Analyzing Your Factor Bets

August 19, 2019

How To Read The Factor Box

So how do we interpret this factor box? Let’s start on the right. MSCI, in its great giant computer in the sky, probably tracks hundreds—if not thousands—of potential factors. It’s filtered them down into six macro factors that have shown, historically, to be significant potential drivers of returns.

Those six factors are on the right. Each one of these has its own methodology about which you could probably spend a month or two reading documentation, but for example: Value is primarily driven by book-to-price, earnings yield  and long-term reversal trends. Quality includes leverage, earnings variability, earnings quality, investment quality and profitability. And each one of those data sets has its own time-tested methodology.

Establishing A ‘Z-Score’

Each one of these factors is measured at the single-stock level, and then rolled up as a portfolio, and the metric here is a Z-score. For those of us who slept through stats class, a Z-score is a standardized way of looking at standard deviation. So a Z score of -1 would mean a given stock (or portfolio, when aggregated) is 1 standard deviation below the MSCI ACWI IMI in terms of that given factor.

In non-nerd terms, it’s reasonable to think of anything above or below 1/-1 as “a lot,” and anything inside .5/-.5 as “not very much.”

Funds that score +/- 1.5 here are extremely rare. So the box above would suggest “The S&P 500 is a little light on small companies, and a little light on low volatility stocks.” This should surprise nobody. The S&P is a large cap index, and driven by a bunch of FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks that are certainly not low vol.

Fruit Rollups

Where this gets interesting is when you start comparing funds that are explicitly suggesting they’re tracking a particular factor.

For example, let’s say we we’re trying to decide between two popular value ETFs: the iShares S&P 500 Value ETF (IVE) and the Invesco S&P 500 Pure Value ETF (RPV). We know from just the names that both of these funds have the same objective (pick the value stocks out of the S&P 500). But how similar are they really?



To me it seems incredibly obvious. RPV picks smaller, higher-yielding, objectively more “valuey” stocks. The trade-off is that you’re making negative bets on momentum and quality. One of the most important things you can look at if you’re comparing these funds is if they actually do what they claim.

Beyond The Box

I hear you saying, “But, Dave, how do I make the nice little comparison chart you’ve shown here?” Well, the short answer is, we’re working on it. Right now, we’ve worked with MSCI to incorporate the data that drives the individual factor boxes you’ll see on pretty much every equity ETF. I think it’s super cool, but it’s just the beginning. Going forward, we’ll be developing more nuanced ways of making comparisons, so you can tease out these differences without having to flip between fund reports.

We’ll also be making it more intuitive to search and sort based on these factor exposures in our ETF Finder (right now, you can filter for over/underweights, but we’ve got a lot of room to add functionality here.)

But we didn’t want perfection to get in the way of the good here. This is one of the most useful additions we’ve made to the fund pages in the last few years, and we wanted to get this out there.

You’ll see us feature these metrics where it’s interesting in our daily coverage, and I hope you’ll find it useful when you start hunting for that perfect ETF to fill the empty slice in your asset allocation pie chart.

As always, I welcome your feedback at [email protected]. And stay tuned in the coming weeks as we tweak how you can use this data to make better decisions.

For more information about what’s going on under the hood here, check out this blog from MSCI, or you can download the full methodology.

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