Should you go all-in with value funds, momentum-driven stocks, or stick to large caps and low volatility? There’s fund products for all of these individual factors. Some will outperform, others will not. But what about putting all four of those factors into one fund?
“For a lot of investors in a performance driven world it can be difficult no matter how much conviction you have on a particular strategy, because when you get into ten, eleven, twelve years of under performance it gets really hard to stick to these strategies,” says Justin Sibears, a fund manager with Newfound Research. Sibears was talking about what he identifies as the four most relevant factors in investing: value, momentum, size and low volatility. He was speaking with Jay Jacobs, research director for ETF provider Global X in an online webcast titled Exploring Multi-factor Strategies on Wednesday.
Sibears says investors can try timing those key factors, or they can invest in a basket of them in a multi-factor approach and let it ride.
The average correlation of the four factors is close to zero, so there is more benefit from diversification when you include those four strategies in a portfolio.
Based on a survey of investment advisors, 33% said they were currently vetting multi-factor ETF funds and 27.3% said they were currently invested in single factor ETFs. When asked “How would you consider using multi-factor ETFs in a portfolio?” the majority (39.4%) said they use it as a satellite position. The second place finisher was to use it a core replacement for cap-weighted index funds, with 20.5% saying so.
“I view it as a core position, because I think we are in for pretty disappointing equity returns,” Sibears says. “We are buying these because we believe they will outperform the market by a couple of basis points. Why would you think about these products in the first place? Because if you’re worried about equity returning 4% or 5% and you need another two or three percent on top of that in terms of performance, then a satellite is not enough to really capture those gains. If you have a 10% satellite holding, you’re talking about a small, unsubstantial upside. These are not strategies that are going to outperform by 10% or more, especially over a longer time horizon. For me if you really want to get the bang for the buck, a multi-factor fund needs to be a core holding.”
Some academics say there are just too many factors, like 314 to be exact. That’s way too many variables that can lead to false positives. This is why Global X sticks to those four factors above.
Investment managers tending to the portfolios of wealthy clients need to have good economic rational for why the factor works, if they are going to construct a fund on their own. If they are going product shopping, they need to know that the fund managers behind those products have an explicable and transparent reason for picking the factors they’re picking. No one is served by black box investing, where there is no clear understanding for what constitutes a momentum stock for example.
If there is no narrative for why that factor works, then there is no reason to keep assuming it will work in the future.
Value, Momentum, Size and Low Volatility seem to be the four that work broadly and consistently across the world and even outside the equity framework. Momentum and value have worked in other markets too, like currencies and real estate. The low volatility factor comes into play with risk-parity investment strategies.
“For us, seeing the factor working in multiple markets made us feel like we were onto something,” says Sibears.
Global X’s Jacobs likes lumping the four factors into one.
He noted a Goldman Sachs report showing that in the more core multi-factor products, a mixed approach does better from a risk adjusted return perspective, probably thanks to diversification.
Global X has four multi-factor ETFs designed to be core holdings. From their tickers, you have SCIU Unfortunately, we could not get stock quote SCIU this time. up 5.45% year to date, SCID Unfortunately, we could not get stock quote SCID this time. up 4.29%, SCIX Unfortunately, we could not get stock quote SCIX this time. up 9.06% and SCIJ Unfortunately, we could not get stock quote SCIJ this time. up 3.92%.
There is also the iShares Russell 1000 Value Index (Unfortunately, we could not get stock quote IWD this time.), which is a single-factor fund — in this case one based on low valuation. That ETF is up 4.03% YTD and 69.9% over the last five years. The S&P 500 beat it in both periods.
There are also multi-factor mutual funds. Randomly picking two here: the PNC Multi-Factor Small Cap (Unfortunately, we could not get stock quote PLWAX this time.) is up 2.77% YTD and 79.6% over the last five years. That got beat this year by the Vanguard Small-Cap Index Fund (Unfortunately, we could not get stock quote VB this time.), up +4.78% YTD, but then it outperformed over five years by around seven basis points.
Gerstein Fisher’s Multi-Factor International Growth (Unfortunately, we could not get stock quote GFIGX this time.) fund is up 5.62% this year and 25.46% over the last five years. By comparison, the iShares MSCI World (Unfortunately, we could not get stock quote XWD this time.) traded in Toronto is up 3.72% YTD and 87.83% over the last five years.
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