This article was originally published on ETFTrends.com.
Smart beta is one of the fastest-growing segments in the ETFs universe and within that realm, multi-factor ETFs are increasingly popular.
Over the past few years, money managers and fund sponsors started to roll out rules-based, transparent index ETFs that combined some of the attributes that have historically provided active managers with outperformance, such as prominent investment factors like quality, momentum, value, low volatility and size.
The iShares FactorSelect MSCI USA ETF (LRGF) is an example of a successful, thriving domestic multi-factor ETF.
iShares’ FactorSelect ETFs also track smart-beta indices that select components based off four factors, including quality, momentum, value and size. LRGF is part of a five ETF suite of factor select ETFs from iShares, the world’s largest ETF issuer.
LRGF, which turns three years old later this month, holds nearly 150 stocks. The ETF, which tracks the MSCI USA Diversified Multiple-Factor Index, devotes nearly 23% of its weight to technology stocks and almost 27% of its combined weight to healthcare and industrial names.
“The sector tilts in the portfolio are primarily driven by momentum and small size, since the fund measures each stock's value and quality characteristics relative to its sector peers,” said Morningstar in a recent note. “These sector-relative comparisons improve comparability and reduce persistent sector bets, which could be a source of active risk not directly related to the targeted factors.”
Through a multi-factored approach, these new smart-beta ETFs try to deliver enhanced returns and maximize diversification in an attempt to provide potentially improved risk-adjusted returns, compared to traditional market-capitalization-weighted indices.
Specifically, some argue that cap-weighted indices may put an investor at risk of chasing a rally since the best performing stocks would gain the most assets and typically have the largest weight in an index.
LRGF “currently sits in the large-value Morningstar Category, though its value tilt is less pronounced now than it has been in the past,” said Morningstar. “Still, its holdings tend to trade at lower valuations and have smaller market capitalizations than the constituents in its parent index. By design, the fund takes considerable factor risk, but it effectively diversifies firm-specific risk, only parking a fifth of the portfolio in the top 10 holdings.”
LRGF charges 0.20% per year, or $20 on a $10,000 investment, a fee that compares favorably against other smart beta strategies.
For more information on multi-factor strategies, visit our smart beta category.
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