Advisors Can Use Multifactor ETFs to Reduce Volatility

While cap-weighted ETFs can introduce unintended risks to portfolios, multifactor ETFs can help reduce exposure to certain risks.

Many investors look to top-heavy, growth-oriented indexes such as the S&P 500 to get exposure to the U.S. market. Investing in the broader market seems like it should offer balanced exposure; however, it may actually introduce unintended risks.

Volatility risk is a primary concern when allocating to cap-weighted ETFs. Behavioral and capital growth challenges are introduced when funds do not consider the volatility of individual securities when constructing the portfolio.

For investors who want exposure to U.S. large-cap equities but want to reduce volatility, multifactor ETFs may be the solution. Multifactor ETFs seek to target desired return-enhancing factors and reduce exposure to unrewarded risk exposures, including volatility.

See more: “2 Things Investors Get Wrong About Multifactor ETFs

Investors looking to take smarter risks can use a defensive value ETF such as the Hartford Multifactor US Equity ETF (ROUS). ROUS seeks to provide more balanced exposure to U.S. large caps while also dampening volatility.

The defensive value ETF seeks to outperform traditional cap-weighted indexes and reduce volatility by 15% over a full market cycle.

ROUS reduces concentration at the sector, market cap, and individual holding levels, enhancing diversification and limiting concentration risk. The fund limits a single stock’s weight to 1.5% of the portfolio, giving ROUS a very different portfolio composition than its passive U.S. large-cap value peers. 

Many advisors are increasing allocations to value as the current economic environment remains uncertain.

See more: “Advisors Plan to Allocate More to Value Stocks, Survey Shows 

In a recent poll of advisors, 45% of respondents said they planned on increasing their allocation to value, according to Why Valuation Matters in Today’s Market (Date: July 20, 2023. Sample size: 330 attendees, 30% RIAs).

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