Australian Multi Factor

Australia
Vanguard Australia Multi factorVanguard Australia is punching another notch into its actively managed belt, listing Australia’s first multi-factor global ETF.

The Vanguard Global Multi-factor Active ETF (Managed Fund) (VGMF) will hold a basket of global shares and attempt to outperform its market weighted counterparts. It will do so by targeting three factors: value, quality and momentum.

Value will be measured based on price-to-book, price-to-earnings and price-to-free-cash-flow. Quality measured by gross profitability, trailing return on equity and balance sheet strength. And momentum by relative strength. Stocks are then given a composite score based on all three factors.

Explaining the approach to ETF Stream, boss of Vanguard Australia’s quant division Mike Roach said:

“If you simply take a value, quality and momentum portfolio and mash it all together you’re going to get a lot of offsetting positions and you’re going to get increased turnover and volatility associated with that. So we take a composite score and… put in stocks that have a strong score across all three metrics.”

Rebalancings will be monthly on average, Mr Roach said. This will ensure they’re often enough to avoid “signal decay” – where stocks showing signs of value, quality and momentum cease doing so. While also being infrequent enough to keep turnover low. High turnover increases brokerage costs and can undermine performance.

He defended the use of the value factor, which has underperformed strongly the past decade.

“Part of the reason that value pays off over the long term is that it can get a bit uncomfortable. You can get periods of extended underperformance. That’s part of the reason you get rewarded for holding it. But it’s also part of the reason why we’re diversifying the signals of value,” he said.

“We want to make sure investors know what they’re getting into. You’re getting a portfolio that’s very different from the broad market.”

He added that it can help to have an advisor when investing in this type of fund as they can provide the behavioural coaching needed to “stay the course” when times are rough.

The fund will be the first of its kind in the Australian market.

Analysis – a welcome addition to the Australian marketBill Sharpe, the Nobel prize winning economist, was once asked about smart beta and quantitative investing. He responded:

“If there were a way to reliably ‘beat the market’ money would pour in and it wouldn’t work anymore. More simply: economics likely beats mathematics in a competitive marketplace. I am also reminded of a saying I got from Bill Fouse: ‘I never met a backtest I didn’t like’. (Since the ones that wouldn’t have worked are not published).”

It was for this reason (as well as his famous ‘arithmetic of active management’) that he recommends and personally uses Vanguard’s total US stock market index funds.

Nonetheless, there are plenty of investors that are willing to take on more risk than a market weighted index fund. And do so in hope that it may lead to outperformance.

For those of that persuasion, today’s listing is as good a bet as any. The fee is entirely reasonable: at 33 basis points its far cheaper than most actively managed global equities funds in Australia. There’s some academic evidence that tracking these three factors can lead to above market returns. (Although the evidence is more inconclusive than those selling quant funds sometimes portray).

But caveat emptor: quant funds can underperform for long periods. If investors are uncomfortable with this, or unconvinced by the investment thesis, they should stick with market weighted index funds.

USA

Goldman Sachs lists actively managed ultra short duration ETF

For those worried the curve will go negative or those simply worried about duration risk, Goldman is listing a new ETF that goes for very short duration bonds. The Goldman Sachs Access Ultra Short Bond ETF will be actively managed and target an effective duration of one year or less.

To do this, the will invest in investment grade US dollar denominated debts from governments, banks and corporates worldwide. However, the prospectus says that it will mostly end up investing in the debts of US financial institutions. The fund will charge 0.16% in its first year, but after March 2020 may move up to 0.20%, the prospectus indicates.