2019_01_22 — “Index Investing: You May Think You Just Own the Market, but You Are Really a Factor Investor”

Michael Ashley Schulman
4 min readDec 29, 2021


January 22, 2019

Index Investing: You May Think You Just Own the Market, but You Are Really a Factor Investor

Index Investing: You may think you just own the market, but you are really a factor investor

  • An S&P 500 portfolio is mostly a quality, value, and momentum portfolio
  • Across many indices, value and momentum factors tend to be increasingly dominant
  • Minimum volatility and size factors may provide portfolio diversification benefits for index heavy investments

Direct factor investing targets intuitive investment styles — such as minimum volatility, quality, value, momentum, and size — which are broad, persistent drivers of investment return. Factors are often considered the alpha that active managers use to generate outperformance. Historically, factors have earned long run returns that have outperformed the market over three, five, ten, or twenty year horizons. Academics have suggested evaluating managers against factors and then replacing expensive managers by much less expensive factor portfolios that can be mathematically automated. Of course, you still need a manager to evaluate and select the factors.

Five of the most recognized factors are:

  1. Minimum volatility — Lower beta (risk) stocks
  2. Quality — Equities of companies with healthy balance sheets
  3. Value — Stocks that are inexpensive relative to fundamentals
  4. Momentum — Stocks that are moving positively
  5. Size — Smaller, more nimble companies

Companies, and their corresponding equities, can at any point in time fit into one or multiple factor buckets on a relative scale; over time, however, an equity’s position in and amongst the factor buckets will change.

If you deliberately invest in an alpha seeking strategy run by a portfolio manager, you may very well realize that you are already a factor investor and hope or believe that the manager will outperform their benchmark over time. Another option is factor based ETFs. Over the last several years, factor ETFs — also known as smart-beta or strategic-beta ETFs, that target specific factors as well as combinations of factors — have been created and heavily marketed by sell side firms like BlackRock, StateStreet, Vanguard, Fidelity, Charles Schwab, Invesco, Goldman Sachs, and others.

What may surprise you is that even if you are an index investor, you are a factor investor, even if you have consciously or subconsciously avoided directly investing in specific factor or smart-beta ETFs. Indices like the S&P 500 are composed of individual stocks, and each individual stock has various factor attributes. A bottom up evaluation of the S&P 500 reveals that the index is often approximately 30% to 50% weighted to quality with value commonly the second largest factor. Over time, these weightings change with the size, minimum volatility, and momentum factors occasionally part of the weighting.

Index performance is affected by factors in the same way that managed portfolios are according to a study done by Ananth Madhavan, Aleksander Sobczyk, and Andrew Ang, What’s in Your Benchmark? A Factor Analysis of Major Market Indexes (August 21, 2017). “We find that the proportion of the index movements explained by factors has materially increased in recent years, which is consistent with a more top-down, macro-driven environment or the increasing importance of economy-wide risks for financial markets.”

Across indices, value and momentum factors tend to be dominant according to Madhavan, Sobczyk, and Ang. “We find that most market capitalization weight indexes are effectively exposed to only two or three factors, with value and momentum being increasingly dominant.” Their research indicates that the minimum volatility (low beta) factor is often not an index influencer, “The major U.S. equity indexes often contains little, and often no, exposure to minimum volatility.” Thus, index investments may benefit from portfolio diversification into factors like minimum volatility and size that are not dominant in the S&P 500 index. Professional advisors can aid this determination in construct with one’s entire portfolio.

Michael Ashley Schulman, CFA


Disclosure: The views and opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The views and opinions referenced are as of the date of initial publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Forward-looking statements cannot be guaranteed; neither can backward-looking nor current-looking statements. This material is provided for informational purposes only and does not constitute an offer or solicitation to purchase or sell any security or commodity or invest in any specific strategy. It is not intended as investment advice and does not take into account each person’s or investor’s unique circumstances. Information has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Past performance is no guarantee of future results.



Michael Ashley Schulman

Avid traveler and art fan, also Partner & Chief Investment Officer @Running Point Capital, a multifamily office and ultra high-net-worth money-management firm