For its next act, the $3.5 trillion ETF industry wants to sell you the steady income of a dividend, the upside of a small cap and the good night’s sleep of a low-volatility stock. All at once.
And they really hope you buy it. Just about every big fund provider, from Goldman Sachs Group Inc. to BlackRock Inc. and Franklin Templeton Investments, is pinning the next leg of growth on the idea.
Welcome to the world of multifactor investing. It’s the vanguard of money management and a place where no answer is too outlandish to the question, “How many different investment themes can you stuff into an exchange-traded fund?” Following the success of smart beta -- those hybrid ETFs that add a robot’s idea of stock picking to passive indexes -- managers are pitching a new type of diversified portfolio effectively run by a committee of robots.
It might sound a lot like Wall Street snake oil, the mass marketing of highly complex strategies invented by professionals that stand little chance of being understood by ordinary investors. But some very serious people are convinced it’s the future of investing, a way of replicating everything a talented stock picker brings to the table except his emotions and fees.
“The industry is creating more transparent and lower-cost versions of the same quant management we’ve seen over the last couple of years,” said Lance Humphrey, executive director of global multi-assets at USAA Asset Management Co., the biggest buyer of Goldman’s U.S. multifactor fund, with 12 percent of the shares outstanding. “But there are pitfalls. It’s one of my biggest concerns.”
Multifactor is a more complicated version of something a lot of investors struggled to understand in its simpler form, factor investing, the circuitry of smart beta ETFs. Purveyors of factor funds chop up benchmark indexes and bunch companies in groups based on some trait that has beaten the market in the past: cheapness, say, or low volatility.
Decades of research suggests that tying your fortunes to those characteristics is a way to outperform. The idea caught on and today, a firm like State Street Corp. classifies $80 billion of its $2.3 trillion assets in the category.
Enter multifactor, which says if you liked dividend stocks, you’ll love them when combined with momentum, low-volatility and value shares -- or whatever else you can think up. Confusing as that might sound, the money is flowing in. Morningstar counts 299 ETFs in the category with assets of $251 billion, an 8 percent increase from the start of the year.
Governing Principle
And a considerable swath of Wall Street believes multifactor is how money management will be dragged into the 21st century. To quant pioneers like Cliff Asness of AQR Capital Management LLC and Dimensional Fund Advisors’ David Booth, diversifying across factors has always been a governing principle of money management. The success of their firms is perhaps the strongest argument in favor of the concept’s viability.