Credit: Shutterstock photoFactor investing has become an increasingly sought-after method for investors to enhance a diversified portfolio. The truth is, that until recently, it was difficult to accurately identify and purchase a subset of stocks based on characteristics such as volatility, momentum, size, and quality. Those traits were wholly subjective to a fund managers’ interpretation rather than given the objective data-driven solutions they deserve.
Fortunately, the proliferation of exchange-traded funds over the last half decade have solved this issue and have proven to be one of the hottest trends in investment allocation methods. One of the more well-known suites of factor ETFs are the following series developed by BlackRock:
- iShares Edge MSCI USA Value Factor ETF (VLUE)
- iShares Edge MSCI USA Quality Factor ETF (QUAL)
- iShares Edge MSCI USA Momentum Factor ETF (MTUM)
- iShares Edge MSCI USA Min Vol ETF (USMV)
- iShares Edge MSCI USA Size Factor ETF (SIZE)
Each of these funds offers a unique mix of between 125 - 200 large and midcap stocks culled from the U.S. markets based individual factor tilts. The one outlier being, SIZE, which has over 600 holdings of smaller capitalization stocks relative to its mega-cap slanted peers.
The weighting of the holdings in the iShares products is distributed according to market-capitalization criteria similar to popular domestic benchmarks such as the S&P 500 Index. This makes them suitable to be paired with more diversified total market funds to shape specific risk or objective qualifications.
One of the more attractive qualities of these smart beta indexes are their extremely low costs. All of these ETFs sport embedded expense ratios of 0.15%, making them quite efficient and affordable to own. This is likely why billions of dollars have migrated from high fee mutual funds to these streamlined ETFs.
The following table shows the performance of these iShares factor ETFs over the last one and three years versus the iShares S&P 500 ETF (IVV).
Investors have the capability to use these tools in several distinct ways:
- Objective seeking – those with a bias towards value, momentum, or low volatility may opt to select a factor ETF that directly targets this goal. The ETF provides instant diversification and the capability to evolve over time within the confines of its index constraints. This may be preferable to continually evaluating individual companies to ensure they are meeting similar criteria.
- Sector tilts – Most factor ETFs are going to be inherently overweight certain sectors that are demonstrating characteristics that meet the screening standards. Identifying funds with an emphasis on sector allocations may provide investors with greater flexibility in shaping their portfolio exposure to those intended areas without straying significantly from a multi-sector benchmark.
- Market rotation – active investors may implement factor ETFs through varying market cycles or as a risk management target. Some may choose to own higher risk objectives such as momentum or size during the expansion stage of a bull market. Conversely, a switch to quality or low volatility may be preferable during periods of cyclical weakness.
Investors should also consider there are many similar factor index ETFs from other high-profile issuers such as Vanguard, Fidelity, PowerShares, and State Street. Each has their own unique spin on these flavors based on the specifications of the underlying index as well as the pool of stocks that they are selecting from. Some funds also weight their holdings according to the highest scores within the pool rather than simply following the old market capitalization scheme.
The Bottom Line
The decision to use factors ETFs provides an efficient, transparent, and diversified method of stock exposure that many investors may find to be more attractive than a plain vanilla benchmark. The caveat with these funds is that they will experience periods of outperformance and underperformance versus similar total market ETFs. Additionally, it should be noted that the underlying holdings in these ETFs will incrementally shift over time as new stocks meet the rigid screening criteria and others fall out of favor.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
