This article was originally published on ETFTrends.com.
Investors should consider the broader cyclical trends and how a more dynamic ETF strategy may help people better adapt to changing market conditions.
On the recent webcast, How to Choose Multi Factor ETFs for Your Clients, Mo Haghbin, SVP and Head of Product of Beta Solutions for OppenheimerFunds, highlighted the limitations of traditional styles of investing.
"Most style indices are market-cap weighted and concentrated by sector and to individual stocks. Historically, value and growth styles have come in and out of favor. Yet, timing styles in the short term can prove difficult for the average investor," Haghbin said.
It also doesn't help that traditional style boxes are blunt and only consider market capitalization and value/growth profiles to give investors a guide on fund's investment characteristics.
Alternatively, Haghbin argued that factors provide investors with a multi-dimensional view of a fund and allow for more precise targeting of specific drivers of risk and return.
To better help investors identify factors, Haghbin outlined FTSE Russell's factor definitions. For example, the value factor takes an equally weighted composite of cash flow yield, earnings yield and price-to-sales ratio. The quality factor includes an equally weighted composite of profitability - return on assets, change in asset turnover, accruals - and leverage ratio. The size factor covers the inverse of full market capitalization index weights. The low volatility factor screens for standard deviation of 5 years of weekly total returns. The momentum factor takes the cumulative 11-month return or the last 12 months excluding the most recent month. Lastly, the yield factor covers the 12-month trailing dividend yield.
These various factors also exhibit distinct characteristics and act differently in various market conditions. For example, the value factor has the highest correlation to the size factor and yield factors but has a negative correlation to the volatility, quality and momentum factors. As a result, investors may find uncorrelated excess returns when focusing on the various market factors.
Looking ahead, Irin Kim, AVP of Product Development and Beta Solutions for OppenheimerFunds, argued that understanding the business cycle can guide asset allocation decisions. As the economy slows, with a tight monetary policy, decelerating credit and peaking profit margins, we need to adapt to the late market cycle.
Under different macro environments, factor returns also vary. For example, during a slowdown when growth is above trend and decelerating, investors may want to emphasize the low volatility and quality factors.
"Factors are cyclical, but identifying macro regimes in real time needs to be more dynamic than classic textbook business cycle definitions. Factor diversification is important, similar to asset class and security level diversification," Kim said.
Investors who are interested in a multi-factor approach to helps smooth out the ride can look to something like the Oppenheimer Russell 1000 Dynamic Multifactor ETF (Cboe: OMFL) and Oppenheimer Russell 2000 Dynamic Multifactor ETF (Cboe: OMFS) . The smart beta ETFs select companies through exposure to a subset of multiple market factors, including low volatility, momentum, quality, size and value factors.
Additionally, investors can tilt their portfolio to a specific factor through single-factor ETFs, such as the Oppenheimer Russell 1000 Value Factor ETF (OVLU) , Oppenheimer Russell 1000 Size Factor ETF (OSIZ) , Oppenheimer Russell 1000 Momentum Factor ETF (OMOM) , Oppenheimer Russell 1000 Quality Factor ETF (OQAL) , Oppenheimer Russell 1000 Low Volatility Factor ETF (OVOL) and Oppenheimer Russell 1000 Yield Factor ETF (OYLD) .
Financial advisors who are interested in learning more about multi-factor strategies can watch the webcast here on demand.
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