Do factor ETFs diversify a World ETF? 25 years of MSCI factor indexes

Factor ETFs change how an equity portfolio behaves relative to the market; they do not add a separate return engine. From January 2001 to September 2026, in euros, the MSCI World value, momentum, quality, minimum volatility and small-cap indexes had monthly correlations of 0.83 to 0.98 with MSCI World.

All five lost between 35.6% and 52.4% from October 2007 to February 2009, when MSCI World lost 47.6%, and none of them rose in any of MSCI World's 24 worst months. Their diversification lives in their returns relative to MSCI World, which differ from each other, and in how far they fall, not in whether they fall.

Key takeaways

1. Factor indexes are still equities. MSCI World explained between 68% and 96% of each factor index's monthly variance from 2001 to 2026.
2. Minimum volatility cushioned falls, at a cost. It beat MSCI World in 23 of its 24 worst months and lost 3.9% in 2022 against 12.8%, but grew at 5.9% a year against 6.7% over the full period and 8.6% against 12.1% since September 2014.
3. The factors offset each other relative to the market. Value's relative return had a correlation of -0.32 with quality's since 2014, and an equal mix of four factor indexes roughly halved the tracking error of a single one.
4. Relative droughts were long. Value trailed MSCI World by 31.3% over the five years to August 2020; minimum volatility by 29.5% over the five years to October 2025.
5. Live results were weaker than the back-tests suggest. Since September 2014, only momentum and quality kept pace with or beat MSCI World.

What a factor ETF is

A factor index starts from a broad index, here MSCI World, and selects or reweights its companies by a characteristic:

• Value: low prices relative to book value, earnings and cash flow (MSCI World Enhanced Value).
• Momentum: strong recent price performance (MSCI World Momentum).
• Quality: high return on equity, low debt and stable earnings, within each sector (MSCI World Sector Neutral Quality).
• Minimum volatility: the mix with the lowest expected volatility under constraints (MSCI World Minimum Volatility).
• Small cap: smaller companies not included in MSCI World (MSCI World Small Cap).

Each is tracked by UCITS ETFs available to European investors. We used MSCI's own index data in euros, which reaches back to 2001, and checked it against the matching iShares ETFs.

How closely factors follow the market

Source: Copio calculation on MSCI index data; results by factor (CSV).

Beta measures how much an index moved for each 1% move in MSCI World; tracking error is the annual volatility of its return difference with MSCI World.

Quality is almost the market: a correlation of 0.98 and a tracking error of 2.7%. Minimum volatility is the most different, with a beta of 0.63: it tended to move about two thirds as much as MSCI World. For comparison, EUR-hedged government bonds had a correlation of 0.01 with MSCI World over 2006 to 2026, and gold -0.09, in our falling-months study.

How factors behaved in equity falls

Source: Copio calculation on MSCI index data; monthly returns (CSV).

Every factor index lost at least 29% in the 2000 to 2003 bear market and at least 35% in 2007 to 2009. The differences were real but depended on the crisis:

• Value lost less than MSCI World after the dot-com bubble and in 2022, and more in the financial crisis, when banks dominated cheap stocks.
• Minimum volatility lost less in all three, by 8.9 to 12.0 percentage points.
• Small cap lost less after the dot-com bubble, when large technology companies led the fall, and slightly more in the other two.

In MSCI World's 24 worst months since 2001, minimum volatility did better than MSCI World 23 times, quality 19 times and momentum 18 times; value did better 8 times and small caps 10 times.

Where factor diversification lies: relative returns

Subtract MSCI World's return from a factor's, and what remains is the factor's own bet. Those relative returns are where factors differ from each other.

Source: Copio calculation; relative-return correlations, live and full period (CSV).

Value's bet ran against quality's and momentum's; quality and minimum volatility leaned the same way. That is why combining factors smooths the ride relative to the market: an equal mix of the value, momentum, quality and minimum volatility indexes had a tracking error of 3.5% a year from 2001 to 2026, against an average of 6.3% for each alone. The mix had a correlation of 0.97 with MSCI World and a worst drawdown of 45.4%: its diversification was relative to the market, not away from it.

Relative droughts and the live record

A factor can trail the market for years.

Source: Copio calculation; relative return is the factor's five-year growth divided by MSCI World's, minus one.

Index providers usually design factor indexes using history that is already known, so back-tested returns tend to look better than what follows launch. MSCI launched World Minimum Volatility in April 2008, World Momentum in December 2013, and World Enhanced Value and World Sector Neutral Quality in August 2014; the earlier figures are back-tests.

Since September 2014, value, minimum volatility and small caps grew more slowly than MSCI World, quality kept pace and momentum was ahead. Over this live period, the relationship with the market changed little: value's correlation was 0.86 and minimum volatility's 0.79.

What this means for a portfolio

A factor fund replaces part of a World fund with a different version of the same equity risk. It can reduce or increase the depth of a fall, and it can lead or lag the market for a decade, but none of the five indexes rose in any of MSCI World's 24 worst months since 2001.

If the aim is a holding that behaves differently in an equity crash, the candidates are other asset classes, with their own costs and limits. If the aim is a different equity profile, such as a smaller fall in exchange for lower expected growth, the relevant checks are the factor's drawdowns, its relative droughts and whether you would hold it through them.

Checks you can run on your own portfolio

1. Read the index name on the factsheet. "Value", "quality" and "minimum volatility" funds track different index rules; compare like with like.
2. Look at beta and tracking error, not only past returns. A beta near 1 and a tracking error near 3% mean a fund behaves almost like the market.
3. Check the worst relative five years. Ask whether you would keep the fund after trailing MSCI World by 20% to 30%.
4. Combine factors deliberately, or not at all. One factor fund is a concentrated bet on that factor; several with offsetting relative returns behave closer to the market.
5. Count the factor fund as equity risk. When you add up your exposure to an equity crash, include it in full.

Limits of this analysis

• Index returns exclude fund costs. The four iShares factor ETFs' calendar-year returns differed from their indexes by 0.58 to 0.89 percentage points on average from 2015 to 2025, and the small-cap ETF's by 1.19 from 2019, partly because Xetra closes at 17:30 CET, before US markets close.
• Before each launch date, index returns are back-tests built with hindsight.
• All figures are in euros; in dollars, currency effects differ.
• Factor definitions vary by provider. Another provider's value or quality index can behave differently.
• The analysis covers 25 years with two large bear markets. Factor relationships can change.

How can copio help you examine your own allocation?

Copio is in private beta across Europe, with early access by application. It looks through your funds into asset classes and places each on a return-correlation map as a main driver, a true diversifier, dead weight or a shock absorber, so you can see whether your holdings differ by driver or only by label.

A correlation matrix shows which holdings move together, and a crash test shows how a mix like yours would have fared in past crises. Copio provides educational analysis, not personalised advice; it does not place trades or choose an allocation for you. The free portfolio checker is a first step.

This article is published for information and educational purposes only. It does not constitute personalised investment advice. Past performance is not a reliable indicator of future performance.