While 2015 was the proliferation year for ETFs combining multiple factors such as quality, value and low volatility, CFRA thinks 2017 could be the year when advisor and investor adoption takes off, based in part on 2016’s performance.
However, understanding what’s inside the ETFs offered by such established providers as BlackRock’s iShares and SSGA and newer entrants such as Goldman Sachs, J.P. Morgan and others are important when comparing their record.
Two years ago, the asset management industry seemingly came to an agreement. Investors would soon be ready for a rules-based, transparent approach that combined some of the attributes that historically provided active managers with outperformance. These five attributes, or factors, were quality, momentum, value, low volatility and size.
Active equity mutual funds continued to shed more assets last year—$100 billion in the first 11 months of 2016—than the combined outflows in the previous three years, according to Morningstar. CFRA thinks asset managers were correct to have established products for those seeking lower-cost alternatives.
Different Approaches To Outperformance
Some asset managers partnered with index providers FTSE Russell and MSCI, while others created their own indexes or partnered with another asset manager. Combined, the six U.S.-focused ETFs highlighted below have approximately $2.2 billion in assets.
They all took a different approach with the factor selection and implementation, which has resulted in unique portfolios. In four of the six examples, the ETF outperformed the 11.97% gain for the S&P 500 Index.
The iShares Edge MSCI Multifactor ETF (LRGF) and the SPDR MSCI USA StrategicFactors ETF (QUS) both launched in April 2015 and leverage MSCI’s factor efforts. They each incorporate quality and value. To this, QUS adds in low volatility in an equally weighted manner, while LRGF incorporates momentum and size, and attempts to maximize factor exposure with an optimizer.
Factors Used In Multifactor ETFs
Due to their distinct approaches, the current sector exposure they provide and the performance they achieve have been different. For example, LRGF currently has an 8% weighting in utility stocks, double that of QUS; these and other smart-beta ETFs are rebalanced, and as such, weights will shift.
CFRA thinks the high exposure to the strong-performing utilities sector also contributed to LRGF’s stronger 12.97% gain in 2016 that was ahead of the 9.71% for QUS as well as the 12.16% gain for the iShares Core S&P 500 (IVV). LRGF also has gathered significantly more assets than QUS.
In September 2015, three other multifactor ETFs from established active management firms were launched: the Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC), the JPMorgan Diversified Return US Equity ETF (JPUS) and the John Hancock Multifactor Large Cap ETF (JHML). Here as well, the approaches, the sector exposures and the performances generated are different.
Different Amounts & Types Of Factors
JPUS tracks a FTSE Russell index that incorporates stocks based on their quality, value and momentum attributes. Meanwhile, GSLC uses those three factors along with low volatility in its proprietary index. Lastly, JHML tracks an index designed by Dimensional Fund Advisors that focuses just on size, value and quality.
From a sector perspective, JPUS is unique, as it had more exposure to utilities (13% of assets) than in information technology (12%). GSLC and JHML both had much higher exposure to tech (21% and 19%, respectively) and lower exposure to utilities (4% each).
Sector Exposure In Multifactor ETFs Can Be Different
But a look inside reveals that stakes in large-cap tech stocks are distinct. For example, in late December, JHML had a lower weighting in Facebook than GSLC, but it alone held semiconductor maker Broadcom.
Of the three ETFs, JPUS was the stronger performer in 2016, rising 12.08%. Yet with $1.4 billion in assets, GSLC has been by far the most popular of the multifactor ETFs highlighted in this piece.
DEUS Outperformed All Of Them
Outperforming all five of its multifactor brethren in 2016 was the Deutsche X-trackers Russell 1000 Comprehensive Factor (DEUS), the youngest and one of the smallest of the bunch. DEUS launched in November 2015, seeks to track a FTSE Russell index that combined the five above-mentioned quality, momentum, size, value and low volatility factors. Though it has just $33 million in assets, DEUS’ 12.80% gain in 2016 has been aided by its relatively high exposure to industrials (18%) and low exposure to technology (13%).
However, past performance is not indicative of future results. Indeed, CFRA highlights the records of these five ETFs more to signify the importance of understanding what’s inside. Our ETF rankings of more than 950 equity ETFs are based on a combination of holdings-level analysis and ETF-level analysis, including their expense ratios and bid/ask spreads.
We expect 2017 will be a year when more advisors seek out multifactor ETFs that feel more like active management than IVV and its market-cap-weighted peers, but are cheaper than the 1.1% for a large-cap mutual fund. If they do, we hope they finish their homework and look inside the portfolios first.
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 at @ToddCFRA