Investors who are interested in diversifying their portfolios may consider ETFs tracking factors that rev up returns and potentially position their portfolio for the win.
On the recent webcast (available On Demand for CE Credit), Step Up Your Portfolio With Powerful Multi-Factor Strategies, Marc Chaikin, Founder and CEO of Chaikin Analytics, warned of the increased volatility markets are experiencing as the uptrend on auto-pilot in 2017 quickly turned into a roller coaster correction in 2018.
Given the heightened market volatility, it may be prudent to incorporate a smart beta or factor-based investment strategy that implements academically proven strategies in a efficient and easy-to-use ETF wrapper. A factor can be thought of as any characteristic relating to a group of securities that can help explain their risk and return. Some of the most common factors that have been identified historically are size, value, quality, momentum, and volatility.
Salvatore Bruno, Chief Investment Officer and Managing Director of IndexIQ, pointed out that there is an increasing number of investors and advisors adopting smart beta ETFs. On average, 60% of advisors view smart beta as fitting best with domestic U.S. equities, with most using smart beta to provide alpha, improve diversification, manage volatility, provide exposure to specific strategies or as a good fit with value proposition. More than 8 out of 10 advisors now report being familiar with smart beta approaches.
Multi-Factor Strategies to Create a Diversified Solution
However, the single-factor approach may come with their own limitations. Bruno argued that single factors have been highly cyclical from year-to-year. On the other hand, investors may look to combined multi-factor strategies to create a more diversified solution and potentially enhance returns over time. Additionally, most factor returns are generally not highly correlated, which combining them a great way to diversify a portfolio.
For instance, the momentum factor was the best performing single factor of 2017, but it was also the worst performing single factor of 2016. On the other hand, the size factor was the worst performing factor of 2017 but it was also the best performing factor of 2016.
“While factor performance has historically been cyclical, most factor returns generally are not highly correlated with one another, so investors can benefit from diversification by combining multiple factor exposures,” Bruno said.
Investors can look to the Chaikin Power Gauge, a multi-factor stock selection tool that may help create a more diversified solution to potentially enhance returns over time. ETF investors may gain exposure to a diversified multi-factor approach through the IQ Chaikin U.S. Small Cap ETF (NasdaqGM: CSML) and the large-cap version tracking the same smart beta Chaikin Power Gauge strategy, the IQ Chaikin U.S. Large Cap ETF (NasdaqGM: CLRG).