Which Investment Factors Drove Market Returns in 2017?

Momentum stocks were the best performers in 2017, while growth shares struggled, writes Tom Lauricella

Morningstar News Team 24 January, 2018 | 10:21AM
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Morningstar Risk Model

As stock markets around the world rallied in 2017, momentum stocks provided the most potent fuel for portfolios, along with healthcare shares. Meanwhile, energy exposure or stocks that tend to show high levels of volatility were the worst performers for investors. And having a growth tilt to a portfolio proved unsuccessful.

In 2017, as it’s been for many of the last six years, it’s been all about momentum, which measures how much a stock has risen in price over the past year relative to other stocks. Momentum has been by far and away the most significant factor explaining performance. For 2017, investing in a portfolio of high and low momentum stocks would have returned nearly 8% in the last year.

The Morningstar Global Risk Factor Model identifies drivers of equity returns since 2008 and tracks a stock’s underlying exposure to 36 economic factors, that include style, sector, region and currency exposures. 11 style factors include valuation, economic moat or competitive advantage, size, volatility and financial health.

The second-best driver of returns in 2017 was size, which in the Morningstar risk model, measures the relationship between market capitalisation and returns. Because smaller firms historically outperform large caps stocks, the size factor is constructed to align with this.  A positive exposure indicates small cap stocks and conversely, negative exposure indicates large cap stocks. In 2017, small cap won the size battle. Investing in a portfolio of small and large stocks would have returned nearly 3.8% in the last year.

Volatile and Growth Stocks Underperformed

But the biggest detractor were stocks that tend to be more volatile. The volatility factor subtracted 0.8% from performance. In this instance 2017 was unusual as stocks with higher volatility historically tend to add to returns.

Second worst in terms of a drag on returns for 2017 was a whether the stock had a value or growth bias. And it’s here that investors might find a surprise, given the significant outperformance of growth funds during 2017. We found that portfolios with more value stocks would have fared better than those with a growth profile. The suggestion then is that the out-performance of growth stock indices and funds originated in other factors than the earnings growth potential of those companies, such as momentum.  

In terms of sector factor rankings in 2017, exposure to healthcare offered the biggest lift to a portfolio, with a portfolio with this bias returning 9.8%. Basic materials, which had been top in 2016, contributed 5.3% benefit to returns. Energy exposure was a significant drag, reducing returns by 21%.

But in the final quarter of 2017 there was a shift in performance: consumer defensives moved to the top by adding 3% to returns while technology detracted from returns by 11.2%. Looking at regional exposure, the picture confirms the benefit to a portfolio from emerging markets in 2017.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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