- Investors can express factor views via smart beta ETFs or mutual funds
- Some mutual funds offer higher factor exposure than smart beta ETFs
- Given higher fees, strong views on expected factor performance are required
Similar to wind and water eroding the strongest mountains over time, passive fund management has been gradually capturing market share from active managers globally. The recent announcement of Fidelity, which a decade ago represented the symbolic leader of active fund managers, to launch two index funds with zero fees, highlights the dramatic changes in the fund management industry. However, at the same time, some providers of passive products like WisdomTree are enhancing their product suite by adding actively managed ETFs. It seems that both worlds are partially integrating and that active management will continue to play an important role in the future.
We previously analysed the factor exposure of smart beta ETFs (please see ETFs, Smart Beta & Factor Exposure) and noted their relatively low exposure to common equity factors. In this short research note we will compare the factor exposure of smart beta ETFs and mutual funds, initially by focusing on the Value factor and then expanding to other common equity factors.
We focus on six factors namely Value, Momentum, Low Volatility, Quality, Growth and Dividend Yield in the US stock market. The factor performance is calculated by constructing long-short beta-neutral portfolios of the top and bottom 10% of stocks ranked by the factor definitions, which are in line with academic and industry standards. Only stocks with a minimum market capitalisation of $1 billion are included. Portfolios are rebalanced monthly and each transaction incurs costs of 10 basis points.
Factor exposure is measured by factor betas derived from a one-year regression analysis utilising daily data and the six equity factors as well as the market as independent variables.