Multi-factor ETFs, or those funds employing multiple investment factors, are a rapidly-growing corner of the broader smart beta universe.
Over the past few years, money managers and fund sponsors started to roll out rules-based, transparent index ETFs that combined some of the attributes that have historically provided active managers with outperformance, such as prominent investment factors like quality, momentum, value, low volatility and size.
“The basic idea behind a multifactor fund is that it’s not a bad idea to diversify across these different factor strategies, because although each factor strategy, like targeting stocks with low valuations, small market capitalization, high-quality, good momentum, all those things have tended to work well over the very long term, but they each go through their own cycle of outperformance and underperformance,” said Morningstar.
The iShares FactorSelect MSCI USA ETF (NYSEArca: LRGF) “focuses on four proven drivers of return: financially healthy firms, stocks that are inexpensive, smaller companies and trending stocks,” according to iShares.
History Behind LRGF ETF
LRGF, which tracks the MSCI USA Diversified Multiple-Factor Index, recently turned three years old. The ETF holds 151 stocks. Over the past three years, LRGF has trailed the S&P 500 and the Russell 1000 Index.
Still, investors looking for higher conviction ideas, may want to consider multi-factor funds in strong, uptrending markets.
“I think a multifactor fund can make sense for those who are hoping to earn a higher rate of return than the market. I think that multifactor funds, at least low-cost and well-constructed multifactor funds, can deliver that. The basic idea here is that you get an opportunity to earn higher returns while still diversifying your risk in an effective manner,” according to Morningstar.
Related: Multi-Factor ETFs to Help Better Position Your Portfolio
LRGF devotes nearly 41% of its combined weight to the technology and healthcare sectors. The fund’s three-year standard deviation of just over 10% is inline with that of the S&P 500.
LRGF “is following a bit more of a complex approach, it uses an optimization framework to basically maximize exposure to all those things while at the same time trying to match the same risk level of the parent index,” said Morningstar. “There is lot of moving parts there. But we think that this is a really good way of getting very potent exposure to factors that we think will pay off over the long term.”
LRGF charges 0.20% per year, or $20 on a $10,000 investment, putting it on the lower end of expenses for U.S. large-cap smart beta strategies.
For more information on multi-factor strategies, visit our smart beta category.