Factor-based strategies are doing fine — it’s the narrative that’s broken

In recent years, factor-based investing has faced a fair amount criticism. Professional investors and commentators have questioned whether targeting specific stock characteristics such as value, size, or momentum still delivers the risk-adjusted returns that decades of academic research promised. Some have gone so far as to declare factor-based strategies "dead", pointing to prolonged underperformance, particularly in US markets since the Global Financial Crisis.

Yet the first half of 2025 has delivered a dramatic vindication of factor investing that few saw coming. According to Morningstar data, the DFA International Value fund (DFIVX) has returned 17.97% year-to-date through May, compared to a modest -0.17% for the S&P 500. That's an astonishing 18.14% outperformance in just five months — the kind of dramatic reversal that suggests the narrative around factor investing's demise has been fundamentally flawed.

This isn't merely a short-term aberration. As Larry Swedroe explained in a recent blog post, reveals that international value stocks have quietly outperformed the S&P 500 not just year-to-date, but over the past five years as well. While critics focused on US factor struggles, international markets have been quietly validating the fundamental principles of factor-based strategies.

The evidence suggests that factor-based strategies are working exactly as they should; it's the prevailing narrative about their failure that's broken. This highlights the cyclical rather than structural nature of factor performance, and the critical importance of looking beyond US borders.

The sceptical case: Why many think factor investing is dead

The criticism of factor investing isn't without foundation. As detailed in a comprehensive 2024 report on factor investing sentiment from Finominal, critics point to a litany of concerns that have accumulated over more than a decade.

The most damning evidence comes from performance data. The 20-year relative return of US small cap value stocks versus the S&P 500 Index dipped negative recently for the first time in market history. Two decades is a long time for an expected premium not to show up.

The criticism extends beyond mere performance disappointment. Research by Rob Arnott and colleagues revealed a stark gap between theoretical factor returns and real-world implementation. They found that in practice, value and momentum factor returns were roughly half their theoretical levels, with momentum delivering essentially no net benefit to live investors after costs. This disconnect between backtested promises and delivered results became a recurring theme in the factor investing debate.

Market saturation has emerged as another key concern. By 2019, there were hundreds of factor ETFs chasing the same well-documented anomalies. The argument follows that as thousands of investors flocked to well-known factors via ETFs, any mispricing or "free lunch" was arbitraged away. As one summary noted, "too many smart beta ETFs have arbitraged the factor premia away."

Academic research has also raised troubling questions about the factor zoo. With researchers identifying dozens of new "anomalies" over the years, sceptics worry that many published factors result from p-hacking or overfitting—statistical flukes that won't persist out-of-sample. A 2024 Bloomberg investigation into the Fama-French database titled "Upstarts Challenge a Foundation of Modern Investing" only heightened these concerns, sparking fierce debate about data integrity in factor research.

The international evidence: Factor-based strategies alive and well globally

However, this narrative of failure becomes considerably less compelling when we expand our view beyond US borders. While American factor strategies have indeed struggled, international markets tell a markedly different story, and it's one that academic research strongly supports.

In another recent article, Swedroe examines factor performance globally and reveals persistent premiums outside the US. From October 1996 to May 2025, Dimensional Fund Advisors' international factor funds delivered compelling evidence of factor persistence: DISVX (International Small Value) achieved a 7.95% annualised return, DFISX (International Small) delivered 7.02%, and DFIVX (International Value) returned 6.66%, all comfortably ahead of the 5.45% from the MSCI EAFE Index.

Remarkably, this outperformance persisted even during the post-Global Financial Crisis period when US factors struggled most. In emerging markets, the story is even more compelling: DEFVX (Emerging Value) delivered 9.75% annualised returns and DEMSX (Emerging Small) achieved 10.51% over the period 1999-2025, both significantly ahead of the 7.75% return from MSCI Emerging Markets.

Academic research from the past five years provides robust support for these real-world results. A comprehensive analysis by Blitz et al. in the Financial Analysts Journal (2019) examining factor performance from 1963-2018 found that long factor positions delivered Sharpe ratios up to 1.10 with statistically significant positive alphas (t-statistic = 7.44). Crucially, they found that "long legs of factors remain robust" across different time periods and markets.

Meanwhile, AQR's pure factor fund (QSPRX) provides perhaps the cleanest test of factor efficacy. Using a market-neutral long-short approach to capture value, quality, momentum, and carry factors, the fund has returned approximately 6.5% annually since June 2015 — a substantial 5% premium over T-bills during a period when many declared factor investing obsolete. This performance was achieved with zero correlation to global equities, providing unambiguous evidence that factor premiums persist for skilled implementers.

2025: The dramatic shift

The first half of 2025 has witnessed the most striking vindication of international factor investing in recent memory. The 18.14% year-to-date outperformance of international value over the S&P 500 represents more than just a statistical anomaly; it it reflects fundamental changes in the global investment landscape.

Several structural factors have converged to create this environment. Uncertainty around US trade and tax policy has dampened consumer and business confidence, raising recession risks and challenging the narrative of American economic exceptionalism. The US dollar's decline to 99.05 by late May reflects mounting concerns over tariffs, geopolitical tensions, and threats to Federal Reserve independence, sparking discussions about "de-dollarization" as central banks diversify reserves.

Simultaneously, European markets have benefited from aggressive policy stimulus. Germany's announcement of a €1 trillion fiscal package focused on infrastructure and defence, combined with the EU's relaxation of fiscal rules and consideration of new funding sources, has created a more supportive environment for European equities.

The regional divergence in factor performance has been particularly striking. JPMorgan Asset Management recently noted that European and Japanese value stocks led the equity factor rebound in the first quarter, posting robust gains, while US factor portfolios remained only slightly positive as the market churned sector-wise.

This dramatic reversal serves as a powerful reminder of the cyclical nature of market leadership and the unpredictability of when regimes might shift.

The US situation: Encouraging signs for factor-based strategies

While US factor performance has disappointed for over a decade, mounting evidence suggests this drought may be ending. Historical analysis provides compelling reasons for optimism about a potential revival in US factor premiums.

Recent Analysis from Wes Crill at Dimensional Fund Advisors on reveals that the current situation, while painful, is not unprecedented. The 20-year relative return of US small cap value versus the S&P 500 recently dipped negative for the first time in history — a concerning milestone. However, as the chart below shows, similar periods of factor drought in 1947, 1965, and 1999 were each followed by rapid reversals where small cap value's advantage jumped to more than three percentage points annualised within three years.

As Swedroe notes in his analysis, critics often overlook the primary reason for value's recent US underperformance: not disappointing earnings, but a dramatic widening in valuation spreads between growth and value stocks. Such extreme valuations are historically unsustainable and often precede periods of mean reversion.

The current macro environment may prove more supportive of factor-based strategies. The shift from the low-rate, growth-dominated 2010s to today's higher-inflation, higher-rate environment creates conditions where value stocks have historically performed better. Rising interest rates penalise expensive growth stocks whose future cash flows face higher discount rates, while market volatility and dispersion — essential ingredients for factor differentiation—have increased dramatically from the ultra-calm pre-2020 period.

Academic research supports this cyclical view. A study by Hanauer (2020) found that enhanced value strategies maintain "a solid long-term track record with a highly significant premium" despite recent struggles, while research by Gelderen and Huij in the Journal of Portfolio Management (2013) documented monthly excess returns ranging from 0.4% to 1.9% for various factors in mutual fund applications, with results remaining "significant at the 1% level" and showing that "excess returns persist post-publication."

What the evidence really shows

The weight of evidence suggests that factor investing's struggles represent a cyclical phenomenon rather than structural obsolescence. All risk assets, including factors, experience extended periods of underperformance—this is fundamental to generating risk premiums over time. The S&P 500 itself, heavily exposed to the market beta factor, underperformed risk-free Treasury bills for 15 years (1929-1943), 17 years (1966-1982), and 13 years (2000-2012).

Academic consensus remains remarkably consistent on factor persistence when viewed globally and over appropriate time horizons. Meta-analysis of recent studies reveals that factors deliver "persistent and statistically significant excess returns when implemented with care," particularly through enhanced approaches that use composite metrics, risk management, and careful market selection.

The key insight is that factor investing is neither a magic bullet nor a failed experiment—it's a tool that, when used judiciously with realistic expectations, can enhance portfolio outcomes. Rather than asking whether "factor investing" works in absolute terms, the more productive question focuses on which factors have the strongest theoretical and empirical foundations, maintaining global diversification across markets, and ensuring robust implementation approaches.

Geographic diversification emerges as crucial. The stark difference between US and international factor performance over the past decade underscores the importance of global exposure rather than concentrating on any single market. An emerging markets multi-factor index has outperformed its cap-weighted benchmark by approximately 0.8% annually over the past 20 years—a meaningful excess return that US-focused critics have largely ignored.

Implementation quality matters enormously. The success of sophisticated strategies like AQR's market-neutral approach, combined with the persistent outperformance of carefully constructed international factor funds, demonstrates that skilled execution can capture meaningful premiums even during challenging periods. Long-only approaches often prove more efficient than long-short strategies, as research by Blitz et al. found that "short legs add little value" while long legs capture most factor premiums.

Conclusion

The dramatic performance reversal of 2025 has exposed the fundamental flaw in the prevailing narrative about factor investing. While critics declared factor-based strategies dead based on US performance alone, the global evidence tells a markedly different story of persistent premiums and successful implementation.

The 18% year-to-date outperformance of international value funds serves as a powerful reminder that the strategies themselves were never broken—it was the narrow, US-centric perspective that led to flawed conclusions. This reversal aligns with historical patterns, academic theory, and the extreme valuations that had developed between growth and value stocks.

For investors, the key lesson is clear: factor-based strategies require patience, global diversification, and realistic expectations. They were never designed to work effortlessly or uniformly across all markets and time periods. Instead, they offer a systematic approach to capturing risk premiums that have persisted across decades and markets—premiums that continue to reward disciplined investors willing to weather inevitable periods of underperformance.

As we've seen dramatically in 2025, when market regimes shift, they can do so rapidly and decisively. The quiet outperformance of international value stocks over the past five years, culminating in this year's explosive relative performance, demonstrates that factor premiums remained potent for those who looked beyond the broken narrative.

The evidence is unambiguous: factor-based strategies are doing fine. It was the story we told ourselves about their failure that needed fixing.

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