Factors To Consider

One thing’s for sure: It’s been a bad year to bet against beta. That’s self-evident if you just look at a chart of the Vanguard Total Stock Market ETF (NYSE Arca: VTIracking up a gain of more than 22 percent through October.

Some investors have been able to do better, squeezing out an extra percentage point or two by factor-tilting their equity exposure. Not toward any factor, though. A 2-point return bonus could have been earned for a beta-embracing wager on quality stocks. A smaller premium was on offer for wrangling beta to minimize portfolio volatility. At least that’s the tale of the tape.

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The iShares Edge USA MSCI Quality Factor ETF (NYSE Arca: QUALearned a 0.99 beta coefficient as it cranked out its 24 percent return. The “quality” sought by the fund’s index methodology centers on finding large- and mid-cap companies with high returns on equity, low debt-to-equity ratios and a history of stable earnings growth.

QUAL earns a seemingly modest alpha coefficient but bests all the other factor funds with a high information ratio. This may seem puzzling. Why is QUAL’s alpha just second best? It’s because alpha measures QUAL’s return against the beta-adjusted return for VTI. All else held equal, QUAL’s alpha would have been higher if its beta was lower.

Calculation of the information ratio doesn’t rely on QUAL’s beta. Rather, the ratio’s derived by dividing the fund’s excess return (over VTI) by QUAL’s tracking error. Tracking error is the standard deviation of QUAL’s excess return. The information ratio reveals more of the consistency of a fund’s out- (or under-) performance since it’s based on the entire series of returns rather than end-of-period returns.

The foregoing helps to explain the performance data of the iShares Edge MSCI Min Vol USA ETF (Cboe BZX: USMV), a fund built around an optimization algorithm that consider correlation between stocks as it constructs a minimum variance portfolio.

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Disclosure: None.

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