A Solid Starting Point for Multi-Factor Implementation | ETF Trends

Advisors looking for a straight forward approach to deploying multi-factor strategies in client portfolios should consider cornerstone ETFs, including the Principal U.S. Mega-Cap Multi-Factor Index ETF (NasdaqGM: USMC).

USMC, which tries to reflect the performance of the Nasdaq US Mega Cap Select Leaders Index, is comprised of companies with the largest market capitalization taken from the Nasdaq U.S. 500 Large Cap Index and screened based on a quantitative model. The fund implements a multi-factor indexing methodology during its selection process.

The $1.68 billion USMC is increasingly relevant at a time when many advisors are considering smart beta alternatives.

“Investors are increasingly adopting an alternative weighted indexing approach to traditional capital weighting. Factor Investing, a.k.a. Smart Beta based strategies, are growing at a tremendous pace and have won investors’ hearts,” writes Richard Lin of Nasdaq Global Information Services.

Under the USMC Hood

Compared to the S&P 500 Index, the Nasdaq U.S. 500 Large Cap Index exhibits a higher overweight to the size and low-volatility factor, along with a smaller tilt toward momentum. The Nasdaq U.S. 500 Large Cap Index also includes a heavier overweight to consumer staples, healthcare, and communication services while underweight industrials, financials, real estate, consumer discretionary, and materials.

“The most distinguished advantage of a multi-factor heuristic weighting approach is simplicity. It does not require one to use the sophisticated optimization tool and it does not intend to bet on the outperformance of any single factor,” notes Lin. “However, this also means that the heuristic multi-factor construction approach will, a.) have higher tracking errors, b.) not be the most efficient way to generate alpha (factor active return), and c.) have the worst risk (tracking error) adjusted performance (alpha).”

Individual factors produced uneven returns during different periods or exhibited more cyclical returns. For example, quality and momentum may have outperformed in 2017, but the two factors were also the worst performers in 2016. As a result, investors may want a multi-factor approach, like USMC, as opposed to trying to time single factors. Investors, though, can still tactically over- or underweight single factors to express a market view over the short-term as well.

Historically, quality and low-volatility factors have performed well. Additionally, investors have engaged in further portfolio risk reduction. USMC is higher by 9.27% year-to-date.

For more on multi-factor strategies, visit our Multi-Factor Channel.

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.