 Low Volatility ETF (SPLV) tracks the S&P 500 Low Volatility Index. In reviewing the index methodology the security selection process is straightforward, selecting the 100 least volatile stocks from the S&P 500 Index and weighting them so that the constituents with the lowest observed volatility end up with the largest weight. The index is reconstituted and rebalanced on a quarterly basis (February, May, August, and November).
The Invesco S&P 500 Momentum ETF (SPMO) tracks the S&P 500 Momentum Index. The index methodology explains that final index constituents are selected from the top quintile of momentum ranked constituents for whichever index is utilizing the momentum strategy. In the case of the S&P Index, this of course means that once again, the top 100 names are selected. Positions are weighted by applying the momentum rank and market capitalization described as the "Product of the securities market capitalization in the eligible index universe and the momentum score, subject to security and sector constraints." This index is reconstituted and rebalanced on a semi-annual basis in March and September.
The Invesco S&P 500 Enhanced Value ETF (SPVU) tracks the S&P 500 Enhanced Value Index. The methodology guide spells out that the constituents of the S&P 500 Index are evaluated and scored based on the trio of book value to price, earnings to price, and sales to price. Once these metrics are calculated, each set of values is used to develop a Z-Score (distance away from the group standard deviation) and a simple average is then calculated using the three Z-Scores to arrive at the final Value Score. Weights are determined using the same process described for the S&P 500 Momentum Index. This index is reconstituted and rebalanced on a semi-annual basis in June and December.
My Take
As you can see from the table below, all three of these funds outperformed SPY in the fourth quarter, as well as for the full year, as shown in the graph above. As I mentioned earlier, using these funds isn't meant to be an endorsement of Invesco ETFs, but rather, as some evidence that these factors were working in fourth quarter. My mid-term take is that as the Fed continues to hammer on the broad economy, factors like these, not to mention individual company stories (read: active management) will be places of relative outperformance this year.
Unsurprisingly, my calculated correlation ratios for these strategy proxies compared to SPY also indicate that they are doing something different than SPY -- and, judging from the results, deserve to be on investors' radar.
