October 28, 2019: Multi-factor ETFs vs. Equal Weight Multi-Factor Portfolios

Oct 29, 2019 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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For regular SAA and TAA portfolios, the next re-balance will be on Monday, November 18, 2019. You can also find the re-balance calendar for 2019 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Multi-factor ETFs vs. Equal Weight Multi-Factor Portfolios

In last week’s newsletter, we discussed native value-momentum ETFs vs. an equal weight value and momentum two factor portfolio. Our conclusion is that a native value-momentum doesn’t add much more value, at least based on the short history of these ETFs. 

In this newsletter, we continue to look at ETFs that are constructed based on more factors and their performance compared with equal weight portfolios. 

The multi-factor ETFs

By far, the most successful multi-factor ETF is Goldman Sachs’ ActiveBeta ETFs. Its representative one is GSLC (Goldman Sachs ActiveBeta US LgCp Eq ETF). Based on Goldman Sachs, the so called ActiveBeta ETFs are based on the following four factors: 

It further describes the process of constructing such an ETF portfolio: 

Basically, it scores a stock using the above four factors and then weights it using some proprietary weighting method for each index. It then selects combines these four indices (or portfolios) equally to form the final portfolio. It rebalances quarterly. 

The second and third largest multi-factor ETFs are  USMC (Principal US Mega-Cap Multifactor ETF) and LRGF (iShares Edge MSCI Multifactor USA ETF). Instead of low volatility in GSLC, LRGF or MSCI Multifactor index is based on size (smaller companies) in addition to the three factors: quality, value and momentum. USMC, on the other hand, is a simple size and volatility two factor ETF. It maintains the weights of  top 10% market cap stocks and then scales based on volatility on the rest 90% market cap stocks. One might say that it also includes momentum factor as the trendy stocks are overweighted by keeping the top 10% market cap stocks. 

VFMF (Vanguard U.S. Multifactor ETF) is a little bit more than one year old new comer that has amassed very little assets so far. It seems it utilizes five factors: value, momentum, quality, minimum volatility and the new one liquidity. 

Mutli-factor ETFs vs. an equal weight portfolio

We construct a simple static equal weight portfolio Multi-factor Value Momentum Quality Low Volatility that consists of the following:

Value VTV 25%
Momentum MTUM 25%
Quality QUAL 25%
LowVol USMV 25%

So the portfolio is somewhat similar to Goldman Sachs’ GSLC by using the exact four same factors. The ETFs are just simply the largest ETF in each factor category. It rebalances annually. 

The following table shows the expense ratios, sizes and returns of the above ETFs and the portfolio: 

Multifactor ETFs Performance Comparison (as of 10/28/2019):

ETF/Portfolio AUM (Expense Ratio) YTD
Return**		 1Yr AR 3Yr AR 5Yr AR
Multi-factor Value Momentum Quality Low Volatility N/A 21.4% 16.7% 15.2% 12.0%
GSLC (Goldman Sachs ActiveBeta US LgCp Eq ETF) $6.9B (0.09%) 22.5% 14.0% 14.3%  
USMC (Principal US Mega-Cap Multifactor ETF) $1.5B (0.12%) 18.1% 11.7%    
LRGF (iShares Edge MSCI Multifactor USA ETF) $0.9B (0.2%) 18.7% 9.4% 12.1%  
VFMF (Vanguard U.S. Multifactor ETF) $80 M (0.18%) 15.0% 4.3%    
VTI (Vanguard Total Stock Market ETF) $124B (0.03%)  21.9% 13.3% 13.9% 10.8%

AUM: Asset Under Management

From the above:

  • GSLC has the best performance, least expensive and biggest size (AUM) among these multi-factor ETFs. Its $6.9 billion AUM size allows ample liquidity. 
  • Vanguard VFMF is disappointing (though it’s still young) in terms of returns.
  • The quirky USMC performs well as it’s tilted to technology stocks (NASADQ largest 50 stocks). 
  • Again, the simple equal weight portfolio outperforms even the best GSLC. 
  • Both equal weight portfolio and GSLC have outperformed VTI for the past 1, 3 and 5 years. 

To summarize, ‘smart’ factor ETFs can be very useful. In fact, each factor index can outperform a broad base market cap index in the long term without incurring much more risk. Combining them together, a portfolio or an ETF can be a supplemental to an index fund asset allocation core portfolio. In our opinion, as these factor ETFs become more mature in the near future, it’s even reasonable to utilize these portfolios or ETFs as core funds in a portfolio. This is especially true if we can add a risk avoidance mechanism to avoid large loss during a market downturn. In the future newsletters, we will present portfolios that employ momentum rotation and risk management strategies. These portfolios have shown a great promise to outperform even more over broad market cap indexes in both returns and risk. 

Market overview

It’s encouraging and actually impressive that US companies have well withstood the recent economic and trade shocks: as of last Friday, based on Factset, For Q3 2019 (with 40% of the companies in the S&P 500 reporting actual results), the blended year over year earnings decline for S&P 500 companies was -3.7%, better than -4% expected on 9/30. Many companies were able to deliver better than (revised down) expected results. As of this writing, S&P 500 finally reached another historical high, breaking out of previous highs. 

However, compared with S&P 500, mid cap and small cap stocks have not been able to breach their highs made last September: 

Globally, it’s even more depressing: 

At best, we can say that US large cap stocks are wobbling through, inching even now and then to the upside. Again, the best action is to stay the course. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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