Todd Rosenbluth is director of ETF and mutual fund research at CFRA.
Various asset managers offer multifactor developed international ETFs, appealing to investors seeking an alternative to an index-oriented market-cap-weighted approach.
These ETFs focus on factors—including momentum, quality, size and value—long used by successful active managers. Yet what's inside these ETFs—at the security, sector and country level—differs greatly from popular international index-oriented market-cap-weighted ETFs, and even from each other.
Here we highlight three themes related to international multifactor ETFs:
- Each provider emphasizes different factors. Low-priced stocks are preferred in all nine multifactor ETFs we review, but the funds blend other ingredients—quality, low size and/or low volatility—to make their offerings unique.
- Multifactor ETFs provide distinct sector exposure. Many multifactor ETFs were highly exposed to industrials and had limited stakes in consumer staples and health care relative to broad international benchmarks.
- Vive la France: Numerous multifactor international ETFs had hefty weights in French stocks, but exposure to Germany and Switzerland was more diverse.
Given the distinct sector and country exposure, due to unique index constructions, there were performance differences among multifactor ETFs and market-cap-weighted alternatives.
CFRA reviewed nine multifactor ETFs that use value as an input.
For a larger view, please click on the image above.
Developed international equity ETFs gathered $20 billion in the first quarter of 2018, far exceeding the $6 billion pulled in by U.S. equity funds. Most of the money flowed into market-cap-weighted international funds such as the iShares Core MSCI EAFE ETF (IEFA) and the Vanguard FTSE Developed Markets ETF (VEA) rather than smaller, but strong-performing smart-beta products.
However, international ETFs that screen using multiple fundamental and technical factors collectively have $5 billion in assets, and CFRA thinks inflows will further accelerate as investors become more comfortable with the multifactor approach and methodology.
Investors embraced developed international equity ETFs in the 15 months ended March 2018—these funds gathered $105 billion in new assets. Strong demand in 2017 persisted in the first quarter of 2018 with the addition of $20 billion in new inflows. Multifactor ETFs pulled in less than 5% of the developed international net inflows, as shown in the table above, but their collective asset bases swelled by 18%.
Many of these funds are less than three-years old, and we expect demand to persist throughout the year and into 2019 as educational efforts continue. However, investors should not expect these ETFs to rise and fall in tandem, as they are constructed differently.
Evaluating ETFs & Factors
Here are some of CFRA's most significant findings.
How value is combined is in the eye of the provider. While these nine ETFs all use a value factor input, the other ingredients pulled from the cupboard are different. As shown in the table below, four ETFs include low volatility; six include quality; and four include low size, yet there's limited overlap in usage.
For example, the USAA MSCI International Value Momentum Blend Index ETF (UIVM) combines value and just momentum, yet the John Hancock MultiFactor Developed International ETF (JHMD) mixes value with size and quality.
The PowerShares FTSE RAFI Developed Markets Ex-US Portfolio (PXF) is the lone multifactor ETF to incorporate value with dividend and revenue attributes. PXF was launched in 2007, before investors accepted the combination of value with some other factors.
The JPMorgan Diversified Return International Equity ETF (JPIN) is the largest of the nine international multifactor ETFs evaluated by CFRA; it tracks a FTSE index combining low volatility, momentum, size and value factors. The smallest of the nine is the Xtrackers FTSE Developed Ex U.S. Comprehensive Factor ETF (DEEF). DEEF incorporates low volatility, momentum, size and value like JPIN, but also adds in quality.
Meanwhile, the Goldman Sachs ActiveBeta International Equity ETF (GSIE) and the iShares Edge MSCI Multifactor ETF (INTF) use momentum, quality and value traits. GSIE tracks a proprietary index that includes low-volatility attributes, while INTF replicates an MSCI index that instead folds in the size factor.
Similar Sounding But Different
What's inside similar-sounding ETFs is different. Market-cap-weighted IEFA and VEA are simply constructed based on company size, with large positions in Nestle and Novartis.
In contrast, factor using ETFs tilt toward and away from certain sectors. As shown in the image below, DEEF and INTF are heavily weighted to industrials and underexposed to consumer staples and health-care stocks. Aerospace and defense companies BAE Systems and Thales S.A. are some of INTF's industrial holdings.
Industrials A Favored Sector (% of assets)
At the sector level, DEEF and INTF had 23% and 19% of assets in industrials at the end of the first quarter, respectively, above the 15% stake in market-cap-weighted VEA and IEFA. In contrast, GSIE had a 14% position in the sector.
DEEF and INTF were underexposed to health care (4% vs. 9% for market-cap-weighted examples), but there were other distinctions. The iShares offering was significantly underweighted to consumer staples (5.5% vs. 10%), while DEEF had a 9% stake.
Meanwhile, pharmaceuticals and packaged food companies are underweighted in those two multifactor ETFs.
However, not all multifactor ETFs find the same investment opportunities within a sector. While GSIE has only 10% in health care stocks, 7% of assets are in pharmaceuticals, including top-10 holdings Novartis, Novo Nordisk and Roche Holdings. GSIE does not include a low size factor as some of its peers do.
France was favored over Germany and Switzerland. Both GSIE and INTF had an 11% stake in French stocks, more than VEA and IEFA. Meanwhile, JPIN had only 2.2% and 4.4% weightings, respectively, in Switzerland and Germany, below market-cap-weighted peers.
In the first quarter, these and other multifactor index ETFs lost less than IEFA/VEA despite charging a higher expense ratio, highlighting the differences and benefits of multifactor developed international strategies.
At 8-9% of assets, France is one of the larger countries for market-cap-weighted ETFs, but many multifactor ETFs have a heftier stake. UIVM had the largest stake (12% of assets), followed by GSIE and INTF, as shown in the chart below. There was disparity toward Germany among the ETFs, with JPIN (4%) and DEEF (6%) being offset by JHMD (10%) and PXF (9%).
France Favored Over Germany (% of assets)
However, regarding Japan exposure, all nine smart-beta funds were aligned with VEA and IEFA, holding a 20-plus percentage of assets in Japanese companies.
While investors should not rely on past performance in selecting an ETF, particularly for a short period, the record suggests multifactor ETFs could serve as either a replacement or a complement to a market-cap-weighted international equity index strategy.
We expect the collective asset bases for international multifactor ETFs to climb higher as familiarity and comfort with these strategies grow.
CFRA provides research and ratings on these and other multifactor ETFs available on MarketScope Advisor. We combine our proprietary holdings-level analysis with key fund attributes such as expense ratio and bid/ask spread to generate our proprietary ETF rankings.
At the time of writing, neither the author nor his firm held any of the securities mentioned. Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence's equity and fund business in October 2016. He can be reached at [email protected]. Follow him on Twitter @ToddCFRA.