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.
Specifically, the market equity premium reflects the outperformance of stocks over bonds. The small-cap premium corresponds to the outperformance of small-caps over large-caps. The value premium relates to value stocks over growth stocks. Lastly, the profitability premium shows that highly profitable companies tend to do better than less profitable companies.
Hohn also highlighted a study conducted by University of Chicago Professor Eugene Fama and Dartmouth College Professor Kenneth French found that focusing on smaller stocks and those with lower relative prices may improve a portfolio’s expected return. Additionally, in a separate research paper, profitability is seen as another factor that enhances expected returns.
When combined, the various factors may help improve a portfolios risk-adjusted returns over time. Hohn explained that the Dimensional Fund Advisors’ multi-factor strategies selects securities of a specific sector with a desired market capitalization range, with an increase emphasis on higher expected return securities. The securities will exhibit lower relative price, higher profitability and lower market capitalization. Moreover, securities’ weights are capped to diminish concentration.
John Hancock has come out with a number of smart beta ETF options that track indices developed by Dimensional Fund Advisors, including the John Hancock Multifactor Consumer Discretionary ETF (NYSEArca: JHMC), John Hancock Multifactor Financials ETF (NYSEArca: JHMF), John Hancock Multifactor Healthcare ETF (NYSEArca: JHMH), John Hancock Multifactor Technology ETF (NYSEArca: JHMT), John Hancock Multifactor Consumer Staples ETF (NYSEArca: JHMS), John Hancock Multifactor Energy ETF (NYSEArca: JHME), John Hancock Multifactor Industrials ETF (NYSEArca: JHMI), John Hancock Multifactor Materials ETF (NYSEArca: JHMA) and John Hancock Multifactor Utilities ETF (NYSEArca: JHMU). For broader exposure, investors can look to the John Hancock Multifactor Large Cap ETF (NYSEArca: JHML), John Hancock Multifactor Mid Cap ETF (NYSEArca: JHMM) and John Hancock Multifactor Small Cap ETF (NYSEArca: JHSC).
Financial advisors who are interested in learning more about smart beta investments can watch the webcast here on demand.