Don't Make This Mistake With Factor Investing


Stock buybacks get a lot of negative attention and have (still are?) facing political calls to be curtailed or even banned. The rise in buybacks over the last umpteen years is arguably a byproduct of QE, ZIRP and all the rest as part of a series of unintended consequences where companies appear to have put less into research and development and other forms of capital expenditures (plants, equipment, jobs) and focused more on managing the share price.

Whether this is an efficient or inefficient use of capital is debatable but I think the idea of unintended consequence holds water, maybe you draw a different conclusion but that is not the point of the post. I do believe though, that interference by congress would be anti-capitalistic.

Company buybacks signal a couple of different things. It is a sign that the company expects good things ahead for the prices, they represent some level of regard for shareholders in terms of earnings allocating out over fewer shares and from a supply and demand equation, with everything else being equal fewer shares should mean a higher price or at the very least be a source of upward pressure on the price.

The PowerShares Buyback Achievers ETF (PKW) is a pretty big fund (a little over $1 billion in AUM) that has been trading since 2006. The two other ETFs in the space are cheaper but much smaller. I've looked at and mentioned PKW a few times over the years and as a factor (I think buybacks are simply one of many factors like quality, momentum, valuation and so on) it seems like it has outperformed market cap weighting more often than not, PKW has trailed in five of its 12.5 years of trading but since inception it is up 148% per Yahoo Finance on a price basis versus 103% for the S&P 500.

Two of the five years it lagged were 2017 and 2018 as the scrutiny I mentioned above intensified with a lot of chatter about buybacks being a bubble destined to end badly. This made no sense to me. A broad based factor, PKW has double digit weightings in four sectors, plus another 9% in healthcare, is not going to implode in some hideous fashion by itself. The next time the broad market cuts in half, PKW would likely fall a similar amount (maybe do a little better or do a little worse) but it won't be up a little in a down 50% world, nor will it drop 40% with the SPX is up 10%. Buybacks are a factor and a factor can absolutely lag but there is no death spiral for a broad factor without there being a death spiral for everything.

For some context of how bad factor dispersion could be, it is useful to look at value's big lag compared to growth recently. In 2018 the SPDR Growth ETF (SPYG) fell 5.8% per Yahoo Finance compared to a 14.1% drop for SPDR Value (SPYV). That is a pretty wide gap. This year SPYG is up 17% and SPYV is up 12%.

Arguably, a company that can buyback shares (note there is a huge difference between companies announcing buybacks versus actually doing it) has a lot in common with companies that pass quality screens so I would argue then that buybacks and quality should correlate and it appears they do. According to ETF Reply, PKW has had a correlation in the 90's for most of the last two years with the iShares EDGE MSCI USA Quality Factor ETF (QUAL).

Going forward, like most factors or maybe all of them, there will be periods where buybacks outperform and others where it lags. That is the history and it is only logical as no strategy can always be the best. The outperformance since inception is noteworthy but trying to guess when buybacks would outperform on a year by year basis is barely better than a coin flip. If you're going to buy into a factor you need to stick with it for an extended period. In buying that factor you need to have some basis to believe it can add value over a long period of time (value might be a smoother ride versus outperformance). In that case bailing after a year because that year just so happened to be one where that factor lagged is wildly counterproductive behavior and even worse is a counterproductive behavior likely to be repeated.

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Factor investing has some of the features of passive investing, such as investing systematically at low cost. It also has some of the features of active management by aiming to generate returns above the market cap-weighted index.
Thanks a lot for sharing this very informative post.
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