Multi-Factor Fun With Some New ETFs

Value, momentum, quality, size and volatility are the most studied investment factors, but the typical application of these factors within exchange traded funds has been isolation or the combination of two or three of the factors.

There are not a lot of ETFs that employ value, momentum, quality, size and volatility in their weighting methodology, but the number is growing thanks in part to some recent introductions from Deutsche Asset & Wealth Management (Deutsche AWM), the exchange traded funds issuing unit of German bank Deutsche Bank AG DB.

Last month, Deutsche AWM introduced the Deutsche X-trackers Russell 1000 Enhanced Beta ETF DEUS and the Deutsche X-trackers FTSE Developed ex US Enhanced Beta ETF DEEF. The Deutsche X-trackers Russell 1000 Enhanced Beta ETF, Deutsche AWM's U.S.-focused offering, holds more than 840 stocks, only one of which commands a weight north of 1 percent.

Notable is the fact neither DEUS nor DEEF are a mishmash of the aforementioned investment factors. Rather, the new ETFs are grounded in long-standing research and thoughtful in the application of value, momentum, quality, size and volatility.

"The first step is to convert all of the raw factor scores that we have given each of the stocks in our indexes into what is called a 'Z-score.' This is done simply so that factors can be meaningfully compared. Imagine that you were debating in the office who is a better athlete - Tiger Woods or Michael Jordan. It's obviously difficult to meaningfully talk about their records given their expertise in very different arenas. But one thing you could do (assuming you have tolerant colleagues) is to look at their respective Z-scores," said Deutsche AWM in a new research piece.

The Deutsche X-trackers FTSE Developed ex US Enhanced Beta ETF holds more than 820 stocks, none of which command weights of over 1 percent. That new developed markets ETF is heavily tilted toward Japanese and British stocks as Japan and the UK combine for over 48 percent of the fund's weight. DEEF's third-largest country allocation is 9.15 percent to Australia.

DEEF, which charges a reasonable 0.35 percent per year, allocates 21.3 percent of its weight to financial services stocks and another 19.3 percent to the industrial sector. Consumer discretionary and consumer staples names combine for over 27 percent of the new ETF's weight.

DEUS is a heavily cyclical ETF as consumer discretionary, industrial and financial services stocks combine for over half of that ETF's weight. Top 10 holdings include Southwest Airlines Co. LUV and Bed, Bath & Beyond Inc. BBBY.

ETFs such as DEEF and DEUS offer another important advantage: By combining factors, investors do not have to worry about timing which factors are due to lead and lag.

"The other reason why investors may consider combining factors is that, despite all of them historically having boosted returns over the very long run, there will be periods when individual factors underperform. We have already mentioned the pain that value investors had to endure while they were being derided as dinosaurs during the dot-com boom, but the fact is we would never claim, and nor should anyone else, that these factors always work," said Deutsche AWM.