Single Factor ETFs Can Be Multifactor

June 28, 2017

ETF.com: Sounds like you see WisdomTree as already offering multifactor funds, which is interesting, because my next question was: “Do multifactor funds work?”

Siracusano: WisdomTree is among the first to offer real multifactor ETFs. The way you can show that over time is to see what the loadings are when you regress against the Fama-French factors.

The WisdomTree ETFs—the dividend ones—will typically load very highly to value, but they also are sensitive to quality. Earnings weighted load pretty well to quality, but also are sensitive to value. That’s something you don’t really see in some of the other fundamentally weighted strategies.

The nice thing about starting with a broad universe of stocks is you also have the potential to lower the tracking error relative to the beta benchmarks. So when we look at the tracking error for the WisdomTree Earnings 500 Index or the total earnings index, those tracking errors were less than 2% over 10 years.

What that means is if you can beat the market by 40 or 50 bps [basis points] annualized with a tracking error of less than 2%, you may end up with a higher information ratio than folks who took on 4%, 5% or 6% tracking error over time.

We think, ultimately, multifactor definitely has a place in the ETF industry. But it really comes down to how much active risk the advisor or investor wants to take.

ETF.com: Do you think, in the future, investors are going to be paying more attention to things like factor loading? It seems like we’re hearing more mention of more sophisticated terms like that lately.

Siracusano: Certainly, for the more sophisticated investor, and for the advisor, and certainly as the intermediary, this is something I think is going to become more and more mainstream. After all, people are familiar with Morningstar’s style boxes. But I think you really get to a point where, instead of thinking in terms of value, blend and growth, people are going to say, “It’s not the growth necessarily that I want the exposure to, because growth could just mean very expensive stocks.”

Instead, they may say, “What I really want exposure to is the quality factor and/or the momentum factor that's associated with growth outperforming the market.” So rather than speaking in terms of a style box, I think people are going to gravitate really toward thinking, “Am I getting exposure to the four factors? And if I am, what kind of volatility am I taking on to get that exposure?”

 

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