By the SPDR Americas Research Team Thoughts at a Glance 2017 marked another year of factor performance shifts. s comeback in the US on the heels of the US election and the potential for a Trump-flation trade at the end of 2016 was short lived; it barely outperformed the broader market in 2017., propelled by the tech rally, led the charge in the US and Emerging Markets (EM), outperforming the second-best performing factor quality by 11.8% and 14.9%, respectively. 1 Defensive factors low volatility and dividend yield were among the worst performers in 2017 across all the regions as global synchronized growth spurred investor risk appetite. Both factors are also overweight rate-sensitive sectors, such as Consumer Staples and Utilities, which have been under pressure as investors have become more concerned about central bank tightening. However, with the search for income remaining a top concern, flows into dividend oriented smart beta ETFs persisted, ranking number one in terms of absolute flow totals in 2017. The sharp reversal of factor performance over the past two years demonstrates the cyclicality of factor performance based on market dynamics and exogenous variables. For investors seeking to capture factor premia while mitigating single factor cyclicality, a multi-factor approach may warrant consideration. This point is reinforced by the nearly $8 billion of flows into multi-factor smart beta ETFs in 2017, a figure representing 51% of start of year assets. Figure 1: Smart Beta Factor ETF Fund Flow Heatmap Fund Flow ($M) % AUM Growth YTD From Flows Factors QTD ($M) 6 Months ($M) 12 Months ($M) QTD (%) 6 Months (%) 12 Months (%) Dividend 3,980 5,303 10,967 4.1 5.4 11.2 1,387 2,662 3,948 3.9 7.5 11.1 1,424 2,286 3,001 18.5 29.6 38.9 Multi-Factor 2,867 4,506 7,922 18.3 28.8 50.6 280 501 821 4.8 8.6 14.1 626 194 1,424 4.7 1.5 10.7 2,377 3,513 7,485 10.0 14.9 31.6 Source: SPDR Americas Research, Bloomberg Finance. L.P., as of 12/31/2017. Green highlights the top two segments, red the bottom two segments for a given period. Past performance is not a guarantee of future results. Figure 2: MSCI Factor Index Excess Return by Region US Developed ex-us Emerging Markets Previous Quarter 1 Year -13.7-10.6-4.6-5.1-1.2-2.7-3.4-2.4-3.0-3.4-4.0-1.7-0.1-0.7-1.2-0.6-1.1-0.6-0.9 1.5 2.1 0.3 0.6 2.4 4.1-20 -15-10 -5 0 5 10 15 20 Excess Return (%) Source: FactSet, as of 12/31/2017. MSCI Minimum Volatility, MSCI Enhanced, MSCI, MSCI Small Cap, MSCI High and MSCI indices within each region are used to represent regional factor performance. Excess return is calculated based off MSCI EAFE, MSCI USA and MSCI Emerging Markets Indices respectively. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Past performance is not a guarantee of future results. 1.8 1.6 1.5 1.8 3.5 8.0 January 2018 11.9 15.9
Figure 3: Sector Over/Underweight vs. Index (%) and momentum are significantly overweight in Tech, while value is tilted towards Financials and away from Tech. Dividend yield and low volatility factors are overweight non-cyclical sectors, like Consumer Staples, Utilities and Health Care. Cons. Disc. Cons. Staples Energy Financial Health Care Industrials Tech. Materials Real Estate Telecom. Utilities Minimum Volatility Index -4.7 5.3-4.9-5.3 4.4 0.4-4.8-1.5 2.3 3.9 4.8 High Index -3.0 8.2 1.5-4.9 2.7-2.7-7.6 0.7-2.0 2.7 4.2 Index -0.6-7.6-6.2 0.1-0.1 4.7 19.8-2.7-2.5-2.6 Index 3.2 5.1-6.3-15.4 4.8 1.6 15.8-1.6-2.6-1.7-3.0 Small Cap Index 1.8-4.1-4.4-1.8 5.9-3.5 3.0 7.2-1.9 0.0 Index -4.8-0.1 3.6 10.2-1.4-3.5-9.1-0.4 0.9 2.1 2.5 Source: FactSet, as of 12/31/2017. Exposures are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. Green highlights the top three overweighted sectors, red the bottom three underweighted sectors. Figure 4: Factor 3-Year Correlations Although momentum had been positively correlated to quality and low volatility for three years, it started decoupling with the two in 2017 as the market switched to a risk on tone. Min. Volatility 1.00-0.72 1.00-0.45 0.32 1.00-0.24 0.08 0.61 1.00 0.17-0.29-0.12-0.28 1.00-0.51 0.44 0.48 0.01-0.08 1.00 Source: FactSet, as of 12/31/2017. Minimum Volatility,,,, and are represented by the Minimum Volatility Index, Enhanced Index, Index, Small Cap Index, High Index, and Index. Correlation is calculated using weekly excess returns of factor indices over the Index. Figure 5: MSCI USA Factor Index Beta Sensitivities to Macro Indicators Compared to the broader market, size and value are more sensitive to changes in inflation expectations, while value and momentum are more sensitive to long-term Treasury yields. U.S. 10 Year Yield U.S. 10 Year 2 Year Yield 10 Year Breakeven Inflation Rate Beta to MSCI USA Index 1.42-2.79 5.38 1.13 1.26-1.30 3.51 0.97 0.44-0.86 1.09 0.66 0.43-1.85 1.27 0.82 0.73-1.82 5.14 1.07 1.62-1.29 4.02 0.81 MSCI USA Index 1.12-1.47 4.13 1.00 Source: FactSet, as of 12/31/2017. Minimum Volatility,,,, and are represented by the MSCI USA Minimum Volatility Index, MSCI USA Enhanced Index, MSCI USA Index, MSCI USA Small Cap Index, MSCI USA High Index, and MSCI USA Index. Beta sensitivity is calculated using monthly index returns and monthly macro indicator data in 36 months. Characteristics are as of the date indicated, are subject to change, and should not be relied upon as current thereafter. State Street Global Advisors 2
Figure 6: Factor Quarterly Performance Quilt Chart (%) lost its leadership position to quality and value in Q4 after outperforming for the first three quarters of 2017. Dividend yield and low volatility remain at the bottom. Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 4.45 1.53-2.51 7.20 6.06 5.10 7.97 5.29 8.29 6.44 7.26 7.08 4.06 1.45-4.97 7.09 3.77 5.01 7.24 2.74 7.92 4.25 6.24 7.02 3.81 0.62-6.88 5.63 1.42 2.98 4.87 1.86 6.38 4.20 6.05 6.83 3.05 0.31-7.19 5.50 0.67 1.61 4.82-0.32 5.91 4.03 4.84 5.51 2.31-0.07-8.45 4.71-0.33 1.01 2.59-1.09 5.57 3.36 4.61 5.23 1.89-0.85-9.74 4.61-0.35-0.44 0.65-1.21 5.24 3.20 4.43 4.44 0.22-1.63-11.72 4.23-3.92-1.01-0.89-2.71 4.72 2.77 2.94 3.50 Enhanced Index Index Minimum Volatility Index High Index Small Cap Index Index Source: FactSet as of 12/31/2017. Past performance is not a guarantee of future results. Glossary Factor A factor which screens for companies with a higher than average dividend yield relative to the broad market, and which have demonstrated dividend sustainability and persistence. Excess Returns A security s return minus the return from another security in the same time period. Factor Stocks seen as having a lower risk profile than the overall markets. However, a portfolio comprised of low volatility stocks may not produce investment exposure that has lower variability to changes in such stocks price levels. MSCI Emerging Market Index The MSCI Emerging Markets Index captures large and mid-cap representation across 23 emerging markets countries. With 834 constituents, the index covers approximately 85% of the free floatadjusted market capitalization in each country. MSCI EAFE Index An equities benchmark that captures large- and mid-cap representation across 21 developed market countries around the world, excluding the US and Canada. MSCI USA Index The index is designed to measure the performance of the large and mid cap segments of the US market. Minimum Volatility Index The Minimum Volatility (USD) Index aims to reflect the performance characteristics of a minimum variance strategy applied to the MSCI large and mid cap equity universe across 23 Developed Markets countries.* The index is calculated by optimizing the Index, its parent index, for the lowest absolute risk (within a given set of constraints). Historically, the index has shown lower beta and volatility characteristics relative to the Index. Enhanced Index The Enhanced Index is based on the Index, which includes large and mid-cap stocks across 23 Developed Markets (DM) countries.* The index is designed to represent the performance of securities that exhibit higher value characteristics relative to their peers within the corresponding GICS sector. Index The Index is based on, its parent index, which includes large and mid-cap stocks across 23 Developed Market (DM) countries.* The index aims to capture the performance of quality growth stocks by identifying stocks with high quality scores based on three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth and low financial leverage. The MSCI Indexes complement existing MSCI Factor Indexes and can provide an effective diversification role in a portfolio of factor strategies. Small Cap Index The Small Cap Index is designed to capture small cap representation across 23 Developed Markets (DM) countries. High Index The High Index is based on the Index, its parent index, and includes large and mid-cap stocks across 23 Developed Markets (DM) countries.* The index is designed to reflect the performance of equities in the parent index (excluding REITs) with higher dividend income and quality characteristics than average dividend yields that are both sustainable and persistent. The index also applies quality screens and reviews 12-month past performance to omit stocks with potentially deteriorating fundamentals that could force them to cut or reduce dividends. State Street Global Advisors 3
MSCI USA Minimum Volatility Index The MSCI USA Minimum Volatility (USD) Index aims to reflect the performance characteristics of a minimum variance strategy applied to the MSCI large and mid cap equity universe. The index is calculated by optimizing the MSCI USA Index, its parent index, for the lowest absolute risk (within a given set of constraints). Historically, the index has shown lower beta and volatility characteristics relative to the Index. MSCI USA Enhanced Index The MSCI USA Enhanced Index captures large and mid-cap representation across the US equity markets exhibiting overall value style characteristics. The index is designed to represent the performance of securities that exhibit higher value characteristics relative to their peers within the corresponding GICS sector. MSCI USA Index The MSCI USA Index is based on MSCI USA, its parent index. The index aims to capture the performance of quality growth stocks by identifying stocks with high quality scores based on three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth and low financial leverage. MSCI USA Small Cap Index The MSCI USA Small Cap Index is designed to measure the performance of the small cap segment of the US equity market. MSCI USA High Index The High Index is based on the MSCI USA Index, its parent index, and includes large and mid-cap stocks. The index is designed to reflect the performance of equities in the parent index (excluding REITs) with higher dividend income and quality characteristics than average dividend yields that are both sustainable and persistent. The index also applies quality screens and reviews 12-month past performance to omit stocks with potentially deteriorating fundamentals that could force them to cut or reduce dividends. Factor The tendency for a security to maintain a certain direction of price trajectory. This tendency is well documented in academic research, which has made momentum one of the six smart beta factors that are systematically being isolated in new-generation strategic indexes. Factor One of the six widely recognized, research-based smart beta factors that refers to quality equities. Companies whose stocks qualify exhibit consistent profitability, stability of earnings, low financial leverage and other characteristics consistent with long-term reliability such as ethical corporate governance. Factor A smart beta factor based on the tendency of small-cap stocks to outperform their large-cap peers over long time periods. Standard Deviation Measures the historical dispersion of a security, fund or index around an average. Investors use standard deviation to measure expected risk or volatility, and a higher standard deviation means the security has tended to show higher volatility or price swings in the past. Factor One of the basic elements of style -focused investing that focuses on companies that may be priced below intrinsic value. The most commonly used methodology to assess value is by examining price-to-book (P/B) ratios, which compare a company s total market value with its assessed book value. 1 Source: FactSet, as of 12/31/2017. State Street Global Advisors 4
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