Colliding Factors In A Single Factor Fund

July 25, 2017

If picking what factor to invest in is tricky business because timing factors is practically impossible, and cyclicality means periods of underperformance relative to the market, picking a factor ETF can be just as difficult.

Consider two momentum funds. They both look for companies that have seen strong price gains in recent months and are likely to continue seeing gains ahead, but their diverse approaches to a similar universe mean very different results—sometimes.

The difference in performance between the iShares MSCI USA Momentum Factor ETF (MTUM)—the largest momentum ETF on the market—and the MomentumShares U.S. Quantitative Momentum ETF (QMOM) year-to-date is striking, as the chart below shows. There’s a divergence of 15.6 percentage points between them. In other words, MTUM has delivered roughly 350% of the returns QMOM has shelled out so far in 2017.

(For reference, the second-largest fund in this segment, the PowerShares DWA Momentum Portfolio (PDP), and the SPDR S&P 1500 Momentum Tilt ETF (MMTM), are found somewhere in between MTUM and QMOM in terms of performance. All but QMOM are outpacing the broader market as measured by the SPDR S&P 500 (SPY).)

 

 

What Gives?

There’s the basic portfolio construction differences to start with. Both MTUM and QMOM pick momentum stocks from the U.S. total equity market—they are fish swimming in the same pond.

But MTUM picks and weights stocks by looking at both six- and 12-month holding period returns, and it scales by the volatility of returns over the past three years. The fund essentially goes beyond a pure momentum factor capture by looking at various metrics in its effort to deliver a smooth ride in returns.

QMOM, meanwhile, takes a more classic approach to the momentum factor, targeting the 10% of stocks with the highest total return over the last 12 months, excluding the most recent month. The ETF also excludes stocks that have too many negative-return days during the 12-month period in a mix that’s equal-weighted.

These differences point to two key things. First, that the end result for MTUM is a portfolio that typically tilts toward lower-beta names and much higher market capitalization than QMOM. MTUM has a portfolio beta of 0.92 and a weighted average market cap of $143 billion; QMOM’s beta is 1.51 and has a weighted average market cap of only $16 billion, according to FactSet data.

 

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