Content provided by Sierra Morris, CLS Junior Investment Research Analyst

Smart beta has gotten a lot of press lately. This branding isn’t as intuitive as we would like, so CLS has decided to take a different spin on the name and call it “factor investing.” As an added bonus, by changing our labeling we won’t insult any traditional, “dumb” index managers. These factor index funds focus on alternative strategies to weighting rather than market capitalization like most index funds (ex. S&P 500) where investors have the largest exposure to the largest companies. The most popular factor strategies fall into five categories:

  1. Size (weighted other than by large market cap)
  2. Value
  3. Volatility
  4. Quality
  5. Momentum

Sierra blog chart

So far, these indexes appear to beat the market over the long term while at the same time holding less risk.

Size: Indices with a size factor may weight differently by focusing on mid-caps or very simply by just providing an equal weight to every component of an already existing index. These are some of the earliest factor based funds.

Value: The value factor focuses on companies with low valuations such as the price-to-earnings ratio (P/E) and the price-to-book ratio (P/B). The value strategy seems to work best early in the expansion stage.

Volatility: Low volatility and reduced variance in stock returns is the primary focus of the volatility factor. This strategy strives for outperformance over the long haul by seeking steady performance rather than riding wild ups and downs.

Quality: Quality factors place an emphasis on high earnings quality, as well as low earnings variability and leverage. Late in the expansion phase of the economic cycle or when there is uncertainty in the economy is frequently the best time to use this strategy.

Momentum: Momentum factors pay attention to recent trends of outperformance in the 3, 6, and 12 month time frame, as history shows that they will likely continue on their ride upward. This factor tends to work best when the economy is strong – in a secular bull market.

A large reason these strategies are able to provide additional return while carrying less risk is due to their low correlation benefits. For example, using monthly returns and ignoring the level of magnitude, let’s look at the MSCI Quality Index and the MSCI Value Index. According to Blackrock, when one underperforms a standard cap weighted index, 70 percent of the time the other will outperform. Talk about diversification benefits!

CLS has been incorporating factor ETFs in our portfolios such as:

  • USMV – minimum volatility
  • QUAL – quality, MTUM – momentum
  • RYE – equal weighted






An ETF is a type of investment company whose investment objective is to achieve the same return as a particular market index.  An ETF is similar to an index fund in that it will primarily invest in the securities of companies that are included in a selected market index.  An ETF will invest in either all of the securities or a representative sample of the securities included in the index.
The S&P 500® Index is an unmanaged composite of 500-large capitalization companies.  This index is widely used by professional investors as a performance benchmark for large-cap stocks.
Large Cap Investments typically invest in larger companies whose market capitalization is over $10 Billion.  Mid Cap Investments typically invest in mid-sized companies whose market capitalization is between $2 Billion and $10 Billion.  Small Cap Investments typically invest in smaller companies whose market capitalization is between $300 Million and $2 Billion.