Multifactor ETFs

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Dead Man Walking
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Multifactor ETFs

Post by Dead Man Walking » Tue Nov 20, 2018 1:45 am

I've been following the threads on factor-based investing. I'm not interested in all asset factor-based funds; however, factor-based equity funds have piqued my interest due to the possibility of risk-adjusted returns that exceed the risk-adjusted returns of index funds. My interest increased when Vanguard introduced the U.S. Multifactor ETF (VFMF). I have investigated multifactor ETFs and discovered that there are about 300 of them. Many of them are sector funds. I've read about different implementations of factor-based security selection: The top down method which places stocks in sleeves which exhibit one factor and the bottom up method which selects stocks that exhibit a factor but don't cancel out the factors of other stocks in the portfolio. I have no idea which method is better. I'm appealing to the expertise of Bogleheads who have a better understanding of multifactor equity ETFs than I. Have any of you determined which multifactor equity ETFs are suitable additions to a diversified portfolio?

DMW

PFInterest
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Re: Multifactor ETFs

Post by PFInterest » Tue Nov 20, 2018 6:46 am

No one knows the future.

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vineviz
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Re: Multifactor ETFs

Post by vineviz » Tue Nov 20, 2018 8:44 am

Dead Man Walking wrote:
Tue Nov 20, 2018 1:45 am
Have any of you determined which multifactor equity ETFs are suitable additions to a diversified portfolio?
Sounds like you've done a lot of research, so you probably already found this thread: viewtopic.php?t=253019

My view is that a multifactor fund is probably more suitable as a core US equity holding rather than something you'd want to add in small amounts to a diversified portfolio. Combining a multifactor ETF with total stock market fund is almost certainly going to dilute the factor exposure of the overall portfolio to the point that it's going to be hard to see much impact.

My opinion is that the best core multifactor ETF right now is Vanguard US Multifactor ETF (VFMF). It so far has exhibited pretty strong factor exposure and a very low ER for this kind of fund. I like the bottoms-up approach it takes, which makes more sense to me theoretically than the sleeve-based approach. iShares Edge MSCI Multifactor USA ETF (LRGF) is the other good choice, in my opinion, for many of the same reasons. Personally I use VFMF in my portfolio because of its slightly more active approach and its heavier focus on mid- and small-cap stocks.

The other interesting multifactor ETF to me is Russell 1000 Dynamic Multifactor ETF (OMFL). If I were to use a fund in the way you suggest (adding it to an already diversified portfolio) this is probably the one I'd use. It's a little more expensive and is much more actively managed than the other funds, rotating through different factors at different times. In their words:
Capitalizes on the cyclicality of factor performance by employing a dynamic overlay that looks at leading economic indicators and market sentiment to determine the current market environment and then increases exposure to the factors that fare best in that environment.
A result of this is that it's going to be very hard to evaluate, because over long periods of time it will look like it has not much factor exposure because it will load up on different factors at different times. Oppenheimer does a pretty good job of explaining their approach, but a fund like this is always going to be a bit more of a black box than an index-based multifactor fund.

Because most of these funds are so new, there isn't much data to use to evaluate their track record. Still, the last three months have produced wide disparities in total returns. VFMF and LRGF are both down about 8% while OMFL is only down 2% (the S&P 500 is down about 5% over the same time frame). The differential isn't always going to go in Oppenheimer's favor, obviously, but I think this disparity illustrates that the different approaches will likely produce substantially different results. VFMF and LRGF have both had more value and small size loadings during this period, and small cap value funds down 10% on average over the past three months.

If you go down this road, my advice would be to replace all (or at least most) of your core US equity holding with either VFMF or LRGF. If you want to add 15% or 20% as a multifactor 'tilt' I'd probably just use a small cap value fund like IJS/VIOV/SLYV or else a "big bet" multifactor ETF like OMFL.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Topic Author
Dead Man Walking
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Re: Multifactor ETFs

Post by Dead Man Walking » Wed Nov 21, 2018 3:38 am

vineviz,

Thanks for the detailed response. I had read the thread to which you referred. It is one reason why I began my investigation of factor-based funds. As some responses in that thread pointed out, tax consequences and the brief history of these funds should be a consideration when choosing to invest in these funds. I'm in my seventies; consequently, an investment in new funds has to either be with new money or via rebalancing in order to avoid paying significant capital gains taxes. Furthermore, I have always preferred dipping my toes in the water before I jump into the pool. I see that strategy as prudent considering the brief history of the funds and the possibility that the strategy employed by the funds may fluctuate due to the their inexperience with this new model. Your suggestion of OMFL is a reasonable alternative in my situation. Thanks again for your well thought out response.

DMW

lassevirensghost
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Re: Multifactor ETFs

Post by lassevirensghost » Fri Jun 07, 2019 11:09 pm

vineviz wrote:
Tue Nov 20, 2018 8:44 am



My opinion is that the best core multifactor ETF right now is Vanguard US Multifactor ETF (VFMF). It so far has exhibited pretty strong factor exposure and a very low ER for this kind of fund. I like the bottoms-up approach it takes, which makes more sense to me theoretically than the sleeve-based approach. iShares Edge MSCI Multifactor USA ETF (LRGF) is the other good choice, in my opinion, for many of the same reasons. Personally I use VFMF in my portfolio because of its slightly more active approach and its heavier focus on mid- and small-cap stocks.

. . .

If you go down this road, my advice would be to replace all (or at least most) of your core US equity holding with either VFMF or LRGF. If you want to add 15% or 20% as a multifactor 'tilt' I'd probably just use a small cap value fund like IJS/VIOV/SLYV or else a "big bet" multifactor ETF like OMFL.
vineviz, would VFMF be suitable as a holding in a taxable account?
“Groucho, how do you invest your money?” | “All in bonds.” | “But Groucho, they don’t pay much return.” | “They do when you have a lot of em!”

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