International Style

The growth of factors

Investors have always loved a bargain—lower relative priced securities (value), more profitable companies (quality), stocks with upward-trending prices (momentum), and less volatile firms (min vol). Factor investing has been around for decades and is supported by a wide body of academic literature, including six Nobel prizes. While these investing concepts have been studied in tens of thousands of papers and confirmed with decades of empirical evidence, it is not surprising that more and more investors have adopted the ability to invest in factor-based strategies in convenient vehicles via the ETF wrapper.

As of the end of Q1 2023, there was $800bn in Factor ETF assets in the US.¹ Approximately 80% of the $800bn was targeting factors in US equities. Only $135bn, or about 17% of those assets, targeted factors internationally. (For the astute reader, the remaining ~3% of factor ETF assets are in fixed income factors).

While factor popularity has certainly grown with equity factor ETFs, there is still an opportunity for investors to gain exposure to these well-known drivers of return in international markets.

Moving abroad

The first question is whether factors are applicable in international markets. Yes! Academics have shown that the same factors that are documented in the US also have exhibited positive excess returns or reduced volatility in international markets.² In some cases, their premiums are even stronger than in the US.

Similar to the US, small size, value, quality, momentum, and minimum volatility in international developed markets have historically outperformed their counterparts. Also similar to the US, the persistence of outperformance has increased the longer the underlying factors have been targeted.

Just as many investors have used factors for their US portfolios—to express views, to help provide diversification by adding factors that their current portfolios don’t contain or are underweight, or to reduce risk in portfolios—investors can likewise attempt to improve their international portfolios by considering expanding their opportunity set to include strategic factor exposure.

Diversification

Value and momentum in the US have been negatively correlated, is that also true for international markets? The data shows even more negative correlations between US value and international momentum.

How can an investor use this information in building optimal portfolios? If the investor has a value bias in their US allocation, then adding targeted exposure to US momentum and international momentum may be beneficial, especially during extended periods of value underperformance. Both value and momentum have positive expected returns,⁴ but they may outperform at different times—one strategy can zig while another strategy zags. Thus, combining lowly correlated sources of returns can potentially reduce portfolio risk. The potential risk reduction and increases in expected return by including international factors may make a compelling case to add them to US-centric portfolios.

Putting it all together

Many financial professionals have started to use factor ETFs to help improve expected returns and lower risk in their portfolios as evidenced by the exponential growth in factor assets over the past decade. But it’s also important to remember that factors have not only been persistent over time but pervasive across markets – including internationally. Investors may want to consider expanding their factor toolkit abroad to capture additional sources of returns in their portfolios. Just as my career has spanned multiple countries and continents, factors can be found around the world.

¹ Source: BlackRock GBI as of 3/31/23.
² See, for example, the following papers documenting factor premiums in international markets: Fama and French (2017), “International Tests of a Five-Factor Asset Pricing Model,” Journal of Financial Economics, for size, value, and quality; Rouwenhorst (2002), “International Momentum Strategies,” Journal of Finance, for momentum; and Ang, Hodrick, Xing, and Zhang (2009),” High Idiosyncratic Volatility and Low Returns: International and Further US Evidence,” Journal of Financial Economics, for low volatility.
³ Correlation is a statistic that explains how variables move in coordination. A positive correlation implies that variables move in the same direction. A negative correlation implies they move in opposite directions.
⁴ Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June and Narasimhan Jegadeesh and Sheridan Titman, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency”, Journal of Finance, March 1993.

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This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics ("factors"). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses. The iShares Minimum Volatility Funds may experience more than minimum volatility as there is no guarantee that the underlying index's strategy of seeking to lower volatility will be successful.

Fixed income risks include interest rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic, or other developments. These risks often are heightened for investments in emerging/ developing markets or in concentrations of single countries.

Prepared by BlackRock Investments, Inc. LLC. Member FINRA

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