Overcoming factor fatigue and is it time to go International?

Ahmed Farooq, CIMA®, CFP

Ahmed Farooq, CIMA®, CFP
Vice President - ETF Business Development at Franklin Templeton Canada

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So much has happened in 2020. It was back in late January that I was in Hollywood, Florida for Inside ETFs. Little did I know then, that this event would be my last conference for the year.

We are now in our sixth month of the pandemic and lock down restrictions are easing here in Canada, as well as in Europe and Asia. Unfortunately, the U.S. has gone in the complete opposite direction, particularly its southern and mid-western states. Amid it all, live sports are back, and with the U.S. presidential election coming up in the fall, 2020 is a year we are sure to remember for the rest of our lives. 

From an investment perspective, the global proliferation of ETFs has continued in 2020 regardless of the disruption caused by the pandemic. For the first half of the year, there was CAD$22 billion in net inflows in Canada, doubling the total for the same period in 2019. The U.S. market also saw flows move at a record pace—U.S.$194 billion for the six-month period, which is an increase of 70% compared to the first six months of 2019.

In the media, there has been a lot of coverage in the U.S. centered on active ETFs. We largely take active ETFs for granted in Canada because we do not have the same regulatory restrictions as in the United States. As a result, active ETFs have flourished here for over a decade now.

The same can’t be said for smart beta ETFs, which are much more commonplace in the U.S. than in Canada. Factor investing has not caught on as strongly in the Great White North, which begs the question: Why? 

One reason may be the overwhelming product options. According to Jin Li, ETF Analyst BMO Capital Markets, currently there are 244 smart beta ETFs, 153 single factor ETFs and 91 multi-factor ETFs in the Canadian marketplace. Because of that, I think investors and advisors may be suffering from factor fatigue.

Retelling an old story

Factor investing is not new. Dating back to the 1930’s and to the very start of active management, academic research has shown how factors can improve investment results. With the advent of smart beta, or smartening your beta exposure, you can now use ETFs with precise exposures such as value, dividends, low volatility, momentum, small cap or quality. Today, this segment has largely morphed into factor-focused ETFs.

Factors are designed for better outcomes

Factor investing may seem complicated due to the sheer number of products available, all with different nuances to their methodology. Most of these strategies can easily be explained.

Single factors give you direct unbiased exposure to certain types of securities, plus the potential risk of putting all of your eggs in one basket. Multi-factors, in contrast, can minimize some of that risk by putting your eggs in different and complimentary baskets.

Focusing on our Franklin LibertyShares multi-factor methodology, the goal is to provide an experience where the investor has exposure to quality companies, participates in most of the upside, while also providing downside protection.

Is it time to invest internationally?

Factor investing can be applied in a variety of ways, including focusing exposure on particular geographic regions. Recently, I have been hearing a lot from advisors about investing in EAFE (Europe, Australasia and Far East) markets, which represent 44% of the global market. Pivoting to these regions somewhat will offer an opportunity to diversify outside of the U.S. market, which is facing an upcoming election, increasing COVID-19 infection rates, as well as an ongoing trade dispute with China.

International developed equity markets have performed strongly over the past three months, which can be attributed in large part to the 750 billion euro in stimulus for the European region just as COVID-19 case counts have dropped in many of the highly impacted countries. As a result, market analysts have called out attractive valuations relative to U.S. equities and the strength of the euro.

In addition to the added diversification for your portfolio, holding international stocks will provide access to global household names such as Nestle, Unilever, Sanofi and Toyota, to name but a few.

One way to invest in the EAFE markets is through our smart beta solution, Franklin LibertyQT International Equity Index ETF (FLDM). This strategy is designed to lower your overall beta, invest in high quality companies with attractive valuation, increase overall yield, as well as with lower downside capture ratio, all for 40 bps, versus jumping in through a straight beta exposure.

If you would like to learn more about the benefits of our unique multi-factor strategy used in our lineup of smart beta ETFs. Please feel free to contact me or a member of our sales team to learn more.


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What Are the Risks?

Commissions, management fees and expenses may all be associated with investments in ETFs. Investors should carefully consider an ETF’s investment objectives and strategies, risks, fees and expenses before investing. The prospectus and ETF facts contain this and other information. Please read the prospectus and ETF facts carefully before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors. The indicated rates of return are the historical annual compounded total returns including changes in share or unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

Ahmed Farooq’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.