Case study: Enhancing traditional beta exposure through factors

Case study: Enhancing traditional beta exposure through factors

Improve the risk-adjusted returns of traditional US equity beta exposure while limiting tracking error — a government pension plan wanted a factor strategy designed to meet this goal. We partnered with the client and S&P Dow Jones Indices to develop a new family of three multi-factor indices and ETFs: the Quality Value Momentum (QVM) Multi-factor Suite.

The approach

Equity factor investing seeks to identify the stocks of companies with certain quantifiable characteristics that have been shown to contribute meaningfully to returns over time. It’s become a standard solution for institutional investors who are seeking to optimize returns and enhance portfolio diversification.

Our approach targeted three well-established factors:

Quality: Stocks with low leverage and high return on equity, cash flow, and profitability. Quality is a defensive factor that can potentially outperform in down markets.

Value: Stocks trading at a discount to intrinsic value based on measures such as price to earnings or sales. Value is an offensive or pro-cyclical factor that can potentially outperform the broad market during periods of strong equity returns.

Momentum: Stocks with strong recent performance. Momentum is a trending factor that can be offensive or defensive, but it tends to benefit from consistent market trends.

The methodology

The QVM methodology starts with a traditional S&P equity universe. It then ranks each stock based on a composite quality, value, and momentum score, and removes the bottom 10% of stocks with the lowest scores. The portfolio is weighted by float-adjusted market capitalization.

Eliminating a small percentage of stocks from the parent index and weighting the remaining positions by market capitalization helps keep tracking error low.

The solutions

This strategy is available in three ETFs based on the S&P 500 Index, S&P MidCap 400 Index, and S&P SmallCap 600 Index.

• QVML — Invesco S&P 500 QVM Multi-factor ETF
• QVMM — Invesco S&P 400 QVM Multi-factor ETF
• QVMS — Invesco S&P 600 QVM Multi-factor ETF

The ETFs were launched on June 30, 2021, so they have a live performance track record longer than three years.

The pension plan used these ETFs as a complement to traditional US equity beta exposure. The funds give the client the ability to quickly adjust exposures as part of their quarterly asset allocation process.

For institutional investors interested in potentially harvesting factor premia, but who are unable or unwilling to assume significant tracking error, this approach may be optimal.