The fund targets stocks with high exposure to value, momentum, small size, and quality factors. By spreading its bets across a wide variety of stocks and adhering to strict risk constraints, this fund avoids uncompensated risks and earns a Positive Process Pillar rating.
The fund selects its holdings from the large- and mid-cap-focused MSCI World Index. It uses a complex optimiser to maximise its desired factor exposure while considering each stock's factor exposures and correlations with each other, under a set of constraints to reduce uncompensated bets. By integrating stocks' targeted factor scores, the strategy can achieve deeper tilts than if it mixed separate factor portfolios together. The strategy uses a composite of three equally weighted value and quality metrics within each sector to measure stocks' value and quality factor loadings, respectively. The fund measures momentum across sectors using 12- and six-month relative price strength and "historical alpha." Historical alpha measures each stock's two-year risk-adjusted excess return.
The United States accounts for approximately 55%-60% the index value, followed by Japan (13%-15%), the United Kingdom (5%-7%), and France (3%-5%).
Information technology is the index’s largest sector, with a 20%-25% weighting, followed by industrials (15%-20%) and financial services (10%-15%).
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With an ongoing charge of 0.50%, the iShares Edge ETF is cheaper than the bulk of its category peers and is adequately priced compared with other multifactor exchange-traded funds.
Index funds should provide the returns of their benchmark, less fees. However, the fund typically outperforms its benchmark. This is partly due to the quality of portfolio optimisation. But it can also be attributed to the fact that the fund is domiciled in Ireland and benefits from a lower dividend-withholding tax rate on US stocks than the one used for index calculations. Besides, the fund also benefits from securities-lending revenues.
The fund’s annualised tracking error has been relatively low. Tracking error is a measure of how consistently a fund tracks its benchmark index. The closer the tracking error is to zero, the better or more efficient the fund is.
Investors should also consider trading costs, including bid-ask spreads and brokerage fees, when buying and selling the ETF.
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IShares uses physical optimised replication to replicate the performance of the MSCI World Diversified Multiple Factor Net Return Index. Instead of holding all the index’s constituents in the same weightings, the fund holds a sample basket of securities that reflects the return and risk characteristics of the index. While this replication method helps minimise trading costs, it can create tracking error. The fund uses futures for cash management purposes. This is standard practice and helps limit tracking error.
IShares engages in securities lending and can lend up to 100% of the securities within the fund to improve its performance. The gross revenue generated from this activity are split 62.5/37.5 between the fund and the lending agent BlackRock, whereby BlackRock covers the costs involved. The fund lent out 2.6% on average, generated 0.01% net income, and had 8% of the portfolio maximum on-loan over the past 12 months ended December 2017. To protect the fund from a borrower’s default, BlackRock takes collateral greater than the loan value. Collateral levels vary between 102.5% and 112% of the value of the securities on loan, depending on the assets provided by the borrower as collateral. Additional counterparty risk-mitigation measures include borrower default indemnification. Specifically, BlackRock commits to replace the securities that a borrower would fail to return. The indemnification agreement is subject to changes, in some cases without notice.
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The iShares Edge MSCI World Multifactor ETF’s stringent approach to risk management makes it a good core proposition for the long-term investor.
This fund seeks to maximise its exposure to stocks with attractive value, momentum, small size, and quality characteristics while matching the risk level of its parent index, the MSCI World Index. The fund uses an optimiser to construct its portfolio that weighs each stock’s targeted factor characteristics against its risk contribution.
Empirical research has shown that these factors have systematically generated higher risk-adjusted returns and have beaten the market over the long term. Generally, the outperformance of single factors has tended to vary over time. Meanwhile, by allocating across multiple factors, the fund diversifies its sources of outperformance and provides investors with a smoother ride across different market regimes.
This strategy has delivered stronger value and mid-cap tilts than its multifactor peers in the Global Large-Cap Blend Morningstar Category. It aggressively pursues its targeted factors and has a higher active share than many other multifactor strategies. This strategy further strengthens its style tilts by considering its holdings' factor exposures holistically rather than mixing stocks that score well on different individual factors, which can dilute the portfolio's factor exposures. This integrated approach should slightly improve the fund's return potential.
The fund has delivered above-average risk-adjusted performance during the past trailing one-year period and since its inception in September 2015 when compared with peers in the category, which includes actively managed funds.
IShares Edge MSCI World Multifactor ETF targets stocks that have higher-than-average exposure to time-tested factors that have historically been associated with market-topping performance. The fund's factor tilts are stronger than most of its peers, but its portfolio construction is opaque and complex. The fund's relatively low fee and stringent risk management should contribute to its edge over the long run, but its short live track record limits its Morningstar Analyst Rating to Bronze.
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This fund targets stocks with strong value, momentum, small size, and quality characteristics, which have historically been associated with better performance in nearly every market studied over long horizons. Each factor that this fund targets has a reasonable risk-based and/or behavioural explanation that has been extensively tested in academia and practice. Although these factors have strong long-term track records, each can underperform the broad market for extended stretches. Combining factors with low correlations to one another, such as value and momentum, can yield a more stable risk/return profile than any single-factor fund in isolation. A smoother ride may help investors to stay the course when a particular factor experiences a dry spell.
The fund uses well-established metrics to measure factor exposures and considers how well a stock scores across all four of its targeted factors to select and assign weightings in the portfolio. Strategies that use an integrated factor combination approach like this one can achieve more-aggressive factor tilts than those that use a portfolio-mixing approach. Portfolio mixing combines separate single-factor sleeves into an overall portfolio. The advantages of portfolio mixing include transparency and that it is easier to attribute performance across factor sleeves. But these strategies run the risk of combining offsetting positions from separate sleeves that dilute factor exposures in the final portfolio. Although this fund uses an integrated approach, it includes several risk constraints that limit its tracking error to the large-cap global developed market. These risk controls protect the fund from taking large uncompensated bets but obscure its portfolio construction process.
The fund uses an optimiser to maximise its factor tilts while matching the risk level of its parent. The optimiser layers on constraints such as limiting turnover and individual stock and sector tilts relative to its selection universe, the MSCI World Index. The optimiser also strives to minimise the fund's exposure to nontargeted factors such as dividend yield and liquidity. These risk controls likely reduce the fund's style purity. The portfolio that results from this complicated construction process ends up in the Global Large Cap Blend Morningstar Category.
Although this fund lands in the Large Cap Blend Morningstar Category, it may behave differently from the average fund in the category. The fund's average holding has a market capitalisation of USD 19 billion, which is approximately one fourth of the category average. This smaller size orientation stems from the fund's explicit targeting of smaller stocks and from breaking the link between market capitalisation and its weightings. Because the fund anchors its sector weightings to a broad market-cap-weighted index (MSCI World Index), its sector weightings differ substantially from its category. As of this writing, the fund has overweightings in basic materials, real estate, industrials, and technology at the expense of financial services, communication services, consumer defensive, and healthcare.
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Investors have three other global multifactor ETFs to choose from.
The synthetically replicated Lyxor J.P. Morgan Multi-factor offers exposure to quality, value, low size, low beta, and momentum at only 0.40%. Its underlying strategy, the J.P. Morgan Equity Risk Premia World Multifactor Index, is made up of five equally weighted single-factor indexes.
Another option is the Source Goldman Sachs Equity Factor Index World ETF, also synthetically replicated. It levies an ongoing charge of 0.65%. The index offers exposure to quality, value, low size, low beta, and momentum, controlling for country and sector risk versus the broad market. Each factor is weighted according to its risk contribution, once correlations between factors are considered. To mitigate idiosyncratic risk, each constituent is capped at 0.5%.
And lastly, the third option is the Amundi Index Equity Global Multi Smart Allocation Scientific Beta (ongoing charge: 0.40%). The underlying strategy offers exposure to value, low size, low volatility, and momentum. Then, the factors are weighted by using a combination of five equally weighted diversification strategies that include maximum deconcentration, maximum decorrelation, efficient minimum volatility, efficient minimum Sharpe ratio, and diversified risk weighted. The final step, which tackles the factor allocation, aims to minimise the relative tracking error versus the market.
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