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1 November 2018

Differentiate between ETFs with Factors

Currently there are over 1,500 equity ETFs available on the market, these comprise regional, sector, single and multi-factor strategies and to complicate things further ETFs are also being constructed using a combination of these.

Comparing ETFs may seem straightforward when focusing on one category, however even these ETFs can be exposed to various factors and different portfolio construction methodologies. As the popularity of ETFs increases, comparison across multiple products will only become more and more complex. How can investors best manage this confusing selection process without becoming completely overwhelmed?

What’s in a name?

Investors are faced with a number of challenges when examining ETFs. There is inconsistency, for example, in the labelling used to describe funds with a number of different terms being used, such as: Enhanced Volatility – Low Volatility; Managed Volatility – Optimised Volatility; and Minimum Variance – Low Beta. Likewise, it is extremely difficult for investors to discern amongst products tagged with a ‘multi-factor’ strategy.

Overall, given that there are many potential drivers of returns in any investment portfolio, investors need to get a deeper handle on what they are getting when investing in a particular ETF or any strategy for that matter. It is important to know if the drivers of returns you expect, could be clustered around more than just one style. For example, a Value ETF could be significantly exposed to cheaper ‘value’ factors like Book/Price and Cash Flow Yield. Yet, along with these factor exposures might come many others, such as more or less exposure to ‘income’ factors or quality factors. If you could understand what other exposures you are getting along side your desired style, it might make deciding which ETF to choose, that much easier.

Transparent analysis across all fund types

Although factor investing is on the rise and being embraced by the industry to gain competitive advantage, essentially every portfolio or fund (including ETFs) has a factor orientation, regardless of strategy. Since factors provide the most transparent way to analyze these funds, investors would be amiss to ignore the substantial insight that factor analysis can bring.

Because at Style Analytics we have been performing factor analysis for over 20 years, we recognize the value that factor analysis can bring in evaluating all investments, going above and beyond the recent trend and popularity of factor-based strategies. We are the only independent firm that focuses exclusively on factor analysis and we fundamentally believe that our factor-based analytical tools provide the transparency, which is key in adding value and building trust with an end investor.

Intuitive and independent

There is a growing need for investors to understand how seemingly similar ETFs are actually different, beyond simply fees and performance. Through the analysis of factors, investors can better discern how different ETF options fit into their overall plan. Research can also be extended beyond simply the headline theme or exposure, so as to determine whether different factor exposures fit in with the broader goals or criteria of a portfolio. Furthermore, investors can utilise factors in the analysis of all manner of portfolios, not just simply ETFs, to gain transparency and ultimately a better understanding of their investments overall.

Want to know more? We talked with on how factor analysis can help investors compare equity ETFs, and how critical factor analysis is for ETF issuers looking for differentiation and growth. Click Here to watch.