If an advisor is choosing between single-factor or multifactor exchange-traded funds for a client’s portfolio, there are several fund attributes the advisor needs to consider, panelists at the Morninstar Investment Conference said Tuesday.
Single-factor ETFs can provide higher short- and medium-term returns, but the question is if the advisor can take advantage of those single factors, said Yasim Dahya, executive director and head of the Americas beta specialist team for J.P. Morgan Asset Management.
If advisors want to pick more than one single factor when adding to client portfolios, they need to ensure they’re not accidently doubling down on a theme. Dahya used the example of low volatility and quality factors. She said J.P. Morgan sees them as part of the same family since they share a similar economic rationality, which may mean the advisor might overweight the portfolio to this theme.
Antonio Picca, head of factor-based strategies at Vanguard, said single-factor ETFs also allow manager diversification, which can have its own benefits.
Feifei Li, director and head of investment management at Research Affiliates, said multifactor ETFs are a better approach for advisors who are concerned about tracking error from the parent market-cap weighted index.
Risk-adjusted returns are better with multifactor funds, Dahya said. When selecting a multifactor fund, Dahya said, advisors need to make sure the factors in the multifactor fund are unique, such as a fund that pairs value with momentum, two factors that are normally negatively correlated.
Dahya, Picca and Li spoke Tuesday on a panel about factor ETFs at the Morningstar Investment Conference in Chicago.
As advisors choose factor funds, whether single factor or multifactor, Picca said there are several different decisions advisors need to make. Those decisions include the ETF’s stock selection, weighting methodology (market cap, market-cap tilt or equal weighted), sectors bias, if any, and how the advisor implements these.
While single-factor ETFs can be used tactically, Picca said timing is extremely difficult. “People think it’s one or two choices, but in reality it’s four choices: which factor you want to overweight, which factor you want to underweight, when do you get in and get out. You have to get all of these choices right to make sure you’re adding value.”
One of the benefits of a multifactor fund is that it keeps investors exposed to the factor at all times. Picca said one of the reasons why it’s difficult to time factors is that they can be elusive, and there’s an opportunity cost to not having the exposure. For example, the value factor can give the best returns early on for a few months, but it's hard to get ahead of that factor before it starts to express its premium. “If you’re not fully exposed to value, you’re leaving money on the table and risk underperforming for a long period of time,” he said.