Multi-factor smart beta ETFs perform well amid volatile conditions

Sep 4th, 2015 | By | Category: Equities

For many, the investment holy grail is a strategy that will outperform across all stages of the market cycle. Multi-factor smart beta strategies are one of the more recent attempts to achieve this. The heightened volatility witnessed so far in 2015 has provided an excellent backdrop against which to judge their performance.

Multi-factor smart beta performs well amid volatile conditions

Combining well understood smart beta strategies may help weather volatile markets.

Individual factor smart beta strategies have historically provided excess returns versus market-cap weighted indices, but this performance is not consistent and periods of underperformance may need to be endured in order to reap the rewards in the long term.

Low-volatility strategies, for example, which are known for their defensive characteristics, are expected to outperform in volatile and falling markets. Thus far this year they appear to have lived up to this expectation, with the MSCI World Minimum Volatility Index essentially flat year to date while its parent index, the MSCI World, is down 3.8%. Of course, in less volatile periods this factor may underperform. This is borne out by the performance of the MSCI World Value Weighted Index, reflective of the value factor, which is down year to date, demonstrating that factors don’t always outperform in all market environments.

The question is whether a combination of these factor strategies will produce the excess returns expected of the individual factors or will the opposing forces wash out any potential upside?

The outperformance of Scientific Beta Multi-Beta Multi-Strategy Indices, produced by EDHEC-Risk Institute’s smart beta arm, Scientific Beta, offers evidence in support of multi-factor strategies. Their range of indices have posted positive relative year-to-date performance in comparison to their cap-weighted counterparts, with an average outperformance of 3.1%. During the month of August alone, these same indices all made positive returns, with an average outperformance of 1.6%.

According to Scientific Beta, multi-factor offerings aim to provide robust performance in relation to cap-weighted indices in all market conditions. This robustness is due to the balance of factor exposures and a good diversification of weighting schemes. This enables each of the multi-factor indices to benefit over the long-term from exposure to the rewarded risk factors that they represent and for volatility to be reduced by the diversification technique.

Scientific Beta’s flagship Multi-Beta Multi-Strategy Index offers investors exposure to a smart beta strategy which blends four equity factors (volatility, valuation, size and momentum) with a combination of smart beta diversification strategies. By diversifying across factors, the strategy attempts to smooth the time-varying relative performance of the individual factors. It could constitute a core holding for long-term investors looking for global equities exposure and the opportunity to outperform capitalisation-weighted indices.

These indices are provided based on two factor weighting methodologies: equally weighted and equal contribution to risk (tracking error). Both can be accessed in an ETF structure via the Morgan Stanley Scientific Beta Global Equity Factors UCITS ETF (GEF LN), which tracks the equally weighted index, and the Amundi ETF Global Equity Multi Smart Allocation Scientific Beta UCITS ETF-A EUR (SMRT FP), which tracks the equal contribution to risk index.

Alternatively, investors can tailor their own multi-factor portfolio to their expectations and requirements using single factor ETFs from the likes of Lyxor, iShares and Deutsche AWM. These issuers offer suites of factor-based ETFs which cover, amongst others, the low-volatility, quality, size, value and momentum factors.

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