Factor Benchmarking with ETFs, and Canada Moves to the Top
Investment factors have been around for decades, but ETFs targeting single and multiple factors are a much newer invention. However, that doesn’t stop index providers and investment researchers from constructing hypothetical indexes and detailing their hypothetical historical performance. For most investors, the actual performance of real factor ETFs is where the rubber meets the road. After all, as much as we would all like to, we cannot buy past performance.
Additionally, since it is impossible to invest in an index, hypothetical or otherwise, I use actual factor-based ETFs as benchmarks. However, we are still in the early stages of factor ETF evolution, which renders my current benchmark selections far from perfect. Therefore, many of the ETF selections will likely change as better representatives establish themselves. Additionally, some of the factors themselves are likely to change in the coming years. For now, we have to work with what we have.
You may have seen some articles on factor investing that refer to the “four” or the “big six” factors. These generally refer to Small Size, Value, Low Volatility, Momentum, Yield, and Quality. As you will see below, Value and Quality are actually multiple factors in and of themselves. I extended my weekly factor analysis to include 11 categories to match the quantity of categories on my sector analysis. In doing so, I added the single factors of Market Capitalization, High Beta, and Dividend Growth along with two multifactor categories of Growth and Fundamental.
Here is an alphabetical list of the 11 primary factor categories I track and their benchmark ETFs:
Dividend Growth—SPDR S&P Dividends (SDY): This factor seeks companies that have consistently increased their dividends, as opposed to focusing on current yield. SDY follows the S&P High Yield Dividend Aristocrats Index, which holds stocks from the S&P Composite 1500 Index that have consistently increased dividends for at least 20 consecutive years. SDY holds 108 stocks, has $15 billion in assets, a yield of 2.6%, and an expense ratio of 0.35%.
Fundamental—PowerShares FTSE RAFI US 1000 (PRF): Fundamental weighting seeks to eliminate technical and price factors by focusing on four fundamental measures: book value, cash flow, sales, and dividends. PRF selects the 1,000 equities with the highest fundamental strength and weights them by their fundamental scores. PRF has about $4.7 billion in assets and an expense ratio of 0.39%.
Growth—Guggenheim S&P 500 Pure Growth (RPG): Although many analysts classify Growth as a single factor, it is actually composed of multiple factors. In the case of RPG, its underlying smart–beta index selects and weights stocks from the S&P 500 Index based on sales growth, earnings growth, and price momentum. This ETF holds 115 stocks, about $2 billion in assets, and has a 0.35% expense ratio.
High Beta—PowerShares S&P 500 High Beta (SPHB): Beta is a measure of a stock’s sensitivity to market moves, which is not synonymous with volatility. Therefore, the High Beta factor is not the opposite of the Low Volatility factor. SPHB’s underlying index selects the 100 stocks from the S&P 500 Index with the highest sensitivity to market movements, or beta, over the past 12 months. SPHB has about $800 million in assets, an expense ratio of 0.25%, and a one-year beta of 1.6 versus the S&P 500.
Low Volatility—iShares Edge MSCI Min Vol USA (USMV): Many analysts refer to this as just the “volatility” factor, but we include the word “low” for clarification as some investors pursue various high-volatility strategies. Another common term is “minimum volatility,” as is the case for the USMV benchmark ETF. USMV uses a rules-based methodology to optimize and determine weights for securities in an attempt to minimize overall portfolio volatility. It has 184 stocks, about $12 billion in assets, and an expense ratio of 0.15%.
Market Capitalization—iShares Russell 1000 (IWB): Market capitalization is the traditional default factor of index investing. This ETF represents the 1,000 largest publicly held U.S.-incorporated companies using a market-capitalization weighting. It provides broad exposure covering approximately 90% of the U.S. equity market. IWB holds $17 billion in assets and has an expense ratio of 0.15%.
Momentum—iShares Edge MSCI USA Momentum Factor (MTUM): The most widely followed definition of momentum is the total return of the past 12 months minus the most recent month, which is really an 11-month return calculation delayed by a month. MTUM’s underlying index uses a risk-adjusted measurement of price momentum over six-month and 12-month periods, where the risk-adjustment process uses the three-year weekly standard deviation of returns. This ETF has 123 stocks, about $2 billion in assets, and an expense ratio of 0.15%.
Quality—iShares Edge MSCI USA Quality Factor (QUAL): Often considered the most nebulous factor, not everyone’s definition of the quality is identical. At its core, the Quality factor attempts to filter out companies in questionable financial condition and focus on those with high sustainable earnings. To achieve those goals, QUAL’s underlying index considers return on equity, earnings variability, and debt-to-equity measurements in constructing a cap-weighted, sector-neutral portfolio, where sector-neutral means the same sector allocations as the broad U.S. market. This ETF has 125 stocks, about $3.6 billion in assets, and carries a 0.15% expense ratio.
Small Size—iShares Russell 2000 (IWM): Often referred to as just the “size” factor, we include the word “small” for clarification. Although it is a capitalization-weighted index, the Russell 2000 is the most widely followed small-cap benchmark. It excludes the 1,000 largest stocks and represents approximately 8% of the U.S. equity market. IWM holds $39 billion in assets and has an expense ratio of 0.20%.
Value—Guggenheim S&P 500 Pure Value (RPV): Although many analysts refer to Value as a single factor, it is actually composed of multiple factors. In the case of RPV, its underlying smart–beta index selects and weights stocks from the S&P 500 Index based on their price-to-book ratio, sales-to-price ratio, and earnings-to-price ratio. This ETF holds 116 stocks, about $1 billion in assets, and has a 0.35% expense ratio.
Yield—iShares Core High Dividend (HDV): The yield factor targets stocks with the highest current dividend yield. HDV currently holds the 75 stocks in the Morningstar Dividend Yield Focus Index. The underlying index applies quality screens and provides diversified sector exposure. HDV has more than $6 billion in assets, a current yield of 3.5%, and an expense ratio of 0.08%.
Canada ETF Grabs the Global Leadership
The iShares MSCI Canada ETF (EWC) asserts its leadership role as it and other resource-rich countries gain strength. Changes in the sector rankings play into the resource theme as Materials climbs to third.
Sectors: The majority of the sector benchmark ETFs lost momentum, although it was nearly even, with five showing improvement while six weakened. Health Care posted the best improvement, climbed three steps out of the basement, and moved into a positive intermediate-term trend. Other sectors with improved relative-strength rankings included Materials, Technology, and Consumer Discretionary. The moves by Materials and Technology placed each back into the top five, and Energy’s drop from third to sixth place made it possible. Utilities had a noticeable drop as it fell three spots to 10th. Consumer Staples replaced Health Care on the bottom, and Financials extended its time at the top to 10 weeks.
Factors: Only small changes among the factor benchmark ETFs are visible this week. The top five of High Beta, Small Size, Value, Fundamental, and Market Cap have been firmly entrenched for four weeks. Allowing for some minor position changes, this group of five have been in control of the factor rankings for the past nine weeks. This week’s changes included Quality moving two steps higher to sixth, with Yield performing the opposite feat. Another change was Momentum’s escape from last place by pushing Low Volatility and Growth lower. Although the mathematical algorithm forces each category into a specific position in the relative-strength rankings, the chart below indicates that the bottom-four categories are in a near-tie for last place.
Global: All global categories gained momentum, pulling the bottom four out of the red. Resource-rich regions made the largest gains, as Pacific ex-Japan zoomed five places higher and Canada secured the leadership position. Aided by recent strength in the Materials sector, gold, and their local currencies, the Australia-Brazil-Canada (“ABC”) posted significant gains. While iShares MSCI Australia (EWA) and iShares MSCI Brazil (EWZ) are not directly represented in the global categories, they do hold the dominant allocations within the Pacific ex-Japan and Latin America benchmarks. Canada’s ascension caused the U.S. to slip down to third, but the U.S. remains firmly in the hunt. On a relative-strength basis, the U.K. dropped four places to ninth despite increasing its momentum reading. China posted the largest improvement in momentum, but it wasn’t enough to move it out of last place.
Disclosure: At the time of this writing, author is long SPHB, but has no positions in any of the other securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned
“Our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible.”
—John Maynard Keynes
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