Factor-based investing has grown in popularity in the investment world, especially with the expansion of the smart beta ETF space.
On the upcoming webcast (available live and on demand for CE Credit), Smart Investing is More than Factors, Brandon Rakszawski, Product Manager for VanEck, and Dan Lefkovitz, Content Strategist, Indexes at Morningstar, will explore how we got here, where we may go, and dive into a smart investing approach that may stand out from factors and other smart beta approaches.
The so-called smart beta, enhanced, strategic beta, alternative or factor-based index ETFs all follow a similar theme where the underlying indices eschew conventional market capitalization-weighted methodologies for customized or rules-based allocations, tracking a range of strategies from equally weighting stocks to identifying momentum across different corners of the market, among many others. What ties the theme together is the ability to add exposure to specific factors found in traditionally active managed funds.
There are now hundreds of smart beta or factor-based strategies available, ranging from minor tweaks on existing broad-based indices to more customized options that capture returns from specific styles or asset categories.
Last year, single- and multi-factor ETFs saw over $8 billion in net inflows globally, according to Pensions & Investments. Total assets in these types of funds reached almost $560 billion globally by the end of February 2017, with $500 billion in the U.S. alone, according to ETFGI data.
It isn’t just the mom and pop investor looking for smart beta ETFs. The strategies are finding their way into more institutional portfolios. About 65% of U.S. pension funds, including corporate pensions, public pensions, foundations and endowments surveyed by Greenwich Associates are buying and holding ETFs for two years or longer. Looking overseas, European institutions are exhibiting an increasing appetite for factor-based ETFs.
With traditional cap-weighted stock indices pushing toward record highs, more investors are concerned about potential corrections or volatility that could shake up their portfolios. Consequently, more are turning to these smart beta ETFs as a way to potentially generate improved risk-adjusted returns.
For instance, the VanEck Vectors Morningstar Wide Moat ETF (NYSEArca: MOAT), which implements Morningstar’s economic moat rating to identify strong companies with wide economic moats, and can help investors achieve improved long-term, risk-adjusted return by focusing on quality companies that help limit downside risk while still participating in potential gins. From late 2002 through the end of the second quarter, the strategy has delivered an average 4.7 percentage points of annual outperformance relative to the benchmark Morningstar U.S. Market Index.
According to Morningstar’s indexing methodology, there are five sources of economic moats: Intangible assets that include brand recognition to charge premium prices. Switching costs that make it too expensive to stop using a company’s products. Network effect that occurs when the value of a company’s service increases as more use the service. A cost advantage helps companies undercut competitors on pricing while earning similar margins. Lastly, efficient scale associated with a competitive advantage in a niche market.
Financial advisors who are interested in learning more about factor-based investments can register for the Tuesday, September 12 webcast here.