What’s the Best Way to Build a Multifactor Fund?
Integration versus isolation: Weighing the benefits of these two factor combination methods.
A version of this article was published in the March 2017 issue of Morningstar ETFInvestor. Download a complimentary copy of ETFInvestor here.
First came single-factor exchange-traded funds. These funds targeted individual factors associated with attractive long-term risk-adjusted returns. While many have become comfortable with the underpinnings of factors like value and momentum and how investors try to harness them in practice, it can be difficult to understand how to combine individual factor funds. More recently, fund providers have launched a bevy of multifactor funds that offer investors prepackaged factor combinations. Why might an investor opt for a fund that fuses factors together on their behalf? Can this add value relative to a do-it-yourself approach to mixing single-factor funds? And what is the best approach to combining factors in a multifactor framework? I'll set out to answer these questions here.
Adam McCullough does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.