“(Factor, Factor), gimme the news
I got a bad case of lovin’ you
No pill’s gonna cure my ill
I got a bad case of lovin’ you…”
(Adapted from “Bad Case of Lovin’ You (Doctor, Doctor),” by Robert Palmer, 1979)
By Scott Welch, CIMA®, CEPA®, Chief Investment Officer & Partner
Reviewed by Carter Mecham, CMA®, IACCP®
Regular readers know we are firm advocates of both asset class and risk factor diversification. We believe that using both leads to better overall diversification and, therefore, more consistent portfolio performance regardless of the underlying market regime.
So, we believe it appropriate to periodically check in on risk factor performance, as it tends to be less well-covered than its more famous cousin, asset class performance.
Factor Performance in 2025
First, let’s look at the US large cap risk factor performance over the course of 2025.
Source: Ycharts, 12-month data from January 1 – December 31, 2025. You cannot invest in an index and past performance is no guarantee of future results.
Given the dominance of the mega-cap tech stocks over most of 2025, it is no surprise that momentum and growth were the leaders in factor performance, with quality, value, and dividends trailing behind.
But we see a complete reversal if we focus on just the last three months of the year – value, quality, and dividends led the way while growth and momentum trailed off.
Source: Ycharts, 3-month data from October 1 – December 31, 2025. You cannot invest in an index and past performance is no guarantee of future results.
What drove this reversal? We can hypothesize three likely contributors:
- Over the course of Q4, the industry media focused on Artificial Intelligence (AI), but that focus was on (a) whether or not AI firms were in a “bubble” due to their hyperbolic growth over most of the previous two years and corresponding sky-high valuations; and (b) increasing concern over the huge amounts of debt these AI firms were committing to in order to build out their data centers and computational power. These concerns – warranted or not – may have caused some investors to rotate into other parts of the market that carried more reasonable valuations.
- In a similar vein, some investors, who had benefitted from the remarkable rally in the mega-cap stocks, may simply have decided to harvest some of their gains and redeploy into other market styles and sectors.
- There is some investor concern regarding a cooling economy and potentially higher inflation, and so some investors may simply have decided to position their portfolios more defensively. In other words, after riding the tailwinds of a massive rally in the growth and momentum factors (factors that investor sentiment can drive forward long past reasonable valuation levels), some investors may simply have remembered that, over time, fundamentals do matter and opted to rotate into factors that historically have delivered outperformance – value, size, and dividends.
Quality: The Consistent Factor
Now consider the quality factor. As a reminder, and using the “DuPont Analysis,”[1] quality can be defined as companies with stronger balance sheets, earnings, and cash flows, and therefore better ability to maintain or grow dividends, engage in buybacks, and/or maintain margins during economic or market downturns.
Quality is rarely the best preforming factor, but it is also rarely the worst performing factor – it simply is the most consistent, which is why our portfolios anchor on quality.
First, we examine its performance in the S&P 500 index over the past twenty years.
Source: Ycharts, 10-year data through December 31, 2025. You cannot invest in an index and past performance is no guarantee of future results.
Next, we examine how quality has performed relative to a broader cap-weighted benchmark, in this case the MSCI USA index, which includes mid and small cap companies as well as large caps.
We see that is has been the best performing factor over the previous three years – by a fairly wide margin.
Source: State Street Global Advisors “SPDR® ETF Chart Pack” and Bloomberg Finance, L.P., 3-year performance as of November 30, 2025. You cannot invest in an index and past performance is no guarantee of future results. Min. Vol = MSCI USA Minimum Volatility Index | Value = MSCI USA Enhanced Value Index | Quality = MSCI USA Quality Index | Size = MSCI USA Equal Weighted Index | Dividend = MSCI USA High Dividend Yield Index | Momentum = MSCI USA Momentum Index | Factor Mix = MSCI USA Factor Mix A-Series Capped Index. Div. Grower = S&P High Yield Dividend Aristocrats Index. The indexes used above were compared to the MSCI USA Index. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.
Remember the quote attributed to Albert Einstein – “compound interest is the most powerful force in the universe”. With respect to investing, this translates into the fact that if you do not lose as much in a down market, you do not need to gain as much in an up market to still come out ahead over a reasonable time horizon.
Note as well in the above chart the consistency of the “factor mix” performance (teal line), which supports our argument for risk factor diversification.
SMID Caps
What about SMID (small and mid-cap) cap stocks? Interestingly, over the course of 2025, value was the leading factor performer while quality trailed behind. This is the direct result of most of 2025 being characterized by a “junk rally.”
Source: Ycharts, 12-month data from January 1 – December 31, 2025. You cannot invest in an index and past performance is no guarantee of future results.
Note, however, that value and quality have fairly dramatically outperformed growth over the past five years – not surprising in SMID cap as growth can be a difficult investment space.
Source: Ycharts, 5-year data through January 7, 2026. You cannot invest in an index and past performance is no guarantee of future results.
We can illustrate the “junk rally” of 2025 by comparing the performance of the Russell 2000 index versus the S&P 600 index. The Russell 2000 is considered a lower quality index because it allows more negative earning companies to be included in the index.
The 2025 performance of the Russell 2000 index more than doubled that of the S&P 600 index (though the S&P 600 outperforms over longer time periods).
Source: Ycharts, 12-month data from January 1 – December 31, 2025. You cannot invest in an index and past performance is no guarantee of future results.
Source: Ycharts, 15-year data through January 7, 2026. You cannot invest in an index and past performance is no guarantee of future results.
Summary and Interpretation
Let’s conclude by reminding ourselves of why asset class diversification is so important, using the well-known asset class “performance quilt.”
Source: Bloomberg, FactSet, MSCI, NAREIT, Russell, Standard & Poor’s, J.P. Morgan Asset Management. Large cap: S&P 500, Small cap: Russell 2000, EM Equity: MSCI EME, DM Equity: MSCI EAFE, Comdty: Bloomberg Commodity Index, High Yield: Bloomberg Global HY Index, Fixed Income: Bloomberg US Aggregate, REITs: NAREIT Equity REIT Index, Cash: Bloomberg 1-3m Treasury. The “Asset Allocation” portfolio assumes the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCI EAFE, 5% in the MSCI EME, 25% in the Bloomberg US Aggregate, 5% in the Bloomberg 1-3m Treasury, 5% in the Bloomberg Global High Yield Index, 5% in the Bloomberg Commodity Index and 5% in the NAREIT Equity REIT Index. Balanced portfolio assumes annual rebalancing. Annualized (Ann.) return and volatility (Vol.) represents period from 12/31/2009 to 12/31/2024. All data represent total return for the stated period. The “Asset Allocation” portfolio is for illustrative purposes only. Past performance is not indicative of future returns. From the JP Morgan “Guide to the Markets” – U.S. Data are as of December 31, 2025.
As we saw in the MSCI chart from State Street Global Advisors, risk factor performance rotates over time as well, and it is difficult to predict which factor will perform best at any given time.
Though large cap growth faded over the final three months of 2025, it dominated over the past few years. However, there may be signs that factor performance has begun to rotate again over the past 3-6 months or so.
Meanwhile, quality maintains its consistent performance. This is why we believe that when building portfolios diversified at the risk factor level, quality should be the “anchor” or core holding while building satellite factor exposures around it.
As always, we welcome your questions and feedback.
[1] For a more detailed description of the quality factor, see “The DuPont Analysis: One of the Most Powerful Concepts in Finance.”