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Are Equity Multifactor ETFs Working?

October 25, 2017 • Posted in Equity Premium, Momentum Investing, Size Effect, Value Premium, Volatility Effects

Are equity multifactor strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider seven ETFs, all currently available (in order of decreasing assets):

  • Goldman Sachs ActiveBeta U.S. Large Cap Equity (GSLC) – holds large U.S. stocks based on good value, strong momentum, high quality and low volatility.
  • iShares Edge MSCI Multifactor USA (LRGF) – holds large and mid-cap U.S. stocks with focus on quality, value, size and momentum, while maintaining a level of risk similar to that of the market.
  • John Hancock Multifactor Large Cap (JHML) – holds large U.S. stocks based on smaller capitalization, lower relative price and higher profitability, which academic research links to higher expected returns.
  • JPMorgan Diversified Return U.S. Equity (JPUS) – holds U.S. stocks based on value, quality and momentum via a risk-weighting process that lowers exposure to historically volatile sectors and stocks.
  • iShares Edge MSCI Multifactor International (INTF) – holds global developed market ex U.S. large and mid-cap stocks based on quality, value, size and momentum, while maintaining a level of risk similar to that of the market.
  • John Hancock Multifactor Mid Cap (JHMM) – holds mid-cap U.S. stocks based on smaller capitalization, lower relative price and higher profitability, which academic research links to higher expected returns.
  • Xtrackers Russell 1000 Comprehensive Factor (DEUS) – seeks to track, before fees and expenses, the Russell 1000 Comprehensive Factor Index, which seeks exposure to quality, value, momentum, low volatility and size factors.

Because available sample periods are very short, we focus on daily return statistics, along with cumulative returns. We use four benchmarks according to fund descriptions: SPDR S&P 500 (SPY), iShares MSCI ACWI ex US (ACWX), SPDR S&P MidCap 400 (MDY) and iShares Russell 1000 (IWB). Using daily returns for the seven equity multifactor ETFs and benchmarks as available through early October 2017, we find that:

We exclude some other ETFs and truncates some series for those listed above due to many days with little or no trading volume.

The following table summarizes sample periods and performance statistics based on daily data for the seven equity multifactor ETFs and associated benchmarks over available sample periods. Notable points are:

  • Correlations of daily returns with benchmarks range from 0.62 for JPUS to 0.98 for GSLC. Only JPUS appears to offer meaningful diversification.
  • Only one (JHMM) has higher average daily return than its benchmark. Only three have lower daily volatilities than respective benchmarks.
  • Only one (JHMM) has a higher daily reward/risk (average daily return divided by standard deviation of daily returns) than its benchmark, and the difference is slight.
  • Only one (LRGF) has a higher cumulative return than its benchmark, and the difference is slight.

To summarize, we focus on monthly reward/risk results.

The following chart compares monthly reward/risk results for equity multifactor ETFs to those of respective benchmarks over available sample periods. In general, multifactor ETFs slightly underperform based on this metric.

In summary, limited available evidence offers little support for belief that equity multifactor ETFs beat their benchmarks, though one of seven offers some diversification with comparable performance.

 Cautions regarding findings include:

  • Available sample periods are very short, especially in terms of variety of market conditions, undermining confidence in findings. The sample for DEUS is extremely short.
  • The selected benchmarks may not precisely match the ETF universes.
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