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ETF Specialist

What Upcoming Index Changes Mean for Two Factor ETFs

BlackRock is switching benchmarks for two of its factor ETFs, but this change may help one ETF more than the other.

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In 2013,  BlackRock (BLK) launched iShares MSCI USA Value Factor (VLUE) and  iShares MSCI USA Quality Factor (QUAL) to offer low-cost access to stocks with characteristics that have historically been associated with higher returns. Because some sectors naturally have a greater concentration of stocks with low valuations and strong quality characteristics than others, these funds introduce sector biases that investors may not intend. In order to address this potential issue, BlackRock recently announced that it is changing QUAL's benchmark from the MSCI USA Quality Index to the MSCI USA Sector Neutral Quality Index at the end of August 2015. At that time, it will also switch VLUE's benchmark from the MSCI USA Value Weighted Index to the MSCI USA Enhanced Value Index, which is also sector-neutral. This change does not make QUAL any more or less compelling, but it is a meaningful improvement for VLUE.

In the original quality index, MSCI assigns quality scores to each stock in the broad MSCI USA Index. These scores are based on return on equity, debt/capital, and variability in earnings growth over the past five years. It then selects the top-scoring stocks, regardless of sector membership, and weights them according to both the strength of their quality characteristics and their market capitalization. This currently gives QUAL greater exposure to the technology and consumer cyclical sectors than the MSCI USA Index and less exposure to financial services, utilities, and telecom stocks.

Alex Bryan has a position in the following securities mentioned above: VLUE. Find out about Morningstar’s editorial policies.