The Debate on Factor-Based Investing: A Data-Driven Perspective
In recent years, factor-based investing has undergone rigorous scrutiny. Investors have questioned the efficacy of targeting specific stock characteristics, such as value, size, or momentum, in achieving risk-adjusted returns. Critics point to prolonged underperformance, particularly in U.S. markets post-Global Financial Crisis, as evidence of the alleged decline of these strategies.
However, data from the first half of 2025 challenges this narrative. For example, the DFA International Value Fund (DFIVX) reported a 17.97% return year-to-date through May, compared to a -0.17% for the S&P 500. This marked an 18.14% outperformance, suggesting that the perceived demise of factor-based strategies may have been overstated.
Factor Investing: Cyclical, Not Structural
The empirical evidence indicates that factor-based strategies may not be failing but are performing as expected within their historical context. This highlights the cyclical nature of factor performance and underscores the importance of global diversification. Larry Swedroe’s analysis supports the view that international markets continue to demonstrate the viability of these strategies, contrary to the U.S. context.
Understanding the Criticism
Critics cite underperformance as a key issue. Recently, U.S. small-cap value stocks reported a 20-year relative return below that of the S&P 500 Index for the first time. Research by Rob Arnott and colleagues indicates a gap between theoretical and realized factor returns, noting that value and momentum factors were significantly diluted in practice, resulting in minimal net benefit after costs.
Market saturation presents another concern. The proliferation of factor ETFs has potentially arbitrated away the anomalies they sought to exploit. The academic community has also questioned the reliability of numerous identified “anomalies,” suggesting that many result from statistical overfitting rather than genuine inefficiencies.
Global Performance Reinforces Validity
When examining international markets, the argument for factor-based strategies gains empirical support. Swedroe’s examination of data reveals sustained performance for international factor funds relative to the MSCI EAFE Index from 1996 to 2025. Emerging markets have shown even greater returns in value and small-cap factors, further reinforcing the persistence of factor premiums.
Moreover, a study by Blitz et al. in the Financial Analysts Journal (2019) found that carefully managed long factor positions could achieve significant positive alphas across various regions and periods.
U.S. Strategy Outlook
While U.S. factors have lagged, historical patterns present a case for optimism. Dimensional Fund Advisors noted that periods of factor underperformance were historically followed by recoveries. Current valuation spreads between growth and value stocks may set the stage for future reversals, aligning with empirical expectations of mean reversion.
The transition to a higher-rate environment could also favor value stocks, providing a fertile ground for factor-based strategies. Research by Hanauer (2020) and Gelderen and Huij reinforce the potential for resurgence in factor returns, supporting their long-term track record despite recent challenges.
Conclusion: Rational Investing Requires Global Perspective
The comprehensive data increasingly suggests that factor investing’s recent challenges are a cyclical phenomenon rather than indicative of obsolescence. Academic consensus remains steadfast on the persistence of factor premiums when approached globally and over appropriate time frames.
The key insight for rational investors is that factor investing should be viewed as a systematic tool—efficient when implemented with geographic diversification, realistic expectations, and strategic insight. The significant global outperformance of 2025 serves as a reminder of the importance of looking beyond domestic markets for evidence-based investment strategies.
Investors should embrace the notion that factor-based strategies are neither infallible nor obsolete. Instead, they offer a disciplined framework capable of achieving risk premiums over the long term, even amidst short-term underperformance. The story of factor investing is not one of failure; rather, it is a call for broader considerations and robust implementation in an ever-evolving global market.
