Are Factor Funds Hokum?
@JamesMarsh79 Tweeted "if stock markets can drop 23% (US 1987), or 50% (Argentina) this year, correlations and factor investing is almost worthless." Factors include things like momentum, quality, volatility and even more long standing fund strategies like value/growth, even market cap can be considered a factor.
A common use for factor funds is in all ETF-portfolios where two or three factor funds might be used for an investor's equity allocation in a 60/40 portfolio (60% equities, 40% fixed income). This relies on factor funds doing what they're supposed to. I don't have real concerns about about factor funds doing what they are supposed but that does not mean they can always outperform, of course they cannot and if you will look you'll find skeptics or other negative sentiments.
One momentum fund manager I know once talked about momentum doing well most of the time but that it should be expected to lag coming out of a bear market. I would add, value should be expected to lag as the yield curve flattens or during some other type of event where bonds are unattractive. Usually, the dispersion between market cap and various factors isn't dramatic, save for value lately, but it can be meaningful.
The volatility factor plays a huge role in how I manage client accounts. I don't use volatility funds but my overall strategy and the tools I use (long/short, gold and so on) to implement that strategy focus on trying to smooth out the ride over the course of the entire stock market cycle. If you study the factors that interest you, I think you will find that they are intended to deliver some sort of long term result.
Marsh's Tweet refers to one day events, or at least very short term panics if nothing else. In that context, Marsh is right, factors are not likely to help, although some sort of short strategy or VIX strategy might. The downside of a short strategy or VIX strategy is how infrequently they are needed and their potential to be a drag on returns the vast majority of the time. Where I disagree is with the expectation that factors that offer a different way to get long would ever help in the face of a very short term panic.
Even in the face of slightly longer panics (one month is still quite short) as shown in the chart, factors probably won't spare much of the decline. I've written countless blog posts about what I believe is the way to mitigate the full brunt of large declines. Factors might add outperformance over the long term, or not, but they should not be considered as tools to avoid panics.