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Seeking higher returns or
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Contents
Seeking higher returns or lower risk through ETFs
03
Factors and the rise of smart beta
06
Reducing risk through smart beta strategies
06
Enhancing return through smart beta strategies
08
Smart beta ETFs
09
The iShares Edge Minimum Volatility ETFs
10
The iShares Edge Multifactor ETFs
11
2
Seeking higher returns or lower risk
through ETFs
Exchange-traded products (ETPs) continue to grow
economies, equity sectors (such as healthcare and
in popularity, among both retail and institutional
consumer staples), and other asset classes, such
investors. According to the September 2016 edition
as fixed income, commodities and currencies. The
of the BlackRock Global ETP Landscape, 2016 could
newest generation of ETFs encapsulate exposure to
end up being the biggest year ever for ETPs. Global
fundamental factor-based or “style based” strategies.
ETPs gathered US$30.5 billion in September, with
Factors
year-to-date flows climbing to US$243.8 billion,
ahead of 2015’s record-setting pace. There’s now
These ETFs target particular “factors”, which are
US$3.39 trillion invested in ETPs.
fundamental
underlying
drivers
of
long-term
investment return. Factors can be macro-economic,
One of the main reasons why ETPs and exchange-
such as the pace of economic growth and inflation,
traded funds (ETFs) have been some of the most
which can explain returns across asset classes
successful investment products ever launched is
like stocks and bonds: for example, strengthening
that they cover a very wide range of asset classes
economic growth can boost stock prices while rising
and investment exposures, accessible through one
inflation can drive bond prices lower.
listed stock. Retail investors in particular use ETFs
to obtain a range of precise exposures, to more
Alternatively, these factors can be “style” factors,
effectively diversify a portfolio.
which help to explain returns within asset classes.
Most of the new generation of ETFs target equity
style factors.
“One of the main reasons
why ETPs and ETFs have
been the most successful
investment products ever
launched is that they
cover a very wide range of
potential applications.”
For example, within equities, “value” stocks –
which have low prices relative to fundamental
measurements (such as price/equity ratio, dividend
yield or net asset value) – have historically outperformed the broad equity market over the long
term.
The style factors this guide will focus on are: value,
momentum, quality, smaller size (market
capitalization) and minimum volatility. These
factors cater for investors who want stock market
The progression of ETF product development has
exposure, but would like that exposure to be
offered Australian investors access to broad global
designed so as to harness factors to target particular
mainstream market-cap share indices (for example
outcomes.
the MSCI World and the S&P 500), single-country
indices in both the developed world and emerging
3
Let’s look at these factors more closely.
are likely to outperform stocks that showed poor
performance in the period, in the belief that the
stocks with strong momentum will generate excess
Value
return in the next period. This is often a technically-
Value stocks are considered cheap because they are
driven (price charts) strategy.
out of favour with the market and are consequently
priced low, relative to the company’s earnings or
assets. A value stock is usually considered to have
Company quality
a relatively low price/earnings (P/E) ratio and a low
Company “quality” is usually assessed on criteria
price to net tangible assets (NTA) value, but a high
such as balance sheet strength, low debt levels,
dividend yield (because its price has fallen). Value
a record of consistent earnings and dividend
investors look for such value anomalies and buy
growth, high return on equity (ROE), profitability,
the stock because they believe that the market will
management efficiency, consistently rising cash
eventually recognise its true value and the stock will
flow generation, high dividend payout ratios and
be re-evaluated (bid up in price). Inexpensive stocks
sustainable competitive advantage.
– relative to these fundamental measurements –
have tended to outperform.
Some of these criteria are more subjective than
others, but the term “quality” generally denotes
Price momentum
companies
that
historically
have
weathered
Momentum refers to the rate of change of a price. A
economic and market downturns better than
stock changing price quickly has momentum: there
other stocks. Quality stocks traditionally have their
is an empirically observed tendency for stocks rising
strongest relative performance during economic
in price to keep rising, and for stocks with falling
downturns. Quality can be considered a defensive
prices to keep falling. Momentum investing seeks
attribute: it has tended to under-perform, on a
to ride this trend, to buy stocks with strong past
relative basis, only during stronger economic times.
performance in a particular period because they
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Size (capitalisation)
Minimum volatility
Small caps – or small market capitalisation
The stocks in a market index that show the lowest
companies – generally tend to outperform their
historical volatility – that is, they fluctuate in price
larger counterparts, for a range of reasons. They
less than the overall index – tend to be more mature
often have high growth rates, and there is often
companies that are less dependent on continued
an exploitable ‘information gap’ because they are
economic growth: such stocks also tend to have
poorly covered by analysts, and as this gap is filled,
higher than average dividend yields. They tend to fall
the small-cap stocks can appreciate in value quite
by less in market downturns, but they also tend not
quickly. Small, high-growth companies have tended
to rise as much in market rallies.
to outperform their larger counterparts. (There
is no universal definition for “small capitalisation,”
which differs from market to market: in Australia,
for example, “small caps” usually refers to stocks in
the S&P/ASX Small Ordinaries Index, which have a
market value of about $2 billion or lower.)
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Factors and the rise of “Smart Beta”
Investors have become conditioned to think of
Smart beta strategies are growing in popularity, with
“beta” as the market return from an asset class. In
most strategies available today investing in stocks.
equities, beta is usually sought through exposure to
Whether they use a multiple factor or a single factor
a broad market index based on market capitalisation
approach, smart beta strategies give investors the
weights. A newer approach is to target “smart beta,”
potential to fine-tune their exposures and reduce
through strategies that aim to outperform traditional
unintended risks. As a result, using smart beta
benchmarks by targeting exposure to one or more
strategies can result in a more deliberate allocation
of these factors.
to potential sources of risk and return, so as to
enhance the possibility of extra returns – while
Like traditional beta strategies, smart beta strategies
bearing a similar amount of risk as the market – or
also use rules-based indexes; investing in factor-
to reduce risk.
driven indices through smart beta strategies can
allow investors to seek improved returns, reduced
Smart beta strategies blend the characteristics
risk or enhanced diversification. The factors that can
of active and passive investment. They can be
be targeted for smart beta are clear and persistent
considered active in that they can potentially
drivers of investment returns that have been
enhance returns and reduce risk through exposures
identified in the professional investment markets for
to proven drivers of return. But they are passive in
many years, and which have given investors excess
that they are index-driven, and their implementation
returns (that is, over the broad stock market index)
is transparent, systematic and rules-based. This
over extended time frames.
1
means that they tend to have lower fees and higher
capacity than traditional active strategies.
Reducing risk through smart beta
strategies
Some smart beta strategies are built with the goal of
Minimum volatility funds have historically lost less
reducing risk. These “minimum volatility” strategies
during market declines but have still captured
have historically delivered market-like returns with
meaningful gains during market upswings. As
less risk, by targeting lower volatility stocks. Some
shown below, using back-tested data, over the last
minimum volatility strategies will also take into
ten years, the MSCI Australia IMI Select Minimum
account the correlations among stocks and will
Volatility Index has captured 87.7% of the upside of
have guardrails in place to limit sector and country
the broader market but only 73% of the downside.
concentrations.
1. BlackRock publication Smart Beta: Capturing the Power of Factor Investing, Page 2. This publication does not define the “excess returns,”
nor the “extended time frames”. Past performance is not a reliable indicator of future performance.
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Over the same period, the MSCI World Minimum
them over entire market cycles to realise their full
Volatility (A$) Index has captured 70.7% of the
potential benefits. There are minimum volatility
upside, but only 52.1% of the downside. (Upside
strategies that are constructed to mirror the sector
and downside capture ratios measure the portion
and country exposures of a broad market index, so
of broad market return captured by a given index in
investors can use them as long-term building blocks
positive months and negative months respectively.)
for their portfolios. 2
Because minimum volatility strategies are designed
to work best during periods of market volatility and
over the long term, you might consider holding
2.BlackRock, MSCI, as of 31 August 2016.
Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot
invest directly in an index.
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Enhancing return through smart
beta strategies
While minimum volatility strategies are designed to
debt levels and stable earnings. To implement this
reduce risk relative to the overall market, investors
in their portfolio, investors could tactically use a
have used smart beta strategies with exposures to
“quality” exposure as a single-factor smart beta
factors like value, quality, momentum and smaller
strategy.
size (market cap) to seek enhanced returns with
similar amount of risk as the market.
Alternatively, an investor could choose to balance
a share portfolio skewed toward growth stocks by
introducing a smart beta equity fund tilted toward
Single-factor strategies
value. With single-factor smart beta funds, investors
Smart beta strategies capturing one factor can
can build custom portfolios that reflect their own
be used tactically or they can be used to help
investment views and needs. Having said that, there
portfolio diversification. For example, during the late
is evidence to suggest that it is difficult to pre-empt
economic cycle when earnings are deteriorating and
or ‘time’ factors. That is where multifactor strategies
financially healthy stocks are in particular favour,
can help.
investors might do better holding stocks with low
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target key drivers of return while owning a portfolio
Multifactor strategies
with a similar profile and risk to the broad stock
Multifactor strategies are designed to provide
market: in effect, this means that multi-factor equity
diversified exposure to several factors. Depending
funds are diversified portfolios that can be used for
on the market environment, individual style factors
long-term core allocations.
may be more or less relevant, so a portfolio using
a multi-factor approach can potentially add value
The table below explains what factors these
in a variety of market conditions. Over the long
multifactor strategies incorporate and how they are
term, combining factor exposures may produce
calculated.
even more consistent results than factor exposures
3
individually. Smart beta multifactor strategies help
Quality
Financially healthy firms with strong balance sheets typically
outperform lower quality stocks over time
Higher return on equity, earnings
consistency, lower debt to equity
Value
Stocks that are inexpensive relative to their fundemental value generally
outperform growth stocks.
Lower P/E and P/B
Size
Smaller companies, often overlooked or mispriced, have tended to
outperform larger cap stocks
Lower market cap
Momentum
Trending stocks have historically continued to appreciate due to the
“herding effect” of return-following investors
Price appreciation
Smart beta ETFs
New-generation smart beta ETFs are designed
The new iShares Edge range of Smart Beta ETFs
to give investors effectively the ability to diversify
consists of four minimum volatility and multifactor
within the return stream of equities, by capturing
funds designed to provide Australian investors with
investment factors or market inefficiencies in a
a low-cost way to strengthen portfolios, by reducing
rules-based, transparent manner.
risk or enhancing returns. In an environment with
lower returns and increased volatility, being able to
Smart beta ETFs are built around a different index to
generate outperformance or reduce stock market
the traditional market-capitalisation-based indices,
risk at low cost is increasingly important to investors.
with the index designed to harvest a different return
– allowing heightened diversification as well as the
opportunity to earn enhanced risk-adjusted returns.
3. BlackRock publication Smart Beta: Capturing the Power of Factor Investing, Page 3.
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iShares Edge Minimum
Volatility ETFs
The iShares Edge Minimum Volatility ETFs are
risk. Importantly, their benchmark indices have lost
available across Australian and global equities.
less during downturns, when broad markets have
They seek to deliver market-like returns with less
suffered. 4
Fund Name: iShares Edge MSCI Australia Minimum Volatility ETF
Ticker: MVOL
Fee*: 0.30%
Description:
This ETF aims to give investors a diversified exposure to Australian stocks and achieve returns in line with the
market, while incurring potentially less risk. The ETF is designed to allow investors to invest with confidence
through market cycles, with a strategy that aims to reduce losses relative to the broader market during
downturns. Using back-tested data, the ETF’s benchmark index, the MSCI Australia IMI Select Minimum
Volatility (A$) Index, has delivered similar return to the MSCI Australia IMI (A$) Index but with significantly
less risk. 5
Fund name: iShares Edge MSCI World Minimum Volatility ETF
Ticker: WVOL
Fee*: 0.30%
Description:
This ETF aims to offer diversified exposure to a broadly diversified portfolio of global stocks, achieving
returns in line with the MSCI World Index with potentially less risk. The ETF is designed to allow Australian
investors to diversify into global stocks with confidence through market cycles, with a strategy that aims
to reduce losses relative to the broader market during downturns. Using back-tested data, the ETF’s
benchmark index, the MSCI World Minimum Volatility (A$) Index, has delivered similar return to the MSCI
World (A$) Index but with significantly less risk. 6
4. https://www.blackrock.com/au/individual/ishares/smart-beta
5. https://www.blackrock.com/au/individual/literature/brochure/ishares-edge-au-minimum-volatility-brochure.pdf
6. https://www.blackrock.com/au/individual/literature/brochure/ishares-edge-world-minimum-volatility-brochure.pdf
Past performance is not a reliable indicator of future performance. Index performance returns do not reflect any management fees,
transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index.
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iShares Edge Multifactor ETFs
The iShares Edge Multifactor ETFs are also available
companies that have the potential to deliver above
across Australian and global equities. These ETFs
market returns over the long term, with similar risk
provide a cost effective way to seek outperformance
and exposure to the broad market, by focusing on
by investing in either domestic or international
the four main factors identified above.
Fund name: iShares Edge MSCI Australia Multifactor ETF
Ticker: AUMF
Fee*: 0.30%
Description:
This ETF is designed to harvest factor-driven outperformance over the long term in a portfolio of Australian
stocks with a similar profile and risk to the broad market. The ETF aims to target four proven drivers of return
in Australian equities: quality (financially healthy firms), value (inexpensive stocks), size (smaller companies)
and momentum (stocks in a rising price trend). Using back-tested data, the ETF’s benchmark index, the
MSCI Australia IMI Diversified Multiple-Factor (A$) Index, has outperformed the MSCI Australia IMI (A$) Index
over the long-term, achieving improved returns while running a similar level of risk. 7
Fund name: iShares Edge MSCI World Multifactor ETF
Ticker: WDMF
Fee*: 0.35%
Description:
This ETF aims to generate factor-driven outperformance over the long term in a portfolio of global developed
market stocks, while bearing a similar profile and risk level to the broad market. The ETF aims to target four
proven drivers of return in a diversified international shares exposure: quality (financially healthy firms),
value (inexpensive stocks), size (smaller companies) and momentum (stocks in a rising price trend).
7.https://www.blackrock.com/au/individual/literature/brochure/ishares-edge-au-multifactor-brochure.pdf
Past performance is not a reliable indicator of future performance. Index performance returns do not reflect any management fees,
transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index.
11
Why iShares for Smart Beta?
BlackRock is a pioneer in factor-based investing,
provide an easy, transparent and low-cost way to
with decades of expertise in factor research and
access factors, targeting outcomes such as reducing
implementation. iShares Edge Smart Beta ETFs
risk or enhancing returns.
The most comprehensive
Over 30 years of experience
Backed by BlackRock, trusted to
range of smart beta ETFs
and rigorous research in factor
manage more money than any
listed on the Australian
based investing and index based
other investment manager in
Securities Exchange (ASX).^
asset management.
the world.*
^Source ASX, as at 14 October 2016.
*Based on US$5.117 trillion in AUM as of 30 September 2016.
* Management fee as a percentage of a fund’s net asset value. Subject to change.
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