Most sponsors are newer to multifactor ETFs than FlexShares, but still have offerings worth considering. Goldman Sachs introduced five multifactor, low-expense ETFs in its ActiveBeta series in late 2015. The largest of these, its U.S. large-cap ETF (GSLC), has $2 billion in assets. It charges just 0.09%, where the industry average for the average smart beta offering is 38 basis points. The ETF is divided equally into value, momentum, quality and low volatility stocks using criteria such as companies’ book value, cash flow and sales. It draws most of its names from the S&P 500, though its sector and security weighting differ from that of its stock universe.
State Street Global Advisors launched the first multifactor ETFs in 2014 and now has 10 of them, most covering foreign and emerging markets. Its SPDR MSCI USA StrategicFactors ETF (QUS) measures the performance of large and mid-cap companies across the U.S. equity market, and it contains an equal combination of three factors: value, quality and low volatility. At 0.15%, its expense ratio falls below those of many competitors, but its asset base is relatively small at $35 million. The nine other ETFs in the suite have 0.30% expense ratios.
iShares’ multifactor ETFs include the iShares Edge MSCI Multifactor USA ETF (LRGF). The fund draws its constituents from the MSCI USA Index, a cap-weighted group of mid- and large-cap stocks, and it uses companies’ value, momentum, quality and size as its factors. The fund uses a complex optimizer that balances factor characteristics and risks to select stock components. Launched in April 2015, the ETF has a more value-oriented tilt than some of its peers and has about $430 million in assets and a 0.20% expense ratio, making it one of the cheaper offerings in the group. Other multifactor offerings in the series cover small caps, international stocks and emerging market names, as well as individual sectors such as energy, materials and technology.
John Hancock’s suite of multifactor ETFs consist mainly of offerings in specific U.S. sectors such as energy, financials, technology and consumer discretionary. The firm also has more diversified large-cap, mid-cap and developed international offerings. Based on an index designed by Dimensional Fund Advisors, John Hancock’s Multifactor Large Cap ETF (JHML) is divided into smaller-cap stocks, companies with lower relative prices and companies with higher profitability. Because of its emphasis on the smaller members of the large-cap universe, its weighted average market cap is significantly lower than that of its benchmark, the Russell 1000. The ETF has $347 million in assets and a 0.35% expense ratio.
JPMorgan’s Diversified Return Equity Series covers 10 areas, including international stocks, global stocks, mid-caps, emerging markets equities, alternative investments and U.S. equities. Its Diversified Return U.S. Equity ETF (JPUS) uses the Russell 1000 for its universe, and it divides its stocks into quality, valuation and momentum factors. According to its literature, the fund’s risk-weighting process “results in lower exposure to historically volatile sectors and stocks.” It has $258 million in assets and a 0.19% expense ratio.
The quiet giant in the multifactor ETF space is the FlexShares TILT fund, which has more than $1 billion in assets, a six-year history and a 0.25% expense ratio. The tilts here are toward smaller companies and value, which the firm believes are the strongest drivers of long-term returns.
These ETFs, and others in the multifactor camp, take either an “isolated” or “integrated” approach. An ETF using an isolated approach, such as the Goldman Sachs ActiveBeta U.S. Large Cap Equity fund, segregates stocks into factor sleeves under the umbrella of one portfolio. Those that use an integrated approach, such as iShares Edge MSCI Multifactor USA fund, score each stock based on the combination of chosen factors for the portfolio.
An ETF that uses quality, value and momentum, for example, would identify and select component stocks based on all those characteristics rather than separate them into factor sleeves.
With the track record of these ETFs still so new, the jury is still out about whether the isolated or integrated approach works best. A lot depends on what you’re looking to accomplish.
“Consider an isolated portfolio approach if you favor transparency and lower tracking error, but know that you’re forgoing more-pronounced factor tilts,” wrote Morningstar analyst Adam McCullough in a May 2017 article. “For potentially stronger factor tilts and higher tracking error, consider a fund that uses an integrated approach. But remember that an integrated approach is usually more complex and opaque.”
As ETF sponsors continue to clash over which multifactor recipe works best, investors are left to sort through a complex maze of ETFs with short track records. Once longer-term performance starts filtering in, the decision-making process for investors will be made easier by results based on real world returns rather than academic studies.