A Compelling Multi-Factor ETF

  • More issuers are ETFs as smart beta movement takes off
  • The idea behind multi-factor funds is that factors do not always perform well at the same time
  • Growth and value rarely outperform the broader market in unison

As the smart beta movement has taken off in the exchange traded funds universe, more and more issuers are offering ETFs that feature exposure to several investment factors, or multi-factor funds.

The idea behind multi-factor funds, such as the iShares Enhanced U.S. Large-Cap ETF (NYSEArca: IELG), is that factors do not always perform well at the same time. For example, growth and value rarely outperform the broader market in unison. With a multi-factor ETF like IELG investors have exposure to enough factors that their bases are covered to a certain extent as the various investment factors come in and out of favor.

The actively managed IELG tries to generate competitive long-term risk-adjusted returns relative to broad U.S. large-caps by selecting stocks based on a combination of quality, value and size factors. fund managers determine quality through earnings stability, low debt/capital ratio and earnings accruals, or stocks that exhibit high operating cash flow relative to net income. [Stock ETFs to Weather Market Volatility]

IELG “targets stocks with attractive value, quality, and smaller market-capitalization characteristics and currently attempts to offer 95% of the volatility of the Russell 1000 Index. It achieves this volatility reduction through its weighting approach. But the managers limit the portfolio’s sector tilts to 10 percentage points of the Russell 1000 Index,” said Morningstar in a recent note.

The $77 million IELG allocates 27.8% of its weight to technology stocks and 18.5% to financial services, also the S&P 500’s two largest sectors weights. IELG’s top 10 holdings, a group that combines for almost 21% of the ETF’s weight, include Johnson & Johnson (NYSE: JNJ), Nordstrom (NYSE: JWN) and AT&T.