Metal cube with key elements. 3D illustration.

Factor-based exchange traded fund investments raise a lot of questions in most people’s minds, and rightly so. As a relatively new approach in the financial world, potential investors will have to look at several aspects that need careful consideration.

On the upcoming webcast, Gimme five – five key questions for factor investors, Abby Woodham, ETF Strategist for Deutsche Asset Management, Robert Bush, ETF Strategist for Deutsche Asset Management, Rolf Agather, Managing Director of North America Research at FTSE Russell, and George Rector, ETF Consultant at Deutsche Asset Management, will outline key considerations when approaching the relatively new smart beta or factor-based ETF strategies.

Specifically, Deustche Asset Management posed five simple questions that investors should cogitate on when examining factor-based, smart beta strategies: Why should I consider an allocation to these strategies? How do I identify good factors? How do i Decide how many to include? What is a sound methodology for combining factors?

“As an increasingly popular strategy that combines some of the best attributes of the Active, Passive, and Alternative pillars, it warrants careful consideration,” Deutsche Asset Management strategists Robert Bush and Abby Woodham said in a note.

For example, the Deutsche X-trackers Russell 1000 Comprehensive Factor ETF (NYSEArca: DEUS), Deutsche X-trackers FTSE Developed ex US Comprehensive Factor ETF (NYSEArca: DEEF), Deutsche X-trackers Russell 2000 Comprehensive Factor ETF (NYSEArca: DESC) and Deutsche X-trackers FTSE Emerging Comprehensive Factor ETF (NYSEArca: DEMG) select components based on a broad set of five factors, including quality, value, momentum, low volatility and size.

These factors have been traditionally found in actively managed mutual fund strategies, but as index-based ETF strategies move beyond the traditional market capitalization-weighted methodology, more money managers are crafting customized passive index-based ETFs that incorporate active styles or factors.

For buy-and-hold investors, multi-factor investments help combine uncorrelated investment styles to smooth out volatility. Since there are multiple uncorrelated factors at play, it helps guarantee that at least one factor will help support the portfolio during times of distress. Moreover, a multi-factor ETF removes the need for investors to babysit a portfolio and switch between factors in an attempt to time market moves.

Looking at the Deutsche Asset Management’s factors, the quality factor helps hone in on the quality of a company earnings as a better gauge of future earnings performance. The underlying indices may provide a quantifiable measure of each company’s profitability, efficiency, earnings quality and leverage.

The value factor reflects the idea that cheaper equities are thought to outperform more expensive stocks over the long-term. Consequently, the underlying indices will focus on cash-flow yield, earnings yield and sales-to-price of each company as measures of value.

Momentum may reflect the recent price movements over time as an indicator of future stock price movements. Specifically, the underlying indices review the 11-month cumulative total returns of each stock.

Low volatility suggests that portfolios with less volatility or low beta can provide higher-than-average return with smaller drawdowns. The underling indices will calculate the standard deviation of five years of weekly total local returns for each stock.

Lastly, the size factor reflects the historical long-term effect that show long-term outperformance in small-caps over large-caps. The underlying indices will select companies based on full market capitalization.

Financial advisors who are interested in learning more about smart beta, factor-based ETF strategies can register for the Thursday, February 16 webcast here.

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