Mean reversion, or the notion that stock prices tend to revert to long-time levels, is a time-honored investment principle. And a new exchange-traded fund from Global X Funds seeks to capitalize on that with a multifactor portfolio with a built-in mean-reversion mechanism that aims to mitigate downside risk while maintaining the potential for alpha generation.
The Global X Adaptive U.S. Factor ETF (AUSF) that debuted Tuesday allocates across three factors—minimum volatility, value and momentum—on a quarterly basis. The fund puts more weight on the two factors that have recently underperformed and less emphasis on the factor that has recently outperformed (or at least performed better than the other two factors).
Factors are portfolio building blocks that explain the risk and return attributes of the underlying securities. Portfolios can be built that isolate or combine various factors. According to Global X, the three factors emphasized in its new ETF have historically shown advantages compared to broad benchmark indexes.
The AUSF fund tracks the Adaptive Wealth Strategies U.S. Factor Index that was developed by Carroll Financial Associates, a Charlotte, N.C.-based registered investment advisor.
Each factor in the new Global X fund is represented by a sub-index derived from the Solactive U.S. Large & Mid Cap Index composed of the 1,000 largest U.S.-listed companies based on free float market capitalization.
“The fund’s strategy is almost like a factor rotation strategy, but it’s not truly going in and out of factors,” says Jay Jacobs, head of research and strategy at Global X Funds. “It’s kind of tilting toward two factors at a time with the worst recent performance. The idea behind it is you see periods of strong factor performance.”
For example, he notes, the volatility factor did well in 2015 and 2016, while the momentum factor did well in 2017. The AUSF fund either allocates to two factors with a 50 percent/50 percent weighting, or to all three factors with a weighting of 40 percent/40 percent/20 percent depending on the trailing returns of each factor.
“If the performance between the best and second-best performer is less than 2 percent, the fund will be allocated 40 percent/40 percent/20 percent, with the 20 percent being the best performer,” Jacobs says. “In this scenario, the dispersion of returns are so narrow that it doesn’t make sense to get out of the best-performing factor.”
The AUSF fund begins trading with a 50/50 split between minimum volatility and value. Its expense ratio of 0.27 percent is below average for factor-based ETFs.
Jacobs says this fund is intended for use as a core U.S. equity holding in that it invests in U.S. large- and mid-cap companies, and that its portfolio evolves according to different market conditions.