How deeply do FAANGs sink into factor portfolios?

A study looks into the impact of FAANG stocks on factor portfolio returns

How deeply do FAANGs sink into factor portfolios?

The FAANG quintet of stocks has been influential, driving much of the 2018 performance of the Nasdaq 100 and currently accounting for some 35% of the index. But with more and more factor funds being equal-weighted rather than cap-weighted, some may wonder: how much could FAANG stocks influence the performance of factor-focused funds?

Nicolas Rabener, managing director of FactorResearch, shared some insight on this in a recent piece published by the CFA Institute. Using data covering the period 2000-2018, his firm constructed six model factor funds — value, size, momentum, quality, growth, and dividend yield — through beta-neutral long-short portfolios based on the top and bottom 10% of US equity markets.

“[Constructing the value factor model] results in a diversified portfolio of approximately 170 stocks each on the long and short sides,” he said.

After constructing those factor portfolios, the firm looked at how their returns per annum would be impacted if FAANG stocks were excluded.

“Investors may expect FAANG stocks … to be expensive and to outperform, to feature large market caps, high quality, strong growth, and to pay no dividends,” Rabener wrote. “Interestingly, the performance of the factor portfolios that excluded these five stocks reflects these company characteristics.”

After excluding FAANG stocks, the firm found that returns per annum climbed for the models representing value (from 10.7% to 11.1%), size (5.2% to 5.4%), and dividend yield (6.9% to 7.7%) factors. Conversely, excluding FAANGs caused returns per annum to fall among the momentum (from -2% to -2.3%), growth (0.7% to 0.3%), and quality (1.7% to 1.5%) factor models.

The upshot: despite the fact that the portfolios were equal-weighted, the FAANG stocks still had a significant influence on returns, considering the impact removing them had on factor portfolios that were diversified hundreds of stocks.