Factor-based investing has become very popular over the past few years, and the best evidence of this claim is the proliferation of factor-based (often called Smart Beta) ETFs that are available to investors.
I have my own factor-based trading strategies, which I offer on a subscription basis and deliver in a weekly newsletter format. But today I want to share my watch list of ETFs that any investor can use to broaden the scope of their portfolio diversification.
In coming up with this list I used a few screening criteria, because there are too many of these funds to manage easily. I screened for size, return history, Sharpe ratio, adherence to the factor in question, quality and experience of the management team, and how long the fund has been in existence.
Let’s go through some of these items, and see who pops up on my list.
Size of the fund
One criterion is the amount of assets under management (AUM) in the fund. I used an arbitrary number of $1 billion USD. I also considered trading volume, but these big funds are liquid enough for almost any investor. In the tables below I show both AUM and trading volume.
Performance of the fund
For the performance screen I used the 2018 YTD numbers as an approximation of how well these funds performed during a rising market where the bar set by the S&P 500 is quite high. I did not look at the performance during bear markets because very few of these funds were in existence in 2008.
As you scan the tables, be sure to compare each fund’s performance to the other funds in the same category. That’s the only way to get a true sense of how well that particular fund did year-to-date.
Sponsorship of the fund
I screened for quality of the sponsoring firm, and the management team running each fund. I got this data from Morningstar, ETF.com, and Thomson Reuters. It’s very hard to judge the quality of a management team, but I tried to focus on process, rather than personality of the managers.
This is a measure of how efficiently a manager is able to squeeze returns out of each unit of risk. The data is available from Morningstar and others, and is fairly easy to find. I used an arbitrary benchmark of the top half of Sharpe ratios for each factor category. The idea was to eliminate funds that were being run inefficiently, relative to the level of risk being taken.
Adherence to the factor
During my research into factor investing over the last few years, it became obvious to me that some fund managers cheat. They cheat by including high-beta stocks into their portfolios, some of which are not part of the factor family in question. When I saw evidence of this, I eliminated the fund from consideration.
Length of time in existence
I imposed an arbitrary hurdle of three years for longevity. My reasoning was that any fund manager can make a big splash right out of the gate, especially when the fund they are running has been simmering in an incubator for a couple of years and is suddenly showing signs of outperformance.
Three years is a long time to ride on the coattails of an incubator record, which is why I chose this time frame.
Here is the list of factor-based ETFs that passed my screening algorithm. There is something here for everyone, whether you are a dividend seeker, a quality aficionado, or a momentum junkie.
Scan the list and see if you spot something that catches your eye. If you buy the ETF and it goes up, thank me. If it goes down, well that was your own fault!