With exchange traded funds covering most broad index ideas, a new breed of layered, multi-factor strategies could help foster the next leg of growth in the ETF industry.
Following the success of smart beta ETFs that selected components based on a single investment style, such as dividends or low volatility, ETF sponsors are taking the next step and rolling out a number of ETFs that select components based on multiple investment themes, such as dividends, momentum, low volatility and value, which are then all combined into a single ETF. These new multi-factor index ETFs are seen as a way to replicate an active managers’ various investment styles in a cost-efficient, rules-based index fund.
“The industry is creating more transparent and lower-cost versions of the same quant management we’ve seen over the last couple of years,” Lance Humphrey, executive director of global multi-assets at USAA Asset Management Co., the biggest buyer of Goldman’s U.S. multifactor fund, told Bloomberg. “But there are pitfalls. It’s one of my biggest concerns.”
These types of multi-factor strategies are seen as more long-term investment holdings that should be held through up-and-down markets as the ETFs are said to limit market drawdowns and still participate in market gains, potentially providing investors with better risk-adjusted returns over the long run. However, some are worried that many individuals may be tempted to sell when the going gets tough.
“We’re not creating trading vehicles, we’re creating core exposures,” Patrick O’Connor, head of ETFs at Franklin Templeton Investments, told Bloomberg. “It’s still relatively new. There’s definitely folks getting into it, but I think we’re all working on education, which is a good thing.”
[related_stories]Moreover, the multi-factor strategies are still relatively new, with most of these ETFs only coming to market within the past three years, so their track recross are thin. Consequently, potential investors should take the time and perform their due diligence before investing in the products.
“A lot of this is so new, but if we waited until all indexes had a live track-record of seven years, product development would stop,” Rob Nestor, head of iShares U.S. smart beta at BlackRock, told Bloomberg. “So investors should be discerning when they’re looking at backtests and should examine closely the methodology and make sure the factors are captured and backed by empirical evidence. We welcome the examination of that.”
The multi-factor ETF space has been gaining traction among both retail and institutional investors, According to a January survey by Greenwich Associates, 57% of institutional investors utilize multi-factor ETFs, with Goldman Sachs Asset Management offerings among the most popular. Additionally, about 48% said they could increase holdings in the near future.
For more information on multi-factor strategies, visit our smart beta category.