Investors who are interested in diversifying their investment portfolio should delve into the world of factor-based investment strategies and related ETFs.

On the recent webcast, Smart Beta Explained: What You Need to Know for 2019, Ryan Wellman, Product Manager at John Hancock Investments, highlighted the growing demand for smart beta or factor-based strategies, with 9.4% of surveyed financial advisors solely utilizing strategic beta strategies and 54.9% incorporating a blend of strategic beta and cap-weighted beta.

As more look to smart beta strategies, investors should understand that all these fancy appellations basically cover rules-based indexing methodologies that implement factor-based screens, such as value, quality, size, momentum and volatility, among others. Investors can also combine these individual factors into a multi-factor strategy in an attempt to further diversify risk.

“Asset management has evolved to include a variety of ways for investors to gain market exposure, from the pure beta of traditional index strategies to fully active strategies that don’t adhere to an index at all. While each approach has merit, investors should understand that the dispersion of potential returns beyond that of a traditional capitalization-weighted index increases as investors move toward single-factor and fully active approaches,” Wellman said.

Historical and academic data have shown that factor investing works over time. Factors such as size, value and quality have outperformed the broader equity market over the long haul. However, potential investors should be aware that individual factors may follow cycles of outperformance and underperformance. For example, Quality was the best performing factor in 2017 but it was also one of the worst performing factors in 2016. Consequently, Wellman argued that factor diversification through a multi-factor strategy can help produce more consistent outcomes or help smooth out the ride.

To help investors better access these factor strategies to enhance returns and diminish downside risks, John Hancock Investments has partnered up with Dimensional Fund Advisors to launch a number of factor-based ETF strategies. Joe Hohn, Portfolio Manager for Dimensional Fund Advisors, outlined four major factors that help drive expected returns for their smart beta strategies, including the equity premium, small-cap premium, value premium and profitability premium.

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