Traditionally, multi-factor ETFs offer investors exposure to three or four investment factors. The WisdomTree U.S. Multifactor Fund (Cboe: USMF) eschews that approach to focus on the quality and value factors.
USMF tries to reflect the performance of the WisdomTree U.S. Multifactor Index, which is generally comprised of 200 U.S. companies screened for fundamental factors value and quality, along with technical factors momentum and correlation. The WisdomTree fund is up an impressive 20% year-to-date and could be poised to deliver more upside heading into 2020 and beyond.
What’s unique about USMF is its distinct approach to finding value, one of the investment factors the fund focuses on.
“There are several reasons for certain sectors to be structurally value sectors,” said WisdomTree in a recent note. “The most common justification for cyclicals like Financials, Energy and Materials to trade at lower multiples is that their earnings are closely tied to the business cycle, which increases operating risks. This rationale supports the argument that value stocks outperform because of an associated risk premium, and fits in nicely with the efficient market hypothesis.”
Value investing is a popular long-term investment strategy. Value stocks have historically outperformed growth stocks, or companies with high earnings expectations, in almost every market over the long-haul, but that has not been the case for more than a decade.
“The WisdomTree U.S. Multifactor Index (WTUSMF) uses value as one of four factors (value, quality, momentum and low correlation) being directly targeted in its basket of roughly 200 stocks,” according to WisdomTree. “The value factor is composed of six ratios, with each company in the universe given a value score relative to its industry. This is done to avoid some of the potential pitfalls of relying on a single measure of value.”
Value stocks usually trade at lower prices relative to fundamental measures of value, like earnings and the book value of assets. On the other hand, growth-oriented stocks tend to run at higher valuations since investors expect the rapid growth in those company measures, but more are growing wary of high valuations. However, USMF eschews the traditional value approach and features some sector-level surprises as a result.
“Additionally, as part of the weighting process, the sector weights of the index are scaled to be sector neutral relative to the broader U.S. large-cap equity universe,” said WisdomTree. “As a result, Information Technology is the largest sector weight at 21%. In our view, this process produces an Index that has good representation across sectors, and which relies on stock selection as the driver of alpha instead of on sector tilts.”
For more on smart beta ETFs, visit our Smart Beta Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.