In recent years, the number of multi-factor exchange traded funds for advisors to evaluate has grown in exponential fashion. The different products underscore the benefits of model portfolios for multi-factor allocation.
The WisdomTree U.S. Multi-Factor Model Portfolio is an excellent starting point for asset allocators, considering its exposure to ETFs rooted in several investment factors.
“This model portfolio is designed for investors with a long-term horizon looking for exposure to a broad universe of U.S. equities primarily using factor focused ETFs,” according to WisdomTree. “The selected ETFs provide certain factor tilts that have the potential to generate excess return relative to comparable cap-weighted benchmarks over longer-term holding periods. The strategies may use both WisdomTree and non-WisdomTree ETFs.”
"The case for multifactor funds is the case for diversification"
The WisdomTree model portfolio is a direct, effective avenue for multi-factor exposure, and reduces the need for evaluating dozens of funds.
“As the options have grown, so has investors’ research burden. These funds are diverse and often among the most-complex index strategies on the market,” writes Morningstar analyst Alex Bryan. “While many of these strategies may sound similar, there are important differences in their approaches to portfolio construction, which often yield very different portfolios and performance.”
This model portfolio is comprised of seven ETFs, spanning large-, mid- and small-cap equities. At the factor level, size, quality, growth, and value, among others, are represented.
These various factors have exhibited specific characteristics that allowed them to outperform their peers. For example, low volatility include stocks that exhibit lower volatility tend to perform better than stocks with higher volatility. Momentum refers to stocks that rise or fall in price tend to continue rising or falling.
Investors can use these multi-factor strategies to capitalize on the cyclicality of factor performance through a dynamic overlay that screens for leading economic indicators and market sentiment to gauge the current market environment and increase exposure to the areas that tend to fare best in the given conditions.
These types of factor-based investments help investors steer away from the potential risks associated with traditional market-cap weighted funds that can grow top-heavy, especially in a prolonged bullish environment.
“The case for multifactor funds is the case for diversification,” notes Bryan. “Just as it’s prudent to diversify across asset classes, sectors, regions, and securities, it’s a smart idea to spread bets across multiple factors that each have a good chance of long-term success. Doing so can reduce risk and make it easier to stick with these factors through their inevitable rough patches.”
For more on how to implement model portfolios, visit our Model Portfolio Channel.