Back in 2016, founder of Research Affiliates Rob Arnott was cautioning against multi factor strategies. Times have changed, and he’s now advising investors to buy into them, according to an article in Barron’s.
Multifactor strategies blend a variety of factors, reaching for long-term outperformance, and the funds can offer exposure to a number of different traits. In 2016, Arnott argued that factors can only perform when their valuations are unusually inexpensive. Investors were overpaying for future prospects, reducing their overall returns. But now Arnott is telling investors to “embrace multifactors” and “pour money into” them, pointing to the current cheapness of U.S. large-cap value stocks; as of September 2022, they were priced at only 27% of growth stocks valuations. In 2016, value stocks were trading at 40% of growth valuations, making today’s prices look extraordinarily cheap. “Just like a stock can get ahead of its fundamentals, a strategy or a factor can get ahead of its fundamentals and become very richly priced, or…very cheaply priced,” Arnott told Barron’s in an interview.
But others, such as co-founder of AQR Capital Cliff Asness, believe that connecting relative valuation to future performance isn’t the right approach. Asness, who designs multifactor strategies, believes investors should be very cautious of hawkish factor timing and instead just diversify broadly. However, Arnott makes clear that he doesn’t think investors should just dump all their money into cheap factors. “Have an abnormally large allocation to it,” he says, predicting that blending those factors will outperform the S&P 500 through 2027 by at least 2% to 6%. But while the average multifactor fund returned an annualized 8.11% since 2016, the S&P 500 returned 11.48% for the same period, according to Morningstar data that’s cited in the article.
For investors who are looking to select the “right factors,” smart beta factors generally shift in cycles that are determined by the macroeconomic environment. Currently, defensive factors such as dividends and low volatility are more appealing in this risk-off environment, Aniket Ullal of CFRA told Barron’s. But whether or not Arnott’s forecast is correct remains to be seen.