In the dynamic world of exchange-traded funds (ETFs), a critical lesson emerged for investors in 2025: funds that sound identical can contain vastly different investments, leading to sharply divergent returns. As ETFs become the default choice for millions, understanding what lies inside a fund is more vital than ever. This is particularly true for the complex category known as factor ETFs, or smart-beta funds.
The Great Factor ETF Discrepancy
A 'factor' refers to a set of characteristics shared by many companies that influence risk and return, such as value, momentum, or quality. While academic research suggests certain factors outperform over the long term, short-term results among funds chasing the same strategy can vary dramatically. A stark example from 2025 highlights this: the iShares MSCI USA Momentum Factor ETF, targeting stocks with high recent returns, gained an impressive 22.1%. In contrast, the Alpha Architect US Quantitative Momentum ETF, pursuing a similar hot-performance strategy, rose a mere 2.6%.
This wide dispersion was not limited to momentum. Funds based on other popular factors—value (statistically cheap stocks), quality (high-profit, low-debt firms), and minimum volatility (less fluctuating stocks)—also showed significant performance gaps. Differences of 10 percentage points or more between similarly-named funds were common in 2025. According to Nicolas Rabener, founder of London-based investment-research firm Finominal, such wide gaps are the rule, not the exception.
Why Definitions Drive Divergence
The root cause of these disparities lies in how different ETF managers define the same factor. Take the 'value' factor, which focuses on cheap stocks. One manager might define 'cheap' using low price-to-earnings multiples, while another uses sales, assets, cash flow, or a bespoke combination. The potential variations are nearly endless, leading to fundamentally different portfolios.
This creates paradoxical situations. Consider Tesla, which as of early January 2026 trades at roughly 290 times its earnings over the past 12 months. While this seems the antithesis of a value stock, it meets the technical 'value' definition used by several benchmark indexes. Consequently, ETFs like Fidelity Value Factor, iShares Morningstar Value, iShares S&P 500 Value, and State Street SPDR Portfolio S&P 500 Value all hold Tesla as a top-10 position. Meanwhile, funds like Schwab U.S. Large-Cap Value own little or none of the electric vehicle giant.
Navigating the Factor Fund Maze
Experts advise a cautious, informed approach. Jay Jacobs, U.S. head of equity ETFs at BlackRock, notes that many investors, especially those advised by professionals with biases toward value and small-cap stocks, could benefit from diversification across multiple factors. For a self-directed investor heavily exposed to a growth stock like Tesla, a value-factor ETF might serve as a balancing act.
The first step when selecting a factor fund is to scrutinize its holdings list to ensure alignment with your goals. Next, maintain realistic expectations. "Factors work over the long run, but they can’t work all the time," cautions Scott Rodemer, head of factor-based strategies at Vanguard. A factor can underperform for years, even decades, or its long-term gains may come from remarkably short bursts.
Investors must also recognize that factor investing is a form of 'deversification'—it reduces overall diversification by concentrating bets on a market segment. By regulation, a fund with a specific factor in its name must invest at least 80% of assets consistently. The remaining 20%, however, can be allocated at the manager's discretion, sometimes allowing exposure to other factors to curb short-term volatility.
Multifactor funds, which explicitly blend strategies, slightly outperformed in 2025 but trailed the S&P 500 by an average of 2.1 percentage points annualized over the past five years, according to Morningstar data. For many investors who are already fully diversified, the effort to pick the winning factor or the best fund to represent it may not be worth the trouble. The key takeaway for 2026 is clear: in the wacky world of factor ETFs, looking under the hood is not just advisable—it's essential.
