Checking in on Factor ETF Performance

Factor exchange-traded funds are among the most popular strategies on the market, and perhaps the most misunderstood. Before investing in factor ETFs, it’s important to understand what they are and what type of returns you can expect.  

According to index provider MSCI, a factor is simply any stock characteristic “that can be shown to be important ... in explaining risk or returns.” While thousands of factors may exist, only a handful have outperformed the broader stock market over long periods of time. These outperforming factors include value, low size, momentum, low volatility, dividend yield and quality. 

The top-performing factors require a long enough investment time horizon to capture potential outperformance. 

Below, we show the historical returns of various popular factor ETFs compared with their vanilla counterparts. As smart investors know, a certain strategy doing well or poorly in a particular arbitrary time frame doesn’t mean it’ll continue to do so going forward. Factors perform and underperform in cycles. 

The sampling of factor ETFs examined are among the most widely owned, with the largest amount of assets. Hundreds more are trading. Here’s how the most popular factor ETFs stack up against their plain vanilla counterparts. 

Value ETFs 

Value ETFs are among the most popular factor funds. Value is among the six factors that have historically outperformed the broader market over long time periods, according to MSCI research. 

Keep in mind the research may cover long time periods, much longer than a particular ETF has been around, so the outperformance may not have been noticed by some ETF investors. Another thing to remember is that each value ETF is different in the way it captures the factor. Some use price-to-earnings ratios, some use price-to-sales ratios, some use book values … the list goes on. 

The Vanguard Value ETF (VTV), with $95.4 billion in assets, the iShares Russell 1000 Value ETF (IWD), with $50.1 billion in assets and the iShares S&P 500 Value ETF (IVE), with $22.6 billion in assets, are the three largest U.S.-listed value ETFs on the market today. 

The tables below show the returns for these three funds since inception and the returns for their broader counterparts in the same time period.

As you can see, the time period measured and the ETF in question play big parts in determining whether a factor has outperformed or underperformed. 

IWD beat its market-cap-based counterpart, returning 313% since inception, compared with 300% for the iShares Russell 1000 ETF (IWB). IWD was aided by the fact that it launched in the year 2000, during the peak of the dot-com bubble, when value stocks were relatively cheap and the broad market was filled with high-flying, overvalued tech stocks. 

The iShares S&P 500 Value ETF (IVE) got the same benefit from launching in the year 2000, and thanks to that, has outperformed the SPDR S&P 500 ETF Trust (SPY) for much of its existence. But in recent years, as value stocks have fallen out of favor (2022 notwithstanding), SPY has surpassed IVE, more than erasing that outperformance. 

Meanwhile, the largest value ETF, the Vanguard Value ETF (VTV), which launched several years after IWB and IVE, followed a completely different trajectory than its rivals. The dot-com boom and bust had no bearing on VTV, while the underperformance of value stocks since the financial crisis weighs on the fund. Currently, VTV’s lifetime return substantially lags its counterpart. 

Growth & Dividend ETFs 

After value, two of the most popular types of factor ETFs are those focusing on growth and dividends. 

Growth isn’t one of the factors that academic research suggests tends to outperform over time, but that hasn’t stopped billions of dollars from chasing it. On the other hand, dividend is a factor said to beat the broader market over time. Concerns are being raised that such strategies may have become overvalued in recent years as interest rates hit rock-bottom levels (pre-2022).

The Vanguard Growth ETF (VUG), with $70 billion in assets, the iShares Russell 1000 Growth ETF (IWF), with $58.3 billion in assets and the iShares S&P 500 Growth ETF (IVW), with $28.3 billion in assets, are the three largest funds targeting the growth factor. Their returns are shown in the table below. 

The returns for the three largest growth ETFs mirror the value ETFs situation. IWF and IVW, which launched in 2000, underperformed their market-cap-based counterparts as growth stocks struggled in the aftermath of the dot-com bust. However, VUG has outperformed since its launch in 2004. 

In terms of dividend ETFs, the Vanguard Dividend Appreciation ETF (VIG), with $57.6 billion in assets, the Vanguard High Dividend Yield ETF (VYM), with $43.9 billion in assets, the Schwab U.S. Dividend Equity ETF (SCHD), with $36.1 billion in assets and the iShares Core Dividend Growth ETF (DGRO), with $22.1 billion in assets, are the largest funds in the space. Their returns are shown in the table below. 

Source: ETF.com data 

Based on the returns for these four funds since inception, it looks like dividend ETFs have largely performed in line with the broader market over the past decade and a half, with the exception of VYM, which has notably underperformed. 

Other Factors 

There are many ETFs that also target the value, growth and dividend factors. We’ve primarily looked at large cap U.S. equity ETFs, but factors can be applied to other areas of the market, including mid and small caps, international equities and sectors. 

Of course, there are also many more factors that ETF issuers can and do use to select and/or weight the holdings of a portfolio. A few of those were mentioned earlier, including low size, low volatility, quality and momentum. 

We’ll look at those in future articles.  

Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2