With just one month left in the year, the average large cap core mutual fund is again lagging the market-cap-weighted S&P 500 Index that is tracked by popular ETFs. CFRA has concerns that these active products are also trailing behind many relatively cheap multifactor ETFs that track smart beta indexes constructed using a combination of activelike metrics such as lower volatility, quality and value.
The Vanguard S&P 500 ETF (VOO)— the smallest and cheapest of the S&P 500 Index-based ETFs—was up 27.6% in the first nine months of 2019, ahead of the 25.8% gain for the average large cap core (LCC) mutual fund in CFRA’s database.
While there were some bright spots, including the current CFRA five-star-rated American Century Focused Dynamic Growth Fund (ACFOX) and the T. Rowe Price US Equity Research Fund (PRCOX), up 30.1% and 28.8%, respectively, many of their large cap peers have underperformed. The relatively high fee for active management—0.98% for large cap core funds on average compared with 0.03% for VOO—contributes to the challenge mutual funds face.
In the last five years, many asset managers have successfully launched multifactor index-based ETFs that combine three or more investment approaches that have historically exhibited performance success. These factors are low volatility, momentum, size, quality and value.
CFRA reviewed the performance of 10 of these U.S.-focused ETFs, which do not all use the same factors; use them the same way; or have the same criteria for security inclusion. They do, however, share one thing in common: They’re relatively inexpensive, with the priciest charging just a 0.34% expense ratio and eight of them charging 0.20% or less.
Three such ETFs outperformed VOO, and an additional three were ahead of the average large cap core mutual fund. But there was a 940 basis point spread between the top and bottom performers of the group this year, which should serve as a reminder for investors to do some homework to understand what’s inside an ETF rather than simply blindly choosing an asset manager.
The Invesco Russell 1000 Dynamic Multifactor ETF (OMFL), which has $1.1 billion in assets and charges a 0.29% fee, uses all five of the aforementioned factors. But rather than just reconstituting throughout the year using the same factors as many others do, OMFL tracks an index that relies on economic indicators and risk appetite to determine the economic cycle and tilts OMFL toward certain factors.
|Ticker||YTD Total Return (%)||Assets ($M)||Expense Ratio (%)|
In the first half of 2019, OMFL was positioned for a slowdown, and favored low volatility and quality, but shifted initially to an expansion signal, and in November was positioned for a recovery favoring the size and value factors. OMFL rose 31.2% year to date through Nov. 29. At the end of November, OMFL’s highest sector exposure was to financials (22% of assets) and industrials (17%) after CFRA reviewed the ETF holdings.
The SPDR MSCI USA StrategicFactors ETF (QUS) has $622 million in assets and charges 0.15%. The MSCI-based strategy combines three separate factor indexes—a minimum volatility, a quality and a value one—rather than finding companies that score well on all three factors. QUS was up 28.8% this year, as of the end of November, and its largest sector weightings were information technology (26% if assets) and health care (14%).
The third multifactor ETF to outperform VOO this year is the John Hancock Multifactor Large Cap ETF (JHML), which has $933 million in assets and charges a 0.34% fee. Despite the relatively high fee for a multifactor ETF, JHML’s 27.7% year-to-date return nudged ahead of VOO and outperformed many of its peers.
Like QUS, JHML only focuses on three factors, but they are different. JHML emphasizes companies with small size, value and higher profitability (a proxy for quality, in our view) relative to their sector peers. Information technology (21% of assets) and financials (13%) were the largest sectors represented.
The Goldman Sachs ActiveBeta US Large Cap Equity ETF (GSLC), the Xtrackers Russell 1000 Comprehensive Factor ETF (DEUS) and the Franklin LibertyQ US Equity ETF (FLQL) either matched or beat the average large cap core mutual fund this year, even as they were behind VOO.
Meanwhile, the Hartford Multifactor US Equity ETF (ROUS), a $331 million fund, rose just 21.8% in the first 11 months. ROUS uses value, momentum and quality factors, while employing single-stock and sector constraints. ROUS charges a modest 0.19% expense ratio, and recently had 20% of assets in information technology and 16% in health care stocks.
The Global X Scientific Beta U.S. ETF (SCIU), iShares Edge MSCI Multifactor U.S.A. ETF (LRGF) and JPMorgan Diversified Return U.S. Equity ETF (JPUS) also lagged the average large cap core mutual fund this year.
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. For more information, please refer to CFRA's Legal Notice at https://www.cfraresearch.com/legal/.