A Suite of New Multifactor ETFs for Your Watchlist

A version of this article was published in the June 2015 issue of Morningstar ETFInvestor. Download a complimentary copy of ETFInvestor here.

In late April, iShares launched a crop of new multifactor strategic-beta exchange-traded funds, unveiling its FactorSelect suite. The five funds are the latest in a wave of increasingly complex multifactor funds being rolled off asset managers' assembly lines. By our count, 33 of the 88 multifactor strategic-beta ETFs that exist in the U.S. market today were launched in the past 12 months. I think these are some of the best of the bunch.

Combining stand-alone factors in a multifactor format is a sensible strategy to the extent that the factors in consideration are 1) credible; 2) well-constructed; and 3) combined in such a way as to improve the overall risk/reward profile of the resulting portfolio relative to owning any of the factors in a stand-alone format, a traditional cap-weighted index fund, or an actively managed peer. At first blush, the benchmarks underlying the iShares FactorSelect ETFs appear to meet all three criteria.

These indexes look to combine the quality, momentum, value, and low-size factors. Quality has been vetted but remains a relative newcomer. Low size has been called into question, but if nothing else, it can serve to magnify the value effect. Value and momentum are the classics, the peanut butter and jelly of factor investing. They have been tested across multiple time periods, geographies, and asset classes and have proved their worth in out-of-sample tests as well.

MSCI takes the same approach to constructing these factor exposures in the context of the FactorSelect suite as it does for their stand-alone versions—such as the MSCI USA Quality Index, which underlies

The FactorSelect ETFs are sensibly designed and competitively priced, but are they better mousetraps? Only time will tell. These ETFs were launched just three months after MSCI began live calculations for the underlying indexes. I've never met a bad-looking back-test (the ugly ones never see the light of day), and I wouldn't suggest using a good-looking one as the sole basis for an investment decision. For now, I've got these funds on my watchlist.

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