Large And In Charge With This Multi-Factor ETF

Mutli-factor funds have been fertile territory for issuers of exchange-traded funds in recent years. While different issuers apply different methodologies to these products, the basic premise behind multi-factor ETFs is giving investors exposure multiple factors with the aim of easing the factor selection burden.

The multi-factor landscape is expanding to include smaller stocks, international equities and emerging markets fares, but the staple remains domestic large-caps. The iShares Edge MSCI Multifactor USA ETF LRGF is an example of a successful domestic large-cap multi-factor fund. LRGF turns three years old later this month and has almost $974 million in assets under management.

In its nearly three years on the market, LRGF has returned 35 percent, outpacing the Russell 1000 Index by 80 basis points while being slightly more volatile than that broad market benchmark. LRGF has trailed the S&P 500 since inception.

What LRFG Focuses On

Again, different multi-factor ETFs have different objectives and provide exposure to various factors. LRGF focuses on the value, quality, momentum and size factors.

“To do that, it assigns a composite score to each stock in the MSCI USA Index based on its four factor characteristics and uses an optimizer to maximize the portfolio's composite score, subject to several constraints,” said Morningstar in a recent note.

LRGF holds just 148 stocks, a far smaller number than basic, cap-weighted domestic large-cap index funds. That indicates a small number of stocks meet the fund's multi-factor criteria. None of LRGF's holdings exceed weights of 2.5 percent, confirming single stock risk isn't at play with this fund.

“By design, the fund takes considerable factor risk, but it effectively diversifies firm-specific risk, only parking a fifth of the portfolio in the top 10 holdings,” said Morningstar.

Sector Selection

The stock and sector selection effects can play pivotal roles in driving the performances of smart beta strategies, including multi-factor funds. With single stock risk diminished in LRGF, sector selection is important. LRGF allocates less than 23 percent of its weight to technology, a slight underweight to the S&P 500. The fund is also underweight financial services relative to the S&P 500.

“The sector tilts in the portfolio are primarily driven by momentum and small size, since the fund measures each stock's value and quality characteristics relative to its sector peers,” said Morningstar. “These sector-relative comparisons improve comparability and reduce persistent sector bets, which could be a source of active risk not directly related to the targeted factors.”

LRGF has a Morningstar rating of Bronze.

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