Look to Multi-Factor, Smart Beta ETFs to Enhance Your Core Portfolio

In today’s market environment, exchange traded fund investors should consider exposure to rewarded factors while aiming to maintain a controlled level of active risk relative to the market cap benchmark.

In the recent webcast, Blending Quality, Value, Momentum, Size and Minimum Volatility, Robert Hum, Director, US Head of Factor ETFs, iShares by BlackRock; Doug Walters, Chief Investment Officer, Strategic Financial Services; and Arun Singhal, Managing Director, Index Product Management, Qontigo, argued that the investment premium historically offered by market factors such as quality, value, momentum, size, and minimum volatility, has helped investors diversify their traditional equity portfolio allocations. However, these individual factors have also exhibited cyclical trends of their own. Investors can utilize multiple-factor strategies to combine these various stock characteristics to diversify and serve as a core of their investment portfolio.

The strategists explained that targeted factors, like value, quality, momentum, low volatility, and low size, have offered historically rewarding investment results based on traditional and innovative insights. Specifically, value helps investors buy low and sell high. Quality offers profitability and stability. Momentum focuses on winners and avoids losers. Low volatility seeks safety. Lastly, low size focuses on smaller, nimbler companies.

These factors are defined by metrics based on traditional and innovative insights. For example, value is based on book to price, cash flow yield, earnings Yield, times series cash flow yield, and dividend yield. Quality is based on accruals, dilution, gross profitability, change in net operating assets, carbon emissions intensity, and science-based targets. Momentum is based on earnings announcement drift, earnings momentum, and price momentum. Low volatility is based on standard deviation. Finally, low size is based on the market capitalization.

As a way for investors to access these various market factors, BlackRock’s iShares offers a suite of multi-factor ETF strategies, including the iShares US Equity Factor ETF (LRGF), the iShares International Equity Factor ETF (INTF), the iShares MSCI USA Small-Cap Multifactor ETF (SMLF) and the iShares MSCI Emerging Markets Multifactor ETF (EMGF).

The strategists also noted that these ETFs are among the cheapest multi-factor offerings available on the ETF market, with LRG coming with a 0.08% expense ratio, compared to the average 0.42% for the ETF industry and an average 0.87% for the mutual fund industry. Among the foreign large-cap blend morningstar category, INTF has a 0.15% expense ratio, compared to the average 0.34% for the ETF industry and 1.0% for the mutual fund industry.

The STOXX US Equity Factor Index, which acts as the underlying benchmark for LRGF, has also historically outperformed the S&P 500 Index. Looking at the previous 3 year average annualized rolling excess return compared to the S&P 500, the STOXX US Equity Factor Index has outperformed 88% of the time.

The strategists also highlighted the importance of a diversified multi-factor index ETF approach, compared to more focused single-factor strategies. For instance, while the momentum factor may have been the best performing factor and returned 15.3% in 2020, the same momentum factor was the worst performer and returned -15.1% in 2021. On average, the US Equity Factor Indexes generated an average annual excess return of +1.24% compared to the S&P 500 since 2005.

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