Many investors have turned to passive index-based investments to growth their wealth, but a new breed of smart beta index-based ETFs may also help investors achieve targeted outcomes.
“Passive investing is still an important part of asset allocation but investors may look for different risk return profiles, and factor investing can help achieve different outcomes. For example, an investor may be looking for a more diversified portfolio, or to protect downside risk, and combining single factors can achieve those objectives,” Marlies van Boven, Managing Director of Research and Analytics at FTSE Russell, told Pensions Age and European Pensions.
Van Boven explained that by combining different factors, investors have exposure to the different sensitivities to the economic cycle, attaining different risk return profiles. For instance, an investor who wants a more defensive position could combine low volatility with quality, which could help diminish downside risks, but this type of strategy will also not capture the full upside potential. The objective would then be wealth preservation instead of growing wealth.
Furthermore, if an investor is looking for a more diversified approach, one could combine all the factors instead of betting on a single approach. An investor would combine value, size, momentum, quality and low volatility. This would result in a portfolio that does well both up and down markets due to the diversified properties.
“Investors can choose from two different methodologies, a top-down approach where you combine single factor indices into a multi-factor index. Or a bottom-up approach, which is an integrated approach where you combine the factors at the stock level,” van Boven added.
For example, single factor products offer precise exposure to well-established and time-tested investment styles including value, momentum, quality, size, yield and low volatility.
Something like the Oppenheimer Russell 1000 Value Factor ETF (OVLU) plays on the theme of stocks that appear cheap tend to perform better than stocks that appear expensive.