This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Joe Smith, deputy chief investment officer of Omaha, Nebraska-based CLS Investments.
U.S. large-cap multifactor ETFs represent a new way for advisors and their investors to gain access to a unique approach to active management.
These ETFs aim to outperform the market by ensuring the portfolio has a balanced amount of exposure from style factors, including value, momentum, quality, size and low volatility. These factors have been known to explain risk and returns in portfolios.
U.S. large-cap multifactor ETFs took in roughly $3.75 billion in new assets in the last 12 months through the end of February 2019, with total assets now topping $29 billion as of March 22, 2019, according to Morningstar.
Newer entrants—such as the PIMCO RAFI Dynamic Multi-Factor U.S. Equity ETF (MFUS), the Oppenheimer Russell 1000 Dynamic Multifactor ETF (OMFL) and the BlackRock U.S. Equity Factor Rotation ETF (DYNF)—take multifactor investing one step further by rotating among factors as market conditions and economic growth data evolves in order to enhance returns.
The 5 ‘P’s’ Assessment
When it comes to evaluating multifactor ETFs, we believe investors should stick with the five “P’s”: people, philosophy, process, performance and price.
We evaluate the current universe of U.S. large-cap, multifactor ETFs under these dimensions.
Although factor investing in ETFs is relatively new, it has been implemented by a number of investment firms for years. We believe it is important to understand the team of individuals behind the design and implementation of the ETF, and whether or not the work is being sourced internally or outsourced to a third-party index provider.
For example, the Xtrackers Russell 1000 Comprehensive Factor ETF (DEUS) is designed to track the Russell 1000 Comprehensive Factor Index, run by FTSE/Russell. DYNF, a new actively managed multifactor ETF launched by BlackRock, is driven not by an index, but by the insights and factor rotation model maintained by a team of quantitatively focused investors and thought leaders on factor investing.
The people dedicated to incorporating factors have a significant influence on the ETFs and their outcomes.
For a larger view, please click on the image above.
Source: ETF.com; data as of Feb. 25, 2019
Generally, most practitioners would agree that multifactor investing has inherent benefits. Simply having a strategic allocation to each factor in your portfolio, at minimum, has generally been shown to account for an additional 2% in excess returns per year above the market.
Aside from owning a strategic allocation to factors, others believe investors should tactically rotate between factors on a relative basis to add additional performance to the bottom line. This is often referred to as factor timing, where decisions to overweight or underweight a factor relative to a strategic-policy mix of factors is dependent on the factor’s current valuations, degree of momentum, variability in returns, and what part of the business or economic cycle we are currently in.
The great debate over a strategic versus tactical approach to factors can lead to very different outcomes and have meaningful turnover and transaction costs associated with them.