iShares Makes Big Bet On Multifactor ETFs

June 02, 2016

How are yours different, aside from a lower expense ratio?
The major difference is the Hancock funds follow the DFA model, and they primarily focus on value and size—with some quality bent—but they don’t use the momentum factor directly. The use of the momentum factor is the major difference. We have a little bit broader lineup and are priced slightly lower.

The Hancock funds haven’t performed that well. Considering theirs have been slow out of the gate, why will your funds be more attractive?
I think our relationships in the ETF world, our heritage in working with MSCI—the index provider in this space—and our fundamental philosophy on what works in the space will carry the day and allow us to make a case to a variety of different clients on why they make sense, if you were inclined to be a sector investor. We’re not trying to convince nonsector investors to start using sectors. That’s not our focus.

As part of the funds launch, BlackRock also launched a factors website and an iShares smart-beta guide. Why?
The biggest gap in this space is understanding. Factors are not new; we’ve been doing it for 30 years on the institutional side. It’s mostly been the purview of a small cadre of buy-side investors who had access to the data. ETFs have democratized access to factor investing in a very, very efficient way. There is this veil of complication I think we need to lift. Esoterically, in terms of how the methodology is built, there is some complication there, but what drives returns isn’t that complicated.

You’re already the biggest provider of smart-beta ETFs; what’s BlackRock/iShares’ strategy for factor investing going forward?
We built our product to fit into the asset allocation [model] everyone’s familiar with. If you look at our minimum-volatility suite, it’s built to go along with common asset classes. We’re helping people learn how to plug that into the natural asset allocation. We’re spending a lot of time consulting on portfolio construction within the retail and institutional business, where clients give us their portfolio, we do the X-ray on the risk they have and the different dimensions, and figure out how to plug factors into that portfolio to meet the risk/reward equation they’re trying to achieve.

Traditional market-cap weighting still works, but what traditional market weighting doesn’t address are two to three very fundamental client outcomes we hear requested every day: 1) I want participate in the long-trend return of the broad asset classes, but do so with less risk; 2) Despite appreciating the benefits of past investing, I still feel compelled to outperform, and smart beta can do that, too; and 3) I want to build an income portfolio with dividend smart beta.

In February, a research report from Research Affiliates (RA) said there was the possibility things with smart beta might go wrong. Considering who they are, it raised some eyebrows. Is this a concern given how much factor-based investing has grown?
I think in a lot of cases the thread has been lost with regard to what Rob [Arnott] and RA focused on. Valuations matter, but they’re not the only measure. They matter much more to the short-term investor than they do a long-term investor. The rise of valuation in certain areas of the factor space is part of the cycles of factors. It doesn’t change the thesis of outperformance in the long term. To be frank, it will change potentially what that excess return will be from today to some future date.

One of the biggest things [Rob] focused on … was growth of low-volatility and minimum-volatility strategies. Where the analysis missed the boat unquestionably was that the price of insurance has risen; but these strategies are built on exactly what I said—they’re built to mitigate risk, not to outperform. The thread of what a lot of what Rob talked about was having a focus on outperformance. The last 18 months have been sideways to down, and volatility has been high. That’s exactly when you expect minimum-volatility to outperform. When the markets rally, minimum volatility will lag. 

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