Factor Investing

The Powers of factors

Paradigm shift

Investors’ world view is changing
For years, investors looked at the market through the lens of a traditional style box. However, a growing number of investors are shifting to factor investing for a more precise method of portfolio construction.

PowerShares believes this shift is largely due to rising correlations along with low return environments. These dynamics have helped expose the limitations of traditional methods and spurred investors to seek more effective means with which to assess market risk and enhance returns. At the same time, more powerful data analytics as well as advances in research into investor behavior have provided the ability and the insight to better implement more sophisticated strategies.

S&P 500 Index: Investment styles

32 33 35 Large
0 0 0 Mid
0 0 0 Small
Value Blend Growth  
Traditional style boxes provide only a superficial view of a portfolio’s construction – much like the naked eye reveals only a person’s outward characteristics.

For illustrative purposes only.

Factor investing isn’t new

Factor investing is grounded in decades of academic research and continues to quickly evolve, offering investors the potential for better risk-adjusted returns and more truly diversified portfolios.

Six factors have been shown through rigorous academic research to be rewarded across market cycles and geographies – low volatility, momentum, quality, value, small size and dividend yield. 1

The academic origins of factor investing

Source: PowerShares, as of Sept 30, 2017. Past performance does not guarantee future results.

At PowerShares by Invesco, we help investors achieve outcomes that go beyond the limitations of traditional style box investing and cap-weighted benchmarks. By striving to target historically rewarded factors, we’re evolving the concept of smart beta and creating the next generation of ETFs.

1 Source: Getting smart about beta, PowerShares by Invesco, March 13, 2017. We define rewarded factors as those that have been identified, vetted and replicated in academic journals, have been robust across time periods and geographies and have the potential to offer statistically significant excess returns.

What is factor investing?

A factor is a quantifiable characteristic of a security that to a large extent explains its risk-return profile. In essence, factors can be viewed as the DNA, or building blocks, of an investment portfolio.

Investors can build portfolios by selecting stocks that exhibit tilts toward specific factors. Targeting these underlying drivers of return may provide a more finely tuned, systematic approach to portfolio construction.

Six factors – low volatility, momentum, quality, value, small size and dividend yield – are academically supported and have historically demonstrated outperformance across asset classes and geographies. 1

Examines a stock's earnings, book value and sales relative to its price. The higher these fundamental ratios are, the cheaper the stock.
value
Value
Ranks stocks by their market cap, with smaller companies ranking higher.
small size
Small size
Considers the magnitude of up and down price of a stock's trailing 12-month price returns.
low volatility
Low volatility
Stocks that have had high risk-adjusted 12-month returns excluding the most recent month.
momentum
Momentum
Companies with fundamental ratios that point toward a strong balance sheet and stable earnings growth.
quality
Quality
Ranks stocks based on their annualized dividend yield.
dividend
Dividend yield

1 Source: Getting smart about beta, PowerShares by Invesco, March 13, 2017. We define rewarded factors as those that have been identified, vetted and replicated in academic journals, have been robust across time periods and geographies and have the potential to offer statistically significant excess returns.

 

Using factors in portfolios

All portfolios exhibit factor tilts
Because of their fundamental and ubiquitous nature, factors have the potential to drive more precise investment and asset allocation decisions.

Intentionally seeking a diversified portfolio by blending factors may allow investors the opportunity to better match specific investment preferences.

Outcomes based on outlook
Factors perform differently based on macroeconomic influences, such as market volatility. Investors can use factors within portfolios to achieve desired outcomes based on their market outlook. For instance, an investor who is bullish on the market might increase exposure to value and small size, which have historically demonstrated higher volatility and beta relative to the S&P 500.

Adjusting risk up and down using factors

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Factor Volatility Beta to S&P 500
1 Value 15.3% 1.22
2 Small size 13.3% 1.08
3 Momentum 12.0% 0.93
4 Dividend yield 11.0% 0.82
5 Quality 10.8% 0.91
6 Low volatility 9.6% 0.70

Source: Bloomberg L.P., Oct. 9, 2015 to Sept. 30, 2017. For illustrative purposes only.Volatility for the S&P 500 Index Oct. 9, 2015 to Sept. 30, 2017 was 11.4%.Volatility is measured as the annualized standard deviation of daily returns of the indexes. The following indexes were used as proxies for factors: Value - S&P 500 Enhanced Value Index; small size - Russell 1000 Equal Weight Index; momentum - S&P 500 Momentum Index; dividend yield - S&P 500 Low Volatility High Dividend Index; quality - S&P 500 Quality Index; and low volatility - S&P 500 Low Volatility Index. See disclosures information for index definitions.

Factors vs. style box

Think outside the style box

Style box investing, pairing characteristics like growth and value, is based on the premise that the combination may provide differentiated returns. PowerShares believes it is time to think outside the style box.

Investors using a traditional growth and value pairing may be in effect paying more to mirror the market.
A style box portfolio

Portfolio is equally weighted between growth and value stocks The results
Correlation of growth and value: -1.00 The perfect negative correlation between growth and value means the allocations largely offset each other.
Holdings differential vs. the S&P 500 Index: 0.22% Over 99% of the portfolio’s stock holdings are the same as the S&P 500 Index. Rather than diversifying their portfolio, investors using a traditional growth and value pairing may be in effect paying more to mirror the market.

Source: Source: Bloomberg L.P. for correlation data as of Sept. 30, 2017; FactSet Research Inc. for holdings differential data as of Dec. 31, 2016, the date of the last value/growth proxy rebalances. Past performance does not guarantee future results. An investment cannot be made directly into an index. Index returns do not represent fund returns. Holdings differential is the percentage of stocks in a portfolio that is not in a particular index, in this case the S&P 500. The higher the holdings differential the lower the holdings overlap between the portfolio and a particular index. Growth and value are represented by the S&P 500 Growth and S&P 500 Value Indexes, respectively. Correlation of growth and value is measured using the five-year correlation of excess returns to the S&P 500 as of Oct. 9, 2015 to Sept. 30, 2017.

A factor portfolio

Portfolio is equally weighted across the low volatility, quality, momentum, value and dividend yield factors The results
Average correlation of the factors: -0.01 A complimentary portfolio with a low correlation of excess returns across the factors.
Holdings differential vs. the S&P 500 Index: 43% The greater the holdings differential the more potential opportunity for relative outperformance.

Source: Bloomberg L.P. for correlation data as of Sept. 30, 2017; FactSet Research Inc. for holdings differential data as of Dec. 31, 2016, the date of the last value/growth proxy rebalances. Past performance does not guarantee future results. An investment cannot be made directly into an index. Index returns do not represent fund returns. Average correlation is measured by the average correlation of excess returns to the S&P 500 across the factors analyzed from Oct. 9, 2015 to Sept. 30, 2017. The factor indexes that were analyzed were: low volatility - S&P 500 Low Volatility Index; quality - S&P 500 Quality Index; momentum - S&P 500 Momentum Index; value - S&P 500 Enhanced Value Index; and dividend yield - S&P 500 Low Volatility High Dividend Index. See disclosures information for index definitions.

Holdings differential vs S&P 500

Active share vs S&P 500

Source: FactSet Research Inc., as of Dec. 16, 2016, the date of the last value/growth proxy rebalances. Past performance does not guarantee future results. An investment cannot be made directly into an index. Growth/Value is represented by 50% S&P 500 Growth Index and 50% S&P 500 Value Index. The 5 factor portfolio is represented by equally weighting: low volatility - S&P 500 Low Volatility Index; quality - S&P 500 Quality Index; momentum - S&P 500 Momentum Index; value - S&P 500 Enhanced Value Index; and dividend yield - S&P 500 Low Volatility High Dividend Index.

PowerShares factor ETFs

Smart beta ETFs provide efficient, transparent, high-value access to factors.

PowerShares is a pioneer in smart beta ETFs having offered numerous first-to-market innovations. Our funds seek to outperform traditional benchmark indexes while giving advisors and investors access to an innovative array of focused investment opportunities.

Risks & other information

There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including short selling and margin maintenance. Ordinary brokerage commissions apply. The fund's return may not match the return of the underlying index.

Certain funds are considered non-diversified and may be subject to greater risks than a diversified fund.

The prices of equity securities change in response to many factors, including the historical and prospective earnings of the issuer, the value of its assets, general economic conditions, interest rates, investor perceptions and market liquidity.

The momentum style of investing is subject to the risk that the securities may be more volatile than the market as a whole, or that the returns on securities that have previously exhibited price momentum are less than returns on other styles of investing.

A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock market.

Investing in securities of small capitalization companies involves greater risk than customarily associated with investing in larger, more established companies.

Diversification does not guarantee a profit or eliminate the risk of loss.

Note: Not all products are available through all firms.

S&P 500 Low Volatility Index measures performance of the 100 stocks with lowest realized volatility over the past 12 months from the S&P 500. The index benchmarks low volatility or low variance strategies for the US stock market. Constituents are weighted relative to the inverse of their corresponding volatility, with the least volatile stocks receiving the highest weights.

S&P 500 Quality Index is designed to track high quality stocks in the S&P 500 Index by quality score, which is calculated based on return on equity, accruals ratio and financial leverage ratio.

S&P 500 Momentum Index is designed to measure the performance of securities in the S&P 500 Index universe that exhibit persistence in their relative performance.

S&P 500 Enhanced Value Index is an unmanaged index considered representative of large-cap value stocks tracks the performance of the stocks in the S&P 500 Index that have the highest value score.

S&P 500 Low Volatility High Dividend Index consists of 50 securities traded on the S&P 500 Index that historically have provided high dividend yields and low volatility.

Russell 1000 Equal Weight Index is a trademark of Frank Russell Company and has been licensed for use by PowerShares by Invesco. The product is not sponsored, endorsed, sold or promoted by Frank Russell Company and Frank Russell Company makes no representation regarding the advisability of investing in the product.

Beta is a measure of risk representing how a security is expected to respond to general market movements. Smart Beta represents an alternative and selection index based methodology that seeks to outperform a benchmark or reduce portfolio risk, or both in active and passive vehicles. Smart beta funds may underperform cap-weighted benchmarks and increase portfolio risk.

Factor investing is an investment strategy in which securities are chosen based on attributes that have been associated with higher returns.

Return on equity (ROE) is net income divided by net worth.

Volatility is the annualized standard deviation of index returns. There is no guarantee the funds will provide low volatility.