Stock Strategist (ETF Edition): The Case for Multifactor ETFs

[Morningstar Logo] [Company Site] [Company News] [Membership] [Portfolio] [Stocks] [Options] [Funds] [ETFs] [Markets] [Tools] [Personal Finance] [Discuss] Stock Strategist (ETF Edition) The Case for Multifactor ETFs Don’t put all your factor “eggs” in one basket. [tab_bar] by Ben Johnson, CFA | 8/10/2016 6:00:00 AM The article was published in the July 2016 issue of Morningstar ETFInvestor. Download a complimentary copy of Morningstar ETFInvestor [by visiting the website]. The case for multifactor exchange-traded funds is straightforward. It is in essence identical to the case for diversification, which Nobel Prize-winning economist Harry Markowitz has described as the only “free lunch” in investing. Implementation is simple: Don’t put all your “eggs” in one factor. But just because the argument for factor diversification is sound and executing a multifactor strategy is seem­ingly straightforward doesn’t mean it’s easy. In fact, in light of the proliferation of multifactor ETFs, selecting from the now-expansive menu is becoming more difficult by the day. Here I will take a closer look at the case for spreading around one’s factor bets, discuss how to assemble an “A-Team” of factors, and touch on the importance that managing expectations plays in improving the odds of a successful outcome. All by Myself A host of individual factors have been documented by academics and practitioners, though few are widely accepted as being credible. By my count, the ones that hold any water amount to six: value, momentum, size, quality, low volatility, and dividends (which might be thought of as a form of carry in stocks). Each of these factors has been researched by multiple scholars and/or professional investors. Many are present across asset classes and in different markets around the world. They have been subse­quently tested out of sample and still pass muster. They are, in a word, legit. Exhibit 1 shows the long-term performance of some of these factors in a long-only implementation as represented by their corresponding variants of the MSCI World Index. Across nearly three decades, each of these factor indexes has significantly outper­formed its market-cap-weighted parent. During the past 15 years, all but one of these indexes also produced superior risk-adjusted returns, as measured by Sharpe ratio. I mentioned the concept of a “free lunch” earlier—are these factors all unattended sand­wiches? Hardly. To read more, click [here]. Sponsored Links [Buy a Link Now] New: ETF Managed Portfolios Center On [MorningstarAdvisor.com]: Tap into the industry's best source of information on ETF strategies for financial advisors. See key performance data, screen for specific strategy attributes, and learn more about this fast-growing area of the investment marketplace. [Click to get started]. Free Issue | Morningstar's Stock Newsletter >> Morningstar StockInvestor is celebrating more than 10 successful years of high-quality stock investing. Its two real-money portfolios have outperformed the S&P 500 since 2001. [Get new ideas for the core of your stock portfolio]. Search Most Recent Articles [Corporate Credit Spreads Recover on Even Easier Global Monetary Policy, Bouncing Oil Prices, and Strong Payrolls] [Employment Data Casts Doubt on Dire GDP Report] [How to Customize the Bucket Portfolios] Latest Analyst Reports [American Century Select Inv] [PIMCO EqS® Long/Short Institutional] [Natixis ASG Global Alternatives Y] [Vanguard High-Yield Tax-Exempt Adm] [Vanguard Long-Term Tax-Exempt Adm] ABOUT OUR EMAIL TO UNSUBSCRIBE this email address to the Stock Strategist newsletter, please click "reply" and then click "send." This will unsubscribe only this email address to this specific newsletter. All subscription changes will take effect within one business day. Replies are not read by individuals, so please do not use this for queries about Morningstar.com. If you have questions about Morningstar.com or your membership, send a note to [joe@morningstar.com]. ABOUT OUR PRIVACY POLICY Please [click here] to learn about Morningstar's privacy policy. (c) Copyright 2016. Morningstar, Inc. 22 West Washington Chicago, Illinois, 60602 All rights reserved.