Indices based on factors such as low volatility and quality generally feature defensive characteristics. These strategies tend to outperform the broad benchmark in down markets, as previous studies have shown. However, some market participants also believe that active management fares somewhat better than the benchmark in periods of volatility and distress. In 2018, the S&P 500^® rallied 10.56% in the first three quarters and lost 13.52% in the fourth; this provides a good test to compare actively managed mutual funds against passive defensive factor strategies and see which rode the rollercoaster better. In our test, we also include the S&P 500 Equal Weight Index.

Different factors deliver different investment results, due to unique defensive mechanisms. In 2018, low volatility and dividends outperformed while quality lagged, compared with the median performance of all largecap mutual funds. Over the long term, when the cyclicality of the market had smoothed out, all these passive strategies tended to outperform the majority of actively managed mutual funds (see Exhibit 1).