Over the past few years, money managers and fund sponsors started to roll out rules-based, transparent index ETFs that combined some of the attributes that have historically provided active managers with outperformance, such as prominent investment factors like quality, momentum, value, low volatility and size.
The iShares FactorSelect MSCI USA ETF (NYSEArca: LRGF) provides exposure to the quality, value, size and momentum factors.
LRGF, which is nearly five years old, has $975.6 million in assets under management and follows the MSCI USA Diversified Multiple-Factor Index. Factors emphasized in LRGF are “financially healthy firms, stocks that are inexpensive, smaller companies and trending stocks,” according to iShares.
“This index strategy astutely targets stocks with strong value, momentum, small-size, and quality characteristics, while taking comparable risk to the broad market,” said Morningstar in a recent note. “These common stock characteristics are known as factors. Although each of the four above-mentioned factors has been well-documented to produce market-beating performance, they can go through periods of underperformance. It is difficult to forecast when a particular factor may outperform, so diversifying across multiple factors can reduce the risk and magnitude of underperformance should a particular factor experience a dry spell.”
Looking and Living LRGF
Multi-factor ETFs try to deliver enhanced returns and maximize diversification in an attempt to provide potentially improved risk-adjusted returns, compared to traditional market-capitalization-weighted indices.
“The fund applies a unique integrated approach that considers the factor exposures of each holding holistically,” said Morningstar. “So, it doesn’t necessarily own the cheapest stocks, or those with the best momentum, but rather targets those with the best combination of characteristics. This leads to more potent factor tilts than combining separate factor portfolios, as constituents work together. This should improve performance while pegging the fund’s risk to that of the broad, market-cap-weighted MSCI USA Index.”
LRGF holds 157 stocks and allocates just over 27% of its weight to the technology sector. Healthcare and consumer cyclical stocks combine for 23% of the fund’s roster.
“Despite the focus on four factors, the fund lands in the large-cap value Morningstar Category, as the value tilt has dominated over momentum since the fund’s inception,” said Morningstar. “Although the fund’s value tilt is currently milder compared with the Russell 1000 Value Index, the fund typically has stronger small-size and profitability tilts compared with the Russell 1000 Value Index, which should give it an edge over the long term.”
The research lifted its rating on LRGF to Silver from Bronze.
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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.