Multi-Factor Smart Beta ETFs

A Recipe Only As Good As Its Ingredients

April 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Investors have leaned towards multi-factor over single-factor products in recent years
  • The factor selection and portfolio construction of multi-factor ETFs can be challenged
  • Multi-factor ETFs often feature factors, such as growth, which are not supported by academic research while lacking exposure to established ones such as quality and momentum

INTRODUCTION

Investors showed a strong preference for multi-factor over single-factor products in 2017 and 2018, according to FTSE Russell’s annual industry survey, especially if new to factor investing. Some 87% of these allocated to multi-factor portfolios.

This trend can partially be explained by the poor performance of the value factor over the past decade, which has historically been the favorite factor-investing strategy. Investors experienced that factor investing, also referred to as smart beta, does not necessarily imply better beta. Combining value with other factors would hopefully lead to outperformance with a higher consistency.

However, a similar survey by EDHEC indicated that investors demand further development of multi-factor products, indicating either a lack of instruments or dissatisfaction with existing products.

This article examines the universe, performance, and composition of multi-factor exchange-traded funds (ETFs) focused on the US stock market (try Finominal’s Alpha Analyzer for a factor exposure analysis).

UNIVERSE OF MULTI-FACTOR ETFS

The first multi-factor ETF in the US was launched in 2013 and the number of product launches has been relatively moderate, compared with the rapid growth of ETFs for countries, sectors and asset classes, which ranged over 5,000 at the end of 2018.

Furthermore, it is unusual to observe last year’s decrease in available multi-factor products, given the strong investor interest. Product issuers only liquidate ETFs when they fail to reach meaningful assets under management, which is typically a result of poor performance.