Consider Multifactor ETF Strategies in These Volatile Market Conditions

As volatility ravaged markets, exchange traded fund investors should take the time to reevaluate their portfolios and may be considered disciplined factor-based strategies to better engage with markets during this more volatile period.

In the recent webcast, Discipline in a Crisis: How to Invest and Trade ETFs in Volatile Markets, Joseph Hohn, Senior Portfolio Manager, Dimensional Fund Advisors, argued that investors could gain better market exposure through a rules-based approach through improved index design, such as a factor-based or smart beta ETF strategy.

To help investors better access these factor strategies to enhance returns and diminish downside risks, John Hancock Investments has partnered with Dimensional Fund Advisors to launch several factor-based ETF strategies. Hohn outlined four major factors that help drive expected returns for their smart beta strategies, including the equity premium, small-cap premium, value premium, and profitability premium.

Specifically, the market equity premium reflects the outperformance of stocks over bonds. The small-cap premium corresponds to the outperformance of small-caps over large-caps. The value premium relates to value stocks over growth stocks. Lastly, the profitability premium shows that highly profitable companies tend to do better than less profitable companies.

Hohn also highlighted a study conducted by the University of Chicago Professor Eugene Fama and Dartmouth College Professor Kenneth French that found focusing on smaller stocks and those with lower relative prices may improve a portfolio’s expected return. Additionally, in a separate research paper, profitability is seen as another factor that enhances expected returns over time.

When combined, the various factors may help improve a portfolio’s risk-adjusted returns over time. Hohn explained that the Dimensional Fund Advisors’ multi-factor strategies select securities of a specific sector with a desired market capitalization range, with an increased emphasis on higher expected return securities. The securities will exhibit lower relative price, higher profitability and lower market capitalization. Moreover, securities’ weights are capped to diminish concentration.

John Hancock has come out with many smart beta ETF options that track indices developed by Dimensional Fund Advisors, including the John Hancock Multifactor Large Cap ETF (NYSEArca: JHML), John Hancock Multifactor Mid Cap ETF (NYSEArca: JHMM) and John Hancock Multifactor Small Cap ETF (NYSEArca: JHSC), along with a suite of multi-factor sector-specific ETF strategies, to help investors to overweight targeted areas of the market.

The sector-specific, smart beta ETFs include the John Hancock Multifactor Consumer Discretionary ETF (NYSEArca: JHMC), John Hancock Multifactor Financials ETF (NYSEArca: JHMF), John Hancock Multifactor Healthcare ETF (NYSEArca: JHMH), John Hancock Multifactor Technology ETF (NYSEArca: JHMT), John Hancock Multifactor Consumer Staples ETF (NYSEArca: JHMS), John Hancock Multifactor Energy ETF (NYSEArca: JHME), John Hancock Multifactor Industrials ETF (NYSEArca: JHMI), John Hancock Multifactor Materials ETF (NYSEArca: JHMA) and John Hancock Multifactor Utilities ETF (NYSEArca: JHMU).

Hohn explained that these smart beta ETFs are backed by incremental changes to improve an investor’s core exposure. For example, when comparing the John Hancock Multifactor Large Cap ETF to the benchmark Russell 1000 Index weights, JHML is underweight mega-caps and overweight large-caps and mid-caps while also market weight growth and overweight value. The goal is to create a portfolio that tilts toward higher profitability compared to the benchmark Russell 1000.

As investors and financial advisors make adjustments to their portfolios, Will Creedon, Director of ETF Capital Markets, John Hancock Investments, highlighted several useful trading practices that could produce more efficient trades. For example, Creedon warned of making trades during a market open, which have been notoriously more volatile than other periods of the day. Investors should also utilize limit orders over market orders to better manage when and where to enter an ETF position. In today’s volatile markets, it is also important to consider how the ETF is priced to a premium or discount relative to its net asset value. Additionally, for those executing large trade orders, one may leverage a block trading desk to efficiently push through a trade without negatively affecting the market price.

Financial advisors who are interested in learning more about investment strategies for a volatile market can watch the webcast here on demand.