A Dynamic ETF Strategy that Adopts Factor Tilts on Prevailing Market Trends | ETF Trends

Investors can consider a dynamic factor-based exchange traded fund strategy to alternate between S&P 500 investment factors in response to market changes.

In the recent webcast, Take Advantage of Market Rotation by Using a High Beta and Low Volatility Rotation Strategy, Matt Digges, divisional manager at Pacer ETFs; and John Lunt, president of Lunt Capital Management, highlighted a rotation strategy that can move with the market and help investors maximize gains over time.

Public instruments have characteristics and attributes that can be calculated and tracked. Specifically, these factors include identifiable characteristics like momentum, quality, value, and low volatility. Factors describe the behavior or reflect the fundamentals of an investment. Factor investing involves tilting portfolios toward or away from specific factors in an attempt to generate outperformance.

To help investors better adapt as market conditions change, Lunt Capital has expanded the factor opportunity set to include both traditional and non-traditional factor groups, embracing a rules-based, objective, and tactical strategy to rotate between factors moving in and out of favor.

Looking at the Pacer Lunt Large Cap Alternator ETF (ALTL), the strategy aims to rotate between high-beta and low-volatility stocks listed in the S&P 500 Index based on a relative strength signal.

The high-beta index is an index comprised of stocks that are most sensitive to changes in market returns. High-beta stocks tend to be market leaders during the most positive times for the market.

The low volatility index is an index comprised of stocks that exhibit lower price volatility than the overall market average. According to academic research, low-volatility stocks have historically generated better risk-adjusted returns over time.

Both Low Volatility and High Beta Factors exhibit periods of outperformance. The Lunt Capital U.S. Large Cap Equity rotation Index is innovative because it uses a rules-based strategy to alternate between the High beta and Low Volatility factors.

Additionally, the Pacer Lunt Large Cap Multi-Factor Alternator ETF (PALC) and the Pacer Lunt MidCap Multi-Factor Alternator ETF (PAMC) are passively managed funds that rotate amongst value, quality, volatility, and momentum stocks within the S&P 500 Index and S&P MidCap 400 Index, respectively.

Lunt explained that traditional factors include standard-side factors like high momentum, high quality, high value, and low volatility. Additionally, he highlighted non-traditional or opposite-side factors like low momentum, low quality, low value, and increased volatility.

The Lunt Indexes are unique because they look at traditional and non-traditional ways of evaluating factors. Using their rules-based strategy, investors can take advantage of factors that are in favor and avoid factors that are out of favor. Research shows the opposite side of each factor has periods of outperformance. Historically, factors have outperformed the S&P 500 Index long-term but moved in and out of favor in the short term. Between 2011 and 2021, factor-based large cap indices outperformed the S&P 500 Index every year for the past 11 years. Consequently, there are opportunities for outperformance through Factor Rotation when including the opposite side of each factor.

The Pacer Lunt Large Cap Multi-Factor Alternator ETF starts out by differentiating a segment universe by factors. The methodology then evaluates and ranks factor pairs by traditional and non-traditional means. The whole process is re-evaluated on a monthly basis.

“Our strategies ‘look’ very different from their respective benchmarks. If we look the same as the benchmark, we will perform the same. The potential for outperformance comes from being intentionally different,” Lung said.

“Our strategies do not consider sectors when making allocations. Instead, they evaluate the factors stocks exhibit and select the desired factors based on their strength of trend. Our dynamic approach to factor investing is unconstrained by traditional sector weights or prescribed sector ranges.”

Financial advisors who are interested in learning more about a market rotation strategy can watch the webcast here on demand.