Finding the Right Factor ETF for Your Portfolio

Objective seeking – those with a bias towards value, momentum, or low volatility may opt to select a factor ETF that directly targets this goal. The ETF provides instant diversification and the capability to evolve over time within the confines of its index constraints. This may be preferable to continually evaluating individual companies to ensure they are meeting similar criteria.

Sector tilts – Most factor ETFs are going to be inherently overweight certain sectors that are demonstrating characteristics that meet the screening standards. Identifying funds with an emphasis on sector allocations may provide investors with greater flexibility in shaping their portfolio exposure to those intended areas without straying significantly from a multi-sector benchmark.

Market rotation – active investors may implement factor ETFs through varying market cycles or as a risk management target. Some may choose to own higher risk objectives such as momentum or size during the expansion stage of a bull market. Conversely, a switch to quality or low volatility may be preferable during periods of cyclical weakness.

Investors should also consider there are many similar factor index ETFs from other high-profile issuers such as Vanguard, Fidelity, PowerShares, and State Street. Each has their own unique spin on these flavors based on the specifications of the underlying index as well as the pool of stocks that they are selecting from. Some funds also weight their holdings according to the highest scores within the pool rather than simply following the old market capitalization scheme.

The Bottom Line

The decision to use factors ETFs provides an efficient, transparent, and diversified method of stock exposure that many investors may find to be more attractive than a plain vanilla benchmark. The caveat with these funds is that they will experience periods of outperformance and underperformance versus similar total market ETFs. Additionally, it should be noted that the underlying holdings in these ETFs will incrementally shift over time as new stocks meet the rigid screening criteria and others fall out of favor.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article has been republished with permission from FMD Capital.