A Marvelous Multi-Factor ETF

The universe of multi-factor exchange-traded funds is certainly expanding in terms of population, indicating that issuers are betting such funds will benefit from the strategic beta boom.

In its third-annual survey of institutional investors and their views on smart beta products, FTSE Russell found professional investors are expected to ratchet up their use of smart beta ETFs.

FTSE Russell, one of the largest providers of indexes for use with ETFs, surveyed more than 250 money managers, a combined 80 percent of whom manage $1 billion to $10 billion or more than $10 billion. Nearly half of institutional investors surveyed are in North America, with a third hailing from Europe.

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The JPMorgan Diversified Return U.S. Equity ETF JPUS is one of the multi-factor ETFs offering investors exposure to U.S. equities. JPUS, which is almost a year old, can be used as an alternative or complement to traditional cap-weighted U.S. equity index funds.

The Index

JPUS follows the Russell 1000 Diversified Factor Index. The Russell 1000 Diversified Factor Index evaluates constituent firms based on attractive relative valuation, quality traits and positive price momentum, according to FTSE Russell, the index's issuer. Data suggest that among users of factor ETFs or those considering such funds, asset managers tend to focus on the low volatility and value factors, followed by multi-factor strategies.

The index JPUS follows “sets its sector weightings on the basis of the inverse of each sector's historical volatility. This effectively spreads sector-specific risk more evenly. The index then populates each sector with those stocks that earn the highest composite scores based on measures of value, momentum, size, and low volatility. Stocks that score poorly on these measures are tossed out,” according to Morningstar.

The Complexity Factor For Multi-Factor ETFs

While there is some level of complexity with JPUS, as is the case with many multi-factor ETFs, the trade-off could be attractive for some investors. The ETF's emphasis on risk management and volatility reduction could serve investors well during turbulent markets.

Additionally, it is hard to quibble with the returns generated by JPUS, albeit over less than a year. Since coming to market, JPUS is ahead of the S&P 500 by nearly 300 basis points and year-to-date, the JPMorgan ETF is ahead of the benchmark U.S. equity index by 270 basis points.

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JPUS has a “very risk-conscious methodology will likely yield more-muted drawdowns relative to peers tracking cap-weighted indexes, as well as other multifactor ETFs,” noted Morningstar. But its “volatility weighting and the low-volatility component will likely dominate other factor bets.”

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