How can equity investors address the triple threat of a low return environment, scarcity of alpha and the tendency to chase performance? All of these challenges have many investors evolving their approach, utilizing smart beta exchange traded fund strategies as an alternative to traditional active and passive. While this creates opportunity, the disparate array of smart beta, and factor-based products, can create confusion and risk for investors.
On the upcoming webcast, Valuations Matter: The Time for Multi-Factor is Now, Rob Arnott, Chairman and CEO of Research Affiliates, and Andy Pyne, Equity Strategies for PIMCO, will discuss smart beta strategies that follow Research Affiliates’ fundamental indexing methodology. These innovative strategies combine diversified exposure to multiple equity factors with a thoughtful dynamic weighting process that aims to improve excess return potential.
Specifically, the PIMCO RAFI Dynamic Multi-Factor U.S. Equity ETF (NYSEArca: MFUS), PIMCO RAFI Dynamic Multi-Factor International Equity ETF (NYSEArca: MFDX) and PIMCO RAFI Dynamic Multi-Factor Emerging Markets Equity ETF (NYSEArca: MFEM) will incorporate Research Affiliates Fundamental Indexing methodology that screens for five equity factors, including value, quality, low volatility, momentum and size.
Research Affiliates Fundamental Index, like its name implies, is known for its fundamental indexing methodology. The RAFI Dynamic Multi-Factor ETFs will try to underweight the factors that are expensive compared to historical norms and emphasize those that are undervalued, which could create a buy-low, sell-high rules-based discipline.
The new PIMCO RAFI ETFs also implement fundamental indexing, which weights stocks by economic size, rather than by market capitalization, skewing holdings toward components already trading at high valuations.
Securities are then determined by selecting companies based on fundamental weight, calculated using four accounting measures from company financial statements: de-levered sales, calculated as company sales averaged over the past five years multiplied by the ratio of average equity to average assets; cash flow, taken as the company operating cash flow averaged over the past five years; dividend plus buybacks, calculated using the average dividends paid and share buybacks over the past five years; and book value, taken as the most recent company book value.
Related: PIMCO, Research Affiliates Partner to Launch Smart Beta ETFs
Furthermore, the dynamic aspect starts with an equal weighting to each factor plus an additional weight based on a calculation of a factor’s standard momentum and long-term reversal signal relative to other factors. The additional weights to a specific factor are capped at a max of 15% and a minimum of -15% relative to the equal weights.
The methodology also creates factor portfolios focused on an individual factor other than momentum. These factor based sugroups are reconstituted in four so-called tranches with each tranche reconstituted in each quarter. The staggered rebalancing is intended to diversify risk.
Financial advisors who are interested in learning more about multi-factor, smart beta strategies can register for the Tuesday, October 31 webcast here.