Having piled into cyclicals and ditched several big tech stocks at around the mid-point of this year, it seems iShares Edge MSCI USA Momentum Factor UCITS ETF (IUMF) is still playing catch-up with 2021’s market rotations.
We’re approaching the next rebalancing of the index the exchange traded fund (ETF) tracks and research provider CFRA believes further churn lies ahead. CFRA predicts that the fund’s “minuscule” stakes in energy and real estate should move higher on the back of strong recent performance, while Disney (US:DIS) and Berkshire Hathaway (US:BRK.A) could exit the portfolio.
This all makes sense when you consider the fund’s remit. It focuses on a sub-set of stocks in MSCI USA index that have been experiencing a recent “upward price trend”. Given that we’ve seen some big market rotations this year, turnover is to be expected.
One problem here is in the timing. As we noted earlier this year, the fact that the index only rebalances every six months means the fund risks buying into the beneficiaries of a rally that has already seen its best days or may be over. The fund moved heavily into financials around halfway into this year and well after the beginning of the vaccine rally that started in late 2020. Some might now worry that the fund is loading up on energy stocks as they peak.
As 7IM senior portfolio manager Peter Sleep adds: “One of the issues with momentum has been dealing with market reversals. The strategy takes no account of a company’s fundamentals and buys purely on price. As a result, it can buy into some very risky stocks on the way up that can really hurt you if there is a market downturn.”
However, the fund’s infrequent rebalancings are a way of dealing with another problem for momentum investors. While momentum has been found to work extremely well, constantly chasing market winners can equate to high turnover costs that eat away at your excess returns. By only rebalancing every half year, the fund addresses this problem.
For now, being slow to the action seems to have hurt performance. iShares Edge MSCI USA Momentum Factor UCITS ETF had made a year-to-date sterling total return of 19.7 per cent as of 12 November. While this is nice in absolute terms, it lags iShares MSCI USA UCITS ETF's (CU1) 27.5 per cent return, and returns of around 28 per cent for iShares' value and quality-oriented counterparts. iShares Edge MSCI USA Momentum Factor UCITS ETF also lags an iShares MSCI USA multifactor product. That said, the momentum fund is still nicely ahead of the pack over the five years to 12 November.
Trying to play market rotations is no easy task, and active managers with a focus on investment factors have had their own struggles. There’s also no guarantee that one index methodology may consistently succeed when it comes to ETFs. As Sleep puts it: “Every crisis and market reversal is different and what works in the past may not work in the future”.
This all brings us back to the unglamorous mantras of risk management and diversification. Broader, less targeted funds (such as vanilla market trackers or active funds without a significant style bias) might offer a good core exposure, allowing you to take punchier bets at the edges. And understanding the methodology and process driving more targeted ETFs, from factor products to thematics, is essential.
