Factor-based ETFs: where art and science meet
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By Fund Library News Wire  | Thursday, August 10, 2017



By Jay Bhutani, Senior Vice-President, AGF Investments Inc.

Factor investing is one of the most innovative approaches to earning strong, risk-adjusted returns over the long term while reducing volatility and drawdowns. But like all great innovations, factor investing continues to undergo refinements and enhancements to help investors of all kinds maximize the potential to reach their financial goals.

The implementation of factor investing can take many forms, from single factor exposure to one that incorporates a combination of factors. The expanding ETF product universe has variations that range from single to multi-factor approaches across both “smart beta” to more recent actively-managed options, like the suite of Quant-Shares ETFs powered by AGFiQ launched earlier this year. As of February 2017, actively-managed and strategic beta ETFs collectively accounted for 26.8% of total ETF assets, a 7.3% increase over the past three years*.

In what follows, we’ll first look at the building blocks of factor investing, and then consider how utilizing innovative multi-factor approaches can help you meet the challenges of an increasingly difficult and complex market environment.

Factor investing

A factor is a characteristic of a stock, for example, value, momentum, size, or quality, that is correlated with past returns and is expected to be correlated with future returns. For examples, see the box below.

Correlation does not imply a cause-and-effect relationship. It simply means that you will likely see positive returns when the factor is present. Research shows that the correlation between factors and positive returns has been largely stable over time.

Considering that investment performance is driven by various factors, it is important to note, as you can see in the table below, that over long periods of time, these factors can go in and out of favour at different points in the market cycle. In fact, the return differences by individual factors year to year can be significant. For example, momentum gained 19.91% in 2007 only to lose 39.92% in 2008.

Fund managers who use a factor-based investment approach do something similar with their investment screening. Instead of manually analyzing each stock themselves to see if it meets their criteria, advances in technology now provide managers with sophisticated tools to quickly assess thousands of stocks, automatically eliminating the ones that don’t exhibit the factors they are looking for. Stocks that meet the manager’s factor criteria may be added to the portfolio.

Factor-based investing seeks to achieve specific risk and return outcomes, away from a market-cap-weighted index. A single factor-based approach – for example, low volatility – in an effort to manage downside protection, may limit the potential for up-market participation and create underlying concentration risks from investing too heavily in one country, one sector, or one type of security.

A multi-factor approach solves for portfolio diversification and concentration risk. This approach may provide both better upside capture and effective risk management, benefits not offered when concentrating on a single-factor.

Multi-factor Approach + Active Management = Better Outcomes

At AGFiQ, we take a multi-factor approach that solves for various types of risk by analyzing over 140 factors – well beyond the four basic indicators presented earlier. Our active management approach allows us to evaluate risk differently and provide better downside protection while still allowing for upside participation. Through a wider universe of factors to screen securities against, there is greater potential to determine which factors are the actual drivers of performance, with a goal of maximizing investors’ wealth. Furthermore, when you solve for multiple types of risk, you can better focus on generating alpha without taking undue risk.

We believe the result is a fund that is both market responsive and risk aware, built on proven methods and research, plus the precision and consistency of cutting-edge technology. A true integration of the efficiencies of sophisticated technology, the science, with that of active, intelligent portfolio construction and oversight, our art.

*Source: Investor Economics Insight, Investment Funds Advisory Service – Canada, March 2017.

Jay Bhutani is Senior Vice-President, Head of ETF Strategy at AGF Investments Inc. This article first appeared in the Spring 2017 issue of Your Guide to ETF Investing, published by Brights Roberts Inc. Used with permission.


Notes and Disclaimer

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

AGFiQ Asset Management (AGFiQ) is a collaboration of investment professionals from Highstreet Asset Management Inc., a Canadian registered portfolio manager, and FFCM, LLC, a U.S. SEC-registered adviser. This collaboration makes up the quantitative investment team. QuantShares are ETFs offered by AGF Investments Inc. and managed by Highstreet Asset Management. QuantShares ETFs are listed on the Toronto Stock Exchange and may only be bought and sold through licensed dealers.

There is no guarantee that the ETFs will achieve their stated objectives as there is risk involved in investing in ETFs, which are outlined in their relevant prospectus. Before investing, you should carefully consider each ETF’s investment objectives, risks, charges and expenses. Commissions, management fees and expenses all may be associated with investing in QuantShares ETFs. The ETFs are not guaranteed, their values change frequently and past performance may not be repeated. Please read the prospectus carefully before you invest. A copy is available on AGFiQ.com.

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