“We believe this is important because factors are the lowest possible common denominator that drives risk and returns in portfolios – not regional, country, or sector decisions,” Smith said.
Many investors may take on a more diversified approach and include a multi-factor strategy as opposed to singling out any specific factor tilt for their portfolios. Haghbin pointed out that given the cyclicality of single factor performance, some factors may outperform in one year and underperform in another. For example, the quality factor was the best performing factor of 2017 but was among the worst performing factors in 2016. In contrast, the value factor was the best performing factor of 2016, but was at the end of the pack in 2017. Many of these factors show low or even negative correlations to one another, so a multi-factor approach could greatly diversify a factor-based investment strategy.
“Combining 2-3 factors, dependent upon the stage in which we are in the economic cycle allows more control than the binary growth/value decision,” Ellston said. “As an example, given our current outlook of moderate expansion, we would be favoring the Quality factor and possibly the Value or Volatility factors.”
Specifically, during the recovery period when growth is below trend for an economic cycle, size and value outperform. During an expansion phase when growth is above trend and accelerating, the size, value and momentum outperformed. During the slowdown or when growth is above trend and decelerating, the volatility and quality factors shined. Lastly, during a contraction when growth is below trend and decelerating, the momentum, volatility and quality factors stood out.
“We recognize certain factors work in certain parts of the business cycle. Still believe it is important to start with strategic allocation to all factors and to selectively tilt towards or away from certain factors based on cycle, relative valuations, factor momentum, and changes in their risk profiles,” Smith added.
Ryan O’Carroll, ETF Specialist at OppenheimerFunds, highlighted the Oppenheimer Russell 1000 Dynamic Multifactor ETF (Cboe: OMFL) and Oppenheimer Russell 2000 Dynamic Multifactor ETF (Cboe: OMFS), which are multi-factor ETFs that select companies through exposure to a subset of multiple market factors, including low volatility, momentum, quality, size and value factors.
Additionally, investors can tilt their portfolio to a specific factor through single-factor ETFs, such as the Oppenheimer Russell 1000 Value Factor ETF (OVLU), Oppenheimer Russell 1000 Size Factor ETF (OSIZ), Oppenheimer Russell 1000 Momentum Factor ETF (OMOM), Oppenheimer Russell 1000 Quality Factor ETF (OQAL), Oppenheimer Russell 1000 Low Volatility Factor ETF (OVOL) and Oppenheimer Russell 1000 Yield Factor ETF (OYLD).
Financial advisors who are interested in learning more about factor index strategies can watch the webcast here on demand.