In the first part of this post, we analyzed a couple of iShares smart beta ETFs, the iShares Edge MSCI USA Size Factor ETF (SIZE) and the iShares Edge MSCI USA Value Factor ETF (VLUE).

Let’s start the second part with the evaluation of the iShares Edge MSCI USA Momentum Factor ETF (MTUM). Its issuer states that this ETF generates

Exposure to large- and mid-cap U.S. stocks exhibiting relatively higher price momentum

As before, the analysis will start in the first full month of the ETF’s existence and end in July 2016. Here is the cumulative RealAlpha™ chart with related statistics for the ETF:

Cumulative RealAlpha™ for iShares Edge MSCI USA Momentum Factor ETF (MTUM)

The ETF produced a return comparable to that of its reference portfolio, which had a lower volatility. The RealBeta™ of the ETF was considerably below than that of a broad-based equity market ETF.

The following chart and associated statistics show the constant composition of the reference ETF portfolio for the iShares Edge MSCI USA Momentum Factor ETF:

Reference Weights for iShares Edge MSCI USA Momentum Factor ETF (MTUM)

The ETF had major equivalent positions in the Consumer Staples Select Sector SPDR® Fund (XLP), First Trust Large Cap Growth AlphaDEX® Fund (FTC), Health Care Select Sector SPDR® Fund (XLV), PowerShares Dynamic Large Cap Growth Portfolio (PWB), First Trust Dow Jones Internet Index Fund (FDN), and PowerShares NASDAQ Internet Portfolio (PNQI). (The Other component in the chart collectively represents additional two ETFs with smaller weights.)

Not surpringly, the ETF had a strong tilt toward large-cap growth stocks, especially in the consumer staples and healthcare sectors, as well as the Internet industry. Unlike with the previous iShares smart beta ETFs, no single position was clearly dominant in its reference portfolio. It can also be reasonably expected that in the future, the ETF’s exposure to specific sectors and industries will change along with price momentum shifts. Therefore, for a further performance comparison, a similar smart beta equivalent position should be chosen.

Over the same analysis period, MTUM outperformed FTC and PWB in terms of the annualized return and Sortino ratio, and had an equal or higher Sharpe ratio:

Total Return of iShares Edge MSCI USA Momentum Factor ETF (MTUM), First Trust Large Cap Growth AlphaDEX® Fund (FTC) and PowerShares Dynamic Large Cap Growth Portfolio (PWB)

At 0.15%, the expense ratio of MTUM was much lower than the 0.62% of FTC and 0.57% of PWB, which improved relative returns of MTUM. The average correlation between rolling 24-month returns was 0.95 and 0.96 for MTUM with FTC and MTUM with PWB, respectively.

Finally, we will evaluate the iShares Edge MSCI USA Quality Factor ETF (QUAL). According to the issuer, this ETF produces

Exposure to large- and mid-cap U.S. stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth and low financial leverage)

Since QUAL’s inception date was in July 2013, the analysis begins in August 2013. Here is a chart with accompanying statistics of the cumulative RealAlpha™ for the ETF:

Cumulative RealAlpha™ for iShares Edge MSCI USA Quality Factor ETF (QUAL)

The ETF moderately outperformed its reference portfolio, which had a slightly higher volatility. The ETF’s RealBeta™ was lower than that of a broad-based equity market ETF.

The following chart with accompanying statistics depicts the composition of the reference portfolio for the iShares Edge MSCI USA Quality Factor ETF:

Reference Weights for iShares Edge MSCI USA Quality Factor ETF (QUAL)

The ETF had major equivalent positions in the iShares Russell Top 200 Growth ETF (IWY), SPDR® Dow Jones® Industrial Average ETF (DIA), PowerShares S&P 500 Quality Portfolio (SPHQ), Vanguard Dividend Appreciation ETF (VIG), PowerShares NASDAQ Internet Portfolio (PNQI), and iShares U.S. Energy ETF (IYE). Clearly, this ETF had a strong tilt toward mega-cap stocks, especially of the growth classification.

Over the same analysis period, QUAL had a significantly lower return as well as slightly smaller Sharpe and Sortino ratios than those of IWY:

Total Return of iShares Edge MSCI USA Quality Factor ETF (QUAL) and iShares Russell Top 200 Growth ETF (IWY)

The average correlation between rolling 24-month returns of the two ETFs was 0.98.

Conclusion

The above analyses uncovered reference portfolios for select iShares smart beta ETFs. While a wholesale substitution of an ETF with its multi-member reference portfolio may not always be practical, each of these portfolios

  • Built a foundation for assessment of the true risk-adjusted performance of a smart beta ETF.
  • Captured exposures of a smart beta ETF to various stock market styles, sectors and industries (paradoxically, these are exposures of the analyzed factor ETF to various other factors). This may help investors avoid an undesirable overlap with other positions in their overall investment portfolios.
  • Identified a predominant exposure of a smart beta ETF to a single factor. This may help investors substitute a smart beta ETF with another product that implements a traditional market-cap index or with a similar strategic beta strategy.

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