In recent years, smart beta strategies have seen a significant increase in popularity. These systematic strategies seek to measure factors in order to harvest the associated long-term risk premium. Many empirical studies show that smart beta strategies have historically outperformed their capweighted benchmarks. However, different single factors tend to outperform in different market environments.1 Therefore, holding a combination of factor strategies in a blended portfolio could provide a powerful source of diversification and more stable excess returns.
This paper briefly reviews the definition and performance characteristics of the S&P 500® Single-Factor Indices, demonstrates their historical cyclicality and correlation, and presents a few examples of how market participants could potentially use investment vehicles tracking these single-factor indices as part of their own factor allocation, either as strategic or tactical plays. These examples expand the traditional asset allocation frameworks to factors, including optimal allocation frameworks, heuristic allocation frameworks, and a trend-based timing framework.
1. SINGLE FACTORS
The S&P Single-Factor Indices comprise four key factors: low volatility, momentum, value, and quality. A rules-based selection and non-marketcap-weighting approach is used to construct the indices, and diversification and investability are taken into consideration.
The indices are constructed from the universe of S&P Dow Jones Indices’ (S&P DJI) headline global indices, including the S&P 500, S&P Europe 350®, S&P Global BMI, and regional and country benchmarks. Approximately one-fifth of the universe is selected by applying liquidity criteria. The constituents are then weighted two ways: by the inverse of volatility in the case of low volatility indices, and by the product of factor score and market cap for the momentum, value, and quality factors. The indices are rebalanced semiannually except for the low volatility indices, some of which are rebalanced quarterly. Exhibit 1a provides an overview of the S&P Single-Factor Indices.
In this paper, we will focus on the S&P 500 Single-Factor Indices. Exhibit 1b provides the description of the four long-only, single-factor indices, together with a dividend index and an equal-weight index, built on the S&P 500 universe.