Combining smaller stocks with the momentum factor can be a winning strategy when the strategy is properly executed. The Principal U.S. Small-Cap Multi-Factor Index ETF (NASDAQ: PSC) does just that.
PSC’s underlying benchmark, the Nasdaq US Small Cap Select Leaders Index, “uses a quantitative model designed to identify equity securities (including growth and value stock) of small-capitalization companies in the Nasdaq US Small Cap Index (the ‘parent index’) that exhibit potential for high degrees of sustainable shareholder yield, pricing power, and strong momentum while adjusting for liquidity and quality,” according to Principal.
Momentum has been a popular factor as equities are gaining steam behind a post-pandemic rally. With the help of federal governments and central banks, equities have been riding a nice wave of momentum.
“In the short term, there tends to be a continuation of the trends,” said Morningstar analyst Alex Bryan in a recent note. “So it’s really important to have the right time frame in mind. And if you’re going to do this, it’s best to invest in a strategy that does it for you, so you don’t have to worry about maybe messing up the implementation.”
Taking the Edge Off
Momentum investing is rooted in the notion that securities that are on torrid paces will continue acting that way over the near-term while laggards will continue slumping. Long-term data for the momentum factor are compelling, but the factor can be volatile. PSC mitigates some of that turbulence by introducing shareholder yield to the equation, a strategy that adds a dash of quality to the portfolio.
“These strategies require very high turnover, which can be expensive for the funds that are actually trading these stocks. It can also lead to poor tax efficiency. So those are the most notable problems,” notes Bryan.
For its part, PSC is reasonably priced at 0.38% per year or $38 on a $10,000 investment, and there isn’t a significant amount of churn among the fund’s 474 holdings.
Momentum investing can target those companies that are exhibiting high levels of growth. The momentum factor selects company stocks that have recently outperformed based on the idea that “the trend is your friend” and that stock market leaders typically continue to outperform. While momentum strategies are sector agnostic, these funds are often light on defensive sectors. PSC allocates about half its combined weight to healthcare, industrial, and consumer cyclical names.
For more on multi-factor strategies, visit our Multi-Factor Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.