Exchange traded fund investors can consider a unique multifactor approach to constructing a diversified investment portfolio.
In the recent webcast, Cracking Open Factors: Beyond the Style Box, Brad Feeley, Managing Director, ETF Specialist, John Hancock Investment Management, explained that investors should focus on propensity and magnitude when scrutinizing an investment tool. He explained that propensity allocates to areas where more funds tend to outperform the index while magnitude allocates to areas where upside is greater.
Furthermore, investors should consider the impact of the various costs to their long-term investment portfolios. For example, Feeley highlighted the Morningstar tax cost ratio. Morningstar quantifies the impact of taxes on investor returns through the Morningstar Tax Cost Ratio, which measures how much a fund’s annualized return is reduced by the taxes investors pay on distributions – both dividend and capital gains. Looking at tax efficiency across product types, we see that the median 3-year annualized return lost to capital gain taxes for actively managed funds was 1.35%, compared to 0.65% for strategic beta funds and 0.56% for traditional passive index-based funds.
Due to this inefficiency across traditional fund products, many investors have turned to ETFs. ETFs offer a framework for active, passive, and strategic beta implementation through an efficient investment structure.
Michael Stephens, Investment Consultant, John Hancock Investment Management, explained that strategic beta may act as a bridge between traditional passive and traditional active strategies. Strategic beta provides the best of both worlds with a more reliable performance blueprint, easier ongoing due diligence and tax advantages. Strategic beta exposure can also act as a core position or a satellite holding.
Additionally, Stephens argued that a multi-factor strategic beta approach can help investors better diversify risk. Like traditional asset diversification, factor diversification can help produce more consistent outcomes. For instance, the value factor was the worst performing factor in the first half of 2020, but value was also the best performing factor of the second half of 2019. Through a multi-factor approach, investors are able to better smooth out the ride.
Looking ahead, Feeley argued that value and smaller companies may offer the best opportunities for future growth after large growth led the charge this year. Mid-caps are attractively valued, exhibiting a lower price-to-earnings ratio than small- and large-caps and offering one of the best relative values since 2008. He also believed that mid-caps stocks offer an attractive post-recession opportunity.
“We believe that mid caps offer an attractive post-recession opportunity, with the industrials sector being an important return driver in economic recoveries,” Feeley said.
Investors who are interested in strategic beta factor strategies can look to John Hancock’s suite of Multifactor ETFs that track indices developed by Dimensional Fund Advisors. They offer a number of ETFs, including the broad 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 multifactor sector-specific ETF strategies, to help investors to overweight targeted areas of the market.
Investors can home in on finer slices of the market through sector-specific, smart beta ETFs such as 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).
The smart-beta ETFs follow a rules-based selection process that is seen as a multi-factor approach, combining a number of factors in a single portfolio. Securities are adjusted by relative price and profitability. The underlying indices may overweight stocks with lower relative prices and underweight names with higher relative prices. The indices can also adjust for profitability by overweighting stocks with higher profitability and underweighting those with lower profitability.
The underlying indices also implement market-capitalization adjustments where they increase the weights of smaller companies within the eligible universe and decrease the weights of larger names. The weighting methodology helps the ETFs follow a more equal-weight tilt with greater exposure to smaller companies than traditional market-cap weighted index funds in an attempt to capture the size premium and limit risks associated with high-flying, large-cap stocks that may be overbought in an ongoing bull market rally.
Financial advisors who are interested in learning more about factor investments can watch the webcast here on demand.