Vanguard factor funds show significantly higher exposure than competitors

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by kiwimancy

Last year Vanguard Quantitative Equity Group launched their set of factor funds VFVA, VFMO, VFQY, VFMV, VFLQ (13bps) and multifactor fund VFMF/VFMFX (18bps, doesn’t include low-liquidity) in the US. They decided to take a rules-based but unindexed approach with the “aim to offer the transparency of index-based factor products with the potential advantages of active flexibility to maintain more targeted and consistent exposures to desired factors”.

Consistent with that goal, a regression (PortfolioVisuializer, AQR factors, daily returns Feb 16-Dec 31 2018) over the past year shows that they achieve significantly higher factor exposures than any of their competitors.

(Additional regressions: unconstrained time periodsFama French factors)

The funds still have low AUM/liquidity compared to others (VFMF has $900k avg volume) as expected given the large field and their late arrival but I expect that to gradually improve given their strong exposures and low costs.

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Economic research has shown that certain simple properties of stocks can be used to sort them in a way that the higher ranked stocks systematically outperform the lower ranked stocks. This is in addition to the basic CAPM theory that greater exposure to the market (market beta is the original factor) should produce higher returns. Factors do not outperform every year and they have drawdowns like the total market does, but they have done well in the past.

However, some, like small-size, have not done as well after they were published. It’s hard to say whether these factors can survive in a world of strong competition and quantitative algorithms. But the evidence says some of them are still working.

A factor fund can be either long only, buying stocks that exhibit that factor, or long/short buying the ones that have the factor and shorting ones that rank poorly. A multifactor fund like VFMF owns stocks that rank well in a mix of multiple factors.

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Vanguard’s methodology is:

The Value factor is measured by book value/price, forward earnings/price, operating cash flows/price (for non-financials only). The Momentum factor is measured by total returns from month T-12 to month T-1, total returns from month T-7 to month T-1, and the intercept from a 1-year regression of stock returns on their regional benchmark. For financials, the Quality factor is measured by return on equity, variability in return on equity, and equity issuance. For non-financials the Quality factor is measured by return on equity, gross profitability, variability in return on equity, accruals, leverage, and change in net operating assets. The volatility screen removes the 20% most volatile names within each market cap grouping and equally across sectors.



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