High dividend and low volatility had the strongest performance, outperforming the S&P 500 by over 16 and 10 percentage points, respectively. Quality's underperformance is surprising as it's often viewed as a more defensive factor. This illustrates two challenges around factor investing. First, the expected risk-return attributes are based on averages over time. In any one short period, a factor may not perform in line with those attributes. Second, how a factor is targeted matters, especially over short time horizons. For instance, the index composite we created to measure quality has lagged last year whereas many dividend growth strategies, which can also be considered quality strategies, outperformed.
So did strong factor performance in 2022 translate into success for active managers? After all, taking advantage of factors is a lever that active managers can use to try to outperform traditional benchmarks that use market cap to select and weight securities. When describing their process, active managers often target companies that they believe are trading at attractive valuations (value orientation vs. benchmark) and able to sustain the higher dividends, earnings growth rates, return on equity, or some sort of competitive advantage (quality). Also, by deviating away from market cap weighting, an investment process will usually have a smaller size bias.
Some observations on success rate of active equity funds vs. traditional equity benchmarks:
- Within US large cap, most core and value active managers were able to outperform the benchmark last year with success rates of 61% and 69% respectively. Active core and value managers saw similar success within the mid- and small-cap segments as well. Active growth managers struggled to outperform benchmarks across each of the size segments in 2022.
- Active managers have generally had more success in outperforming benchmarks in US large cap value than US large cap growth. One possible reason for greater success within value is the ability to identify, and avoid, stocks that are cheap for a reason. As for why growth managers have struggled, especially in the longer-term time periods analyzed, we'd speculate that many managers have been underweight mega cap growth vs. traditional growth indices. Mega-cap growth has outperformed both large- and mid-cap growth over the past three-, five-, and ten-year periods.
- Interestingly, the two best quarters for active management in 2022 were 2Q, when the S&P 500 was down 16%, and 4Q, when it was up over 7%. These were also the two strongest quarters for factor performance as five of the six factors outperformed in 2Q and all six outperformed in 4Q.
- Over the past 10-years, active managers have struggled to outperform benchmarks across equity segments. Besides fees, we believe the outperformance of US mega cap has posed a headwind. Active managers may allocate some of the portfolio towards smaller companies and/or international markets to try to enhance returns and these segments have generally lagged US mega cap.
- The performance of active managers focusing internationally was weak last year. Most surprising is the Diversified Emerging Markets category where only 28% of managers outperformed. There's generally thought to be more opportunities to generate outperformance in EM and last year, four of the six MSCI factor indices outperformed the MSCI EM Index. Furthermore, cap-weighted benchmarks are heavily weighted in China (often between 25-30% weighting), which lagged in 2022.
Finally, active management performance is driven by more than just factor returns. A manager's skill at identifying alpha opportunities, costs, and a numerous other considerations all come into play. A full factor quilt including the annual performance of individual factors, a multi-factor approach, and the S&P 500 going back is available here.
Read the original blog Equity factors outperformed in 2022, did active managers? 14 February 2023.
Main contributors: Daniel J. Scansaroli, David Perlman, and Christopher Buckle
This content is a product of the UBS Chief Investment Office.