Factor investing has become one of the bigger trends in markets over the past decade. It promises to give investors a better version of index investing by tilting portfolios toward certain “factors” – patterns in the market that have historically delivered higher returns.
Common factor examples include
- value (buying cheap stocks)
- size (buying smaller companies)
- momentum (buying recent winners)
- quality, and
- low volatility
These ideas aren’t new. Academics like Eugene Fama and Kenneth French first identified them in the 1990s as part of their work explaining why some groups of shares tended to outperform the broader market over long periods.
As these ideas caught on, fund managers and index providers rushed to build products around them. The result was a wave of “smart beta” or factor ETFs and managed funds designed to capture these return “premiums” more efficiently than traditional market-cap indices.
Popular factor ETFs on the ASX
On the ASX, factor focused ETFs include funds like
- VanEck MSCI International Quality ETF (QUAL), which tilts toward companies with high profitability and stable earnings;
- BetaShares Global Quality Leaders ETF (QLTY), which targets similar traits with a slightly different screen; and
- iShares Edge MSCI World Minimum Volatility ETF (WVOL), which aims to smooth returns by owning lower-risk shares.
There are also value-focused ETFs such as the VanEck MSCI International Value ETF (VLUE) and ETFs that try to capture the size premium, like the VanEck Australian Equal Weight ETF (MVW), which gives each company the same weight rather than weighting by size.
All of these funds are built on the same idea… that by leaning toward specific factors, investors can outperform a plain market-cap index.
It’s a clever marketing pitch. Smart beta ETFs promise the low fees of passive investing with the higher returns of active management. But as I’ve written before in Should you buy into smart beta ETFs?, that promise hasn’t lived up to the hype.
The theory vs the reality
The idea that factor investing can deliver better long-term returns sounds great in theory. But in practice, there’s little proof that factors which worked in the past keep working in the future.
Once a factor becomes popular, studied, and sold through ETFs and other product structures, the advantage quickly disappears.
What started as an inefficiency gets competed away as more investors pile in.
That’s exactly what’s happened with the so-called proven factors like value and size. They were well known by the 1990s thanks to Fama and French, then became the foundation for hundreds of new funds and indices. Since then, value has underperformed for much of the past twenty years. The size factor has struggled recently too, especially once you adjust for liquidity and risk.
The reason is simple. The more investors crowd into a factor, the lower its future returns become. Every extra dollar chasing the same signal pushes prices up and squeezes out the opportunity.
Factor investing ends up being a victim of its own popularity.
Even the academics who first discovered these patterns now admit the returns fade over time. McLean and Pontiff’s 2016 study, Does Academic Research Destroy Stock Return Predictability?, found that once a factor was published, its extra return dropped by more than half.
A lost decade for factors
The last decade has been a clear example. A review by Robeco covering 2010–2019 found that the combined premium from the classic Fama–French factors (size, value, profitability, and investment) averaged -0.28% per year, compared with +3.95% per year over 1963–2009.
A paper by MSCI noted that over the last ten years to May 2025, four out of seven single-factor indexes underperformed the broad market by 2.6% to 3.5% annually, with enhanced value lagging the most.
Only momentum, quality, and growth managed to outperform during this period. This explains why funds like QUAL have done well in recent years – because it’s focused on the quality factor.
But that’s just one factor. Others, such as value and size, have gone through long stretches of underperformance.
For example, the VanEck Australian Equal Weight ETF (MVW) effectively tilts the fund toward smaller and mid-sized Australian companies – the size factor in action. However, since small caps have lagged large caps over the past five years, MVW has returned 12.6% per year, compared with 14.2% per year for the broader ASX 300 index.
That difference might sound small, but it compounds quickly. Over five years, a $100,000 investment in the ASX 300 would have grown to about $193,000, while the same amount in MVW would have grown to $182,000 – a gap of around $11,000 simply due to factor underperformance.
A study by FTSE Russell found the same thing. After removing off-target exposures, the US “pure” value factor showed almost zero excess return over the long term, with particularly weak results in recent years.
In other words, the supposed “factor premiums” that once looked compelling in academic research have largely disappeared in the real world.
Market-cap indexing is already an “all-factor” approach
What’s often forgotten in the debate is that market-cap weighting already reflects all of these factors in real time. Each stock’s weight in an index represents the combined view of millions of investors about its size, value, quality, and momentum.
A cap-weighted index isn’t a “no-factor” approach. It’s an “all-factor” approach. It automatically adjusts as markets change, without trying to predict which factor will work next.
That’s the beauty of simple index investing. It lets the market decide what matters, rather than relying on a model built on yesterday’s data.
The real lesson for investors
None of this means factors never work. They do, at times. But they don’t work consistently, and rarely after they become mainstream. Their supposed long-term “premiums” tend to shrink or vanish once enough investors start chasing them.
Chasing yesterday’s factors is no different from chasing last year’s top-performing fund manager. The promise of future outperformance usually disappears the moment everyone hears about it.
While factors come and go, costs are forever.
For investors, the smartest approach is to stay diversified, disciplined, and low cost.
The only real free lunch in investing isn’t a factor. It’s diversification.
