Factor investing is one of the rare approaches that stands up to the test of time. Factor strategies build portfolios of stocks that are united by their exposure to one of a few well-vetted risk factors. For example, value funds feature stocks that trade at cheap prices relative to some fundamental measure of value, while quality strategies target profitable stocks. Companies with these traits have historically been tied to market-beating returns over the long term.
That said, the wrong market conditions can cause factors to slump--sometimes for years at a time. Factor funds can challenge investors' patience and be difficult strategies to stick with.
3 Stellar Multifactor ETFs
These exchange-traded funds earn Morningstar Analyst Ratings of Silver.
- Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF GSLC
- WisdomTree U.S. Multifactor ETF USMF
- Hartford Multifactor Developed Markets (ex-US) ETF RODM
Enter multifactor funds, which simultaneously target at least two factors rather than home in on one. Since some factors thrive at different times, these funds marry the efficacy of factor investing with the power of diversification. Like a well-rounded baseball lineup that can drive in runs off righties, lefties, power pitchers, and junkballers, multifactor funds have the tools to handle whatever the market throws at them.
Today, I'll cover a trio of multifactor ETFs whose sensible construction and attractive factor blends earn them medalist Morningstar Analyst Ratings.
Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF
Let's start with a fund that doesn't look too different from the broad large-cap stock market: Silver-rated Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF, which trades under the ticker GSLC.
This index fund comprises four sleeves that each focus on a different factor: value, quality, momentum, and low-volatility. The fund equally weights the four sleeves, then applies a series of constraints that reduce firm-specific and sector risk and dial back turnover.
Combining individual factor sleeves--called a "mixing" approach--breeds mild overall factor exposure. Factor sleeves rarely overlap because stocks that score well in one factor may stack up poorly in another. For example, the value and quality sleeves tend to favor different companies and can wash one another out. Stretched in different directions, this portfolio ends up looking similar to the broad large-cap market.
While quiet, GSLC's factor exposure makes an impact. Its quality tilt is the most pronounced, but the fund's value component curbs exposure to trendy stocks, while momentum penalizes cheap firms that are moving in the wrong direction. Plus, the fund's sector constraints prevent unintended sector bets, leaving performance in the factors' more trustworthy hands. This fund should not out- or underperform the market by more than a couple percentage points per year, but its mild tilts and sound diversification make it a solid choice for investors dipping their toes into the multifactor pool.
WisdomTree U.S. Multifactor ETF
For investors with more conviction in the multifactor tack, Silver-rated WisdomTree U.S. Multifactor ETF, ticker USMF, is worth a look.
Rather than build distinct sleeves, USMF targets the stocks with the best combination of its four preferred factors: value, quality, momentum, and correlation. It admits only 200 companies and weights them by a blend of their factor exposure and inverse volatility. The fund also pins its sector composition to the broad U.S. market and caps each firm's weight at 4% of the portfolio.
This is a bolder approach that results in sharp factor exposure across the board. The portfolio trades at cheaper valuations than the Russell Midcap, its category benchmark, yet trounces that index in profitability metrics like return on invested capital. Momentum exposure has been solid. And perhaps most notably, the fund strikes a very defensive stance--the product of inverse volatility weighting and the correlation factor, which favors stocks that ebb when the market flows. That posture helped the fund rank within the top 15% of its category peers for the year to date through August.
Investors should not expect the same success from USMF when markets rally, but its pronounced multifactor exposure and downside protection make this a compelling mid-cap offering for the long run.
Hartford Multifactor Developed Markets (ex-US) ETF
For the last fund on my list, we'll turn our focus overseas to Silver-rated Hartford Multifactor Developed Markets (ex-US) ETF, ticker RODM.
This fund assigns a composite factor score to large- and mid-cap stocks across 22 foreign developed markets. Value makes up half the score, while momentum and quality represent 30% and 20%, respectively. The fund employs an optimizer to select and weight stocks, aiming to maximize the fund's composite factor score and reduce its volatility by 20% relative to the broad foreign developed market. The optimizer also constrains turnover and holds sector and country allocations within 2% of their market weight to curb unintended bets.
While this fund's optimized approach is opaque, it yields a dynamic portfolio that has delivered on its objectives. Value's marquee role pushes RODM to the large-value segment of the Morningstar Style Box, while the fund's momentum bent and profitability chops stand out. Plus, the fund dials back risk without simply avoiding volatile stocks as it considers firms' correlations with one another, breeding a well-rounded portfolio that has held up well in turbulent markets. Over the long run, this fund should deliver a more attractive risk/reward profile than the MSCI ACWI ex USA Value Index, its category benchmark.
Watch “3 Great ETFs to Play a Supporting Role in Your Portfolio” from Ryan Jackson for additional investment ideas.