ETF News

The strong performance of international equities compared to U.S. equities has been a notable discussion point so far this year, as it marks a reversal of a longstanding trend. While the overall performance of international equities, as shown by the MSCI EAFE Total Return Index, has been impressive, examining the drivers behind the asset class’s return can offer valuable insights for investors.

A Look at Investment Factors

An investment factor is any characteristic of a security that helps an investor understand and explain the long-term risk and return profile of a specific asset. In turn, investors who adopt a factor-based approach aim to leverage these identified traits to improve their portfolio performance. Some of the most common factors are referred to as fundamental factors. Generally, these can be broadly categorized as value, size, momentum, low volatility, dividend yield, and quality.

Broadly speaking, each factor can be defined as follows:

• Size: Smaller companies generally outperform larger ones.
• Momentum: Stocks that recently performed well are likely to continue outperforming.
• Low volatility: Securities with low volatility tend to outperform those with high volatility.
• Dividend yield: Stocks with higher-than-average dividend yields tend to outperform those with lower yields.
• Quality: Companies with strong balance sheets typically outperform those with weaker financials.

Using Fidelity Canada’s Factor ETF suite, we can evaluate the performance of individual factors within the international equity landscape and gain insights into which security characteristics drive excess returns. As shown in the chart below, year-to-date, the value and momentum factors are performing the best, with the value factor slightly outperforming the momentum factor. While the other factor performances are strong, it is noteworthy that the quality factor has the lowest performance of the group.

Both value and momentum factors are seen as cyclical, performing well in rising markets but poorly during declines. Amid economic uncertainty caused by the U.S.’s trade policy, investors sought safe-haven assets, leading to a shift toward other developed economies, which supported these factors' performance. Additionally, announcements of economic actions, such as European nations' willingness to boost defense spending, further increased the appeal of investing in foreign equities. Conversely, low volatility and quality are considered defensive, performing best during economic downturns.

Understanding Your Exposure and Taking Action

For investors interested in factor-based investing, Fidelity’s Factor ETF suite offers straightforward exposure to each factor. However, investors should be aware of how a specific factor could influence their overall portfolio. Given the current strong performance of international equities, both value and momentum are doing well, but this may change as the economic cycle shifts. As such, investors need to be ready to adjust their exposure to factors as economic conditions require. 

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.