An Alternative To Traditional Large-Cap Exposure

Scores of exchange traded funds offer investors exposure to large-cap U.S. stocks. Many apply the traditional cap-weighting methodology while a growing number are fundamentally-weighted, or smart beta ETFs.

Within the fast-growing smart beta are a number of multi-factor ETFs, or those funds that are based on multiple investment factors, such as low volatility, momentum, quality and value. The iShares Edge MSCI Multifactor USA ETF LRGF is part of that group.

LRGF, which is nearly two years old, follows the MSCI USA Diversified Multiple-Factor Index. LRGF holds large- and mid-cap stocks. LRGF's underlying index imposes sector and individual security tilts in an effort to further diminish risk.

“This fund seeks to maximize its aggregate exposure to stocks with attractive value, momentum, small size, and quality characteristics, while matching the risk level of its parent index, the MSCI USA,” said Morningstar in a recent note. “To achieve this, the fund constructs a portfolio using an optimizer that balances each stock's targeted factor characteristics against its risk. This can lead to inconsistent factor loadings through time because the optimizer shrinks its allocation to factors as their volatility increases.”

LRGF currently holds nearly 140 stocks. On a combined basis, technology and healthcare names are about 35 percent of the ETF's weight. 

The investment factors LRGF focuses on include momentum, quality and value. Quality and momentum are evident via LRGF's technology and healthcare weights, among others, while some of the ETF's value propositions comes by way of a 12 percent weight to financial services stocks.

LRGF's “strategy has a stronger value and mid-cap tilts than its multifactor peers. It aggressively pursues its targeted factors and has a higher active share than many of its multifactor peers,” said Morningstar. “This strategy further strengthens its style tilts by considering its holdings' aggregate factor exposures rather than mixing stocks that score well on any one factor. A mixing approach can wash out factor exposures. This approach should be greater than the sum its parts. Although it lands in the large-value Morningstar Category, the index has performed more like a mid-cap value fund.”

LRGF charges just 0.2 percent per year, making the ETF not only inexpensive relative to other smart beta funds, but slightly cheaper than the average ETF of any type trading in the U.S.