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ETF Specialist

Stay Invested With This Multifactor ETF

This fund sacrifices transparent portfolio construction for deeper factor tilts.

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Fight the urge to try and time single-factor equity funds by investing in a U.S. multifactor fund. By combining individual factors that have performed well over the long haul into one portfolio, a multifactor fund can help investors stay the course when any one factor underperforms on a relative basis. In the January 2018 issue of Morningstar ETFInvestor, I picked  iShares Edge MSCI Multifactor USA ETF (LRGF) as one of the funds that I'd park my money in for the long haul because it targets U.S. stocks that have higher-than-average exposure to time-tested factors that have historically been associated with market-topping performance. The fund's factor tilts are stronger than most of its peers', but its portfolio construction is opaque and complex. The fund's low fee and stringent risk management should contribute to its edge over the long run, but its short live track record limits its Morningstar Analyst Rating to Bronze.

This fund seeks to maximize its exposure to stocks with attractive value, momentum, small size, and quality characteristics, while matching the risk level of its parent index, the MSCI USA Index. The fund uses an optimizer to construct its portfolio that weighs each stock's targeted factor characteristics against its risk contribution. This approach leads to inconsistent factor loadings because the optimizer shrinks its allocation to factors as their volatility increases. By targeting factors with low correlations to each other and constraining its stock and sector weightings, this strategy should diversify risk. But the optimization process is complex and opaque, which makes it difficult to assess how the portfolio will shake out.

Adam McCullough does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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