On the recent webcast (available On Demand for CE Credit), Dynamic Approaches to Factor Investing, David Mazza, Head of ETF Investment Strategy and Beta Solutions at OppenheimerFunds, explained that smart beta is supported by factor investing where they exhibit both actively managed and passive index-based investment styles.
“Smart beta is a transparent, rules-based investment approach that sits at the intersection of actively managed and traditional passive portfolios,” Mazza said.
Investors have jumped on the smart beta investment train for a number of reasons, including risk reduction, return enhancement, improved diversification, cost savings, specific factor exposure and income generation. Looking back, some of these factor-based or smart beta strategies have been adopted by many investors over the years. Academic support and existence of factor investing has been prevalent for over half a century, Mazza said.
“With the emergence of Smart Beta, the old separation of alpha and beta has been transformed to include factor betas,” Mo Haghbin, Head of Product and Beta Solutions for OppenheimerFunds, said.
When picking out a factor, Haghbin argued that investors should consider the characteristics that define a “rewarded factor,” or academically proven characteristics that help explain a security’s risk and performance. Specifically, a rewarded factor needs to hold over long time periods, hold across sectors, hold for various definitions, provide logical explanations for its premiums and show results after implementation.
Haghbin focused on six factors that meet the rewarded factor criteria, including value, quality, size, low-volatility, momentum and yield.
Value refers to stocks that appear cheap tend to outperform expensive stocks. The factor is based on cash flow yield, earnings yield and price-to-sales ratio.
Quality refers to higher quality companies outperforming lower-quality companies. The factor is based on profitability, efficiency, earnings quality and leverage.
Size refers to smaller companies outperforming larger company stocks. The factor is screened by full market capitalization.
Low volatility refers to stocks that exhibit low volatility tend to outperform higher volatility stocks. The factor is selected by standard deviation of five years of total returns.
Momentum refers to stocks that rise or fall in price tend to continue rising or falling in price. The factor screens for cumulative 11-month return.
Lastly, yield refers to higher yielding stocks tend to outperform low-dividend-paying stocks. The factor is based off 12-month trailing dividend yield.
Investors can gain targeted exposure to these factors through single factor, smart beta ETFs, such as Oppenheimer Russell 1000 Momentum Factor ETF (Cboe: OMOM), Oppenheimer Russell 1000 Quality Factor ETF (Cboe: OQAL), Oppenheimer Russell 1000 Size Factor ETF (Cboe: OSIZ), Oppenheimer Russell 1000 Value Factor ETF (Cboe: OVLU), Oppenheimer Russell 1000 Low Volatility Factor ETF (Cboe: OVOL) and Oppenheimer Russell 1000 Yield Factor ETF (Cboe: OYLD).
“Of these six factors, each has a history of delivering long-term excess returns, both on a cumulative basis and from a risk-reward perspective,” Rolf Agather, Managing Director of North America Research at FTSE Russell, said.
“Investors have come to understand that a multi-factor approach can provide additional diversification benefits because the security selection process seeks to identify stocks that are favorable on multiple characteristics,” Agather said. “A multi-factor approach combines several factors in one portfolio in an effort to improve client outcomes.”
Investors who want a more diversified approach may consider a portfolio that combines the various academically proven factors into a single investment strategy, such as Oppenheimer Russell 1000 Dynamic Multifactor ETF (Cboe: OMFL) and Oppenheimer Russell 2000 Dynamic Multifactor ETF (Cboe: OMFS). The multi-factor OMFL selects companies in the Russell 1000 Index through exposure to a subset of the low volatility, momentum, quality, size and value factors. OMFS provides access to companies in the Russell 2000 Index through exposure to the same factors.
Financial advisors who are interested in learning more about a multi-factor approach can watch the webcast here on demand.