iShares Makes Big Bet On Multifactor ETFs

iShares brings multifactor methodology to sectors, goes head-to-head with John Hancock.

Reviewed by: Debbie Carlson
Edited by: Debbie Carlson

BlackRock’s iShares recent launch of nine multifactor sector exchange-traded funds represents a big bet on smart beta being an important part of investors’ future portfolio construction.

Additionally, the firm unveiled a new website about factor investing and a smart-beta guide. The world’s largest smart-beta ETF provider also rebranded its current factor-based funds under the name “iShares Edge.” Including the nine new multifactor sector funds, the iShares Edge suite comprises eight single-factor, 15 multifactor, 11 minimum-volatility and one fixed-income ETF, representing more than $28 billion in assets under management. 

Rob Nestor, head of iShares smart beta strategy at BlackRock, spoke to ETF Report about what the ETF provider sees in the space.

Why did iShares launch sector-based multifactor ETFs?
Sectors remain often the first entree for investors into ETFs in general. It’s a place where they frequently test out ETFs if they’re relatively unfamiliar with them. We think our multifactor approach highlights these factors that have outperformed the market in the long term and make a lot of sense in the sector space. We think it’s a great chance to distinguish ourselves in that category and differentiate ourselves with an approach that demonstrates a long-term ability to add value over the broader asset class.

What have investors and fund managers asked you for regarding multisector smart-beta funds?
There are a couple of home offices in the retail space that have indicated interest because they’re frequent model builders. They’re also [into] smart beta aggressively across the board beyond sectors. And they thought that intersection made sense. People are much more interested in a broad asset-class offering in that category, and it’s dominating our discussions across the traditional financial advisors (FAs), across institutions and those home offices.

What type of investor/manager is asking about multisector smart-beta funds?

Across the board, people are asking, but I wouldn’t say it’s overwhelming that people are asking about multifactor sectors. We’re a bit ahead of what we think people are going to want.

A “build it and they will come” sort of thing?
Exactly. The two categories we have had the most communicated interest in are the minimum-volatility category and multifactor. We built ours in a way that’s a little different from the rest of the smart-beta universe. We believe minimum-volatility strategies are primarily a risk-mitigating strategy. Those are not about trying to outperform.

Then there are individual or return-seeking factors. On an individual basis, our multifactor approach is specifically designed to outperform the market with a comparable risk of the market. And so when you think of the classic risk/return chart, minimum volatility is about going left—same return, less risk. Multifactor strategies are going north—same risk, greater return. And those are very distinct portfolio objectives. Those decisions should be made at the portfolio level, not within that product.

These funds seem to be pretty similar to the Hancock Dimensional Fund Advisors smart-beta funds sector funds. What audience are you targeting?
We’re targeting primarily sector allocators and model builders with sectors in mind, so that can be for the retail home office models that a lot of the FAs follow, or asset managers that utilize them as part of a top-down asset allocation model. Or asset managers that are more bottoms-up that don’t utilize all the sectors. They tend to put on bets in the most efficient way possible within a portfolio that would complement single-security holdings. They will often use sector ETFs to efficiently make that call on technology or financials or what have you.


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. 

Debbie Carlson focuses on investing and the advisor space for U.S. News. She is an internationally published journalist with bylines in publications including Barron's, Chicago Tribune, The Guardian, Financial Advisor, ETF Report, MarketWatch, Reuters, The Wall Street Journal and others.