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Using ETFs to enhance your returns

Technology is changing everything: your humble smartphone has millions of times the computational power of the spacecraft that took humans to the moon, you can go for weeks without withdrawing cash thanks to contactless payments, and apparently drones are now delivering burritos. Technology is transforming every aspect of our lives, and the way we invest is no exception. Exchange traded funds (ETFs) have made it possible to build diversified, low-cost portfolios of thousands of stocks and bonds with just a few trades on the ASX.

However that was just the beginning. Smart Beta ETFs take investing to the next level by automating the techniques that professional investors have been using since the 1930’s. Why settle for the market return (referred to as ‘beta’): you can now seek outperformance at a very low cost. This article examines how.

What drives stock returns?

For many decades, active investors have used ‘filters’ or ‘screens’ to identify attractive investment opportunities. These filters have typically targeted ‘factors’, the underlying drivers of return, in order to seek better performance. For example, two classic factors are size and value. Targeting size means investing in smaller companies – they may be more nimble – while seeking value means buying stocks that are believed to be trading cheaply, with lower price to earnings and price to book ratios relative to the broad market. Two other commonly targeted factors include quality and momentum. Professional investors have sought to outperform the market over the years by targeting one or more of these or other factors. Smart Beta ETFs are transforming investing by allowing investors to easily target these factors.

Table 1 – Factors targeted by iShares Multifactor ETFs

Source: BlackRock, as at 30 September 2017. For illustrative purposes only.

Which factor do I buy?

Each of the above factors tends to be rewarded in different market environments and economic cycles. For example, whereas undervalued companies tend to perform when the economy is in recovery mode, markets tend to favour quality stocks with strong balance sheets during recessions. Indeed, different factors have succeeded at different times, and studies suggest that timing factors is just as hard as picking stocks.

Table 2 – The Cyclical Nature of Factors

Source: BlackRock, as at 30 September 2017. For illustrative purposes only.

Accordingly, one response has been to use multiple-factor or ‘multifactor’ strategies, which provide diversified exposure across the four main factors to give investors the best of each exposure. Individual style factors may zig while the others zag, depending on the market environment, so a portfolio that uses a multifactor approach can potentially benefit in a variety of market conditions. What’s more; over the long-term, combining factor exposures may produce even more consistent results than factor exposures individually.

Does it work?

The aim of multifactor strategies is to provide outperformance over the course of the business cycle, so there may be periods where multifactor strategies underperform the broad market, but historical tests suggest that Smart Beta strategies consistently outperform over longer time periods. The past 12 months have been good for global stocks, the broad market delivering returns of almost 18%*. In the same period, the iShares Edge MSCI World Multifactor ETF (WDMF:ASX) has gained nearly 23%, as depicted in the chart below.

Chart 1 – 1 Year Return: World Multifactor ETF vs Market Capitalisation Weighted Index

*As measured by the MSCI World (AUD) Index, as at 17 October 2017. Performance figures represent past performance. Performance is not indicative of future performance and current performance may be higher or lower than the performance shown. Fund net performance is calculated on a NAV price basis, after fund management fees and expenses, and assume reinvestment of distributions. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index.

What’s next?

Smart Beta ETFs provide investors a low-cost, tax-efficient approach to investing. They can potentially improve investment results and increase transparency, often delivering many of the themes present in professional portfolios at a fraction of the cost. What does the future hold? The demand for smart beta is growing rapidly across both individual and institutional investors, who are benefiting from the increased transparency and efficiency of the ETF structure: a Russell study found that over 46% of asset managers report using smart beta investments. The next wave of smart beta ETFs will likely include more fixed income (bond) exposures, and potentially access to alternatives or portfolios with environmental, social & governance (ESG) considerations. Just don’t expect them to deliver burritos to you.

To learn more about BlackRock and iShares Smart Beta ETFs, click here.

About the author

Dhruv Nagrath , BlackRock

This material is issued by BlackRock Investment Management (Australia) Limited ABN 13 006 165 975, AFSL 230 523 (BlackRock Australia). This material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. Before making any investment decision, you should therefore assess whether the material is appropriate for you and obtain financial advice tailored to you having regard to your individual objectives, financial situation, needs and circumstances. This material is not a securities recommendation or an offer or solicitation with respect to the purchase or sale of any securities in any jurisdiction. BlackRock Australia is the responsible entity and issuer of units in Australian domiciled iShares ETFs, including those referred to in this material. BlackRock Australia is also the local agent and intermediary for non-Australian domiciled iShares ETFs that are quoted on ASX and issued by iShares, Inc. ARBN 125632 279 formed in Maryland, USA; and iShares Trust ARBN 125 632 411 organised in Delaware, USA (International iShares ETFs). BlackRock Fund Advisors (BFA) serves as an advisor to the International iShares ETFs, which are registered with the United States Securities and Exchange Commission under the Investment Company Act of 1940. BFA is a subsidiary of BlackRock Institutional Trust Company, N.A. (BTC). BTC is a wholly-owned subsidiary of BlackRock, Inc.®. Any potential investor should consider the latest product disclosure statement, prospectus or other offer document (Offer Documents) before deciding whether to acquire, or continue to hold, an investment in any BlackRock fund. Offer Documents can be obtained by contacting the BlackRock Australia Client Services Centre on 1300 366 100. In some instances Offer Documents are also available on the BlackRock Australia website at www.blackrock.com.au. An iShares ETF is not sponsored, endorsed, issued, sold or promoted by the provider of the index which a particular iShares ETF seeks to track. No index provider makes any representation regarding the advisability of investing in the iShares ETFs. Further information on the index providers can be found in the BIMAL website terms and conditions at www.blackrock.com.au. BlackRock Australia, its officers, employees and agents believe that the information in this material and the sources on which the information is based (which may be sourced from third parties) are correct as at the date of publication. While every care has been taken in the preparation of this material, no warranty of accuracy or reliability is given and no responsibility for this information is accepted by BlackRock Australia, its officers, employees or agents. Except where contrary to law, BlackRock Australia excludes all liability for this information. Any investment is subject to investment risk, including delays on the payment of withdrawal proceeds and the loss of income or the principal invested. While any forecasts, estimates and opinions in this material are made on a reasonable basis, actual future results and operations may differ materially from the forecasts, estimates and opinions set out in this material. No guarantee as to the repayment of capital or the performance of any product or rate of return referred to in this material is made by BlackRock Australia or any entity in the BlackRock group of companies. No part of this material may be reproduced or distributed in any manner without the prior written permission of BIMAL. © 2017 BlackRock, Inc. All Rights reserved. BLACKROCK, iSHARES and the stylized i logo are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. This article was first published on 25 October 2017. This article does not reflect the views of nabtrade.

Dhruv Nagrath

BlackRock

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