As a pioneer in factor investing, we believe in the importance of building investment solutions that emphasize dimensions of the market that years of academic research¹ have linked to higher expected returns. That research has shown a company’s size, relative price,² and profitability³ have historically driven higher returns in equity markets, establishing the framework for multifactor investing. This research and information on market prices can be used to enhance returns and manage risk. It’s a more systematic approach to investing—one we can implement consistently around the world and across asset classes.

What are the benefits of a systematic core approach?

Systematic investing is a rules-based approach to managing money, replacing the sometimes subjective nature of traditional active management by using quantitative research. It avoids the rigidities of indexing through a flexible but process-driven pursuit of premiums, also known as factors. If done well, a systematic, factor-based approach can potentially be more reliable and less costly than a high turnover active strategy without sacrificing the greater diversification and easier monitoring associated with index investing. Many asset owners, consultants, and wealth advisors now recognize that a systematic approach is distinct from indexing and active management, and these strategies can work well together within an asset allocation.

Common examples include using a systematic core portfolio in a core-satellite allocation or using a systematic style portfolio as a “completion” to obtain desired tilts within and across asset classes. The other portfolios can be traditional active, indexed, or alternative, including private.

By focusing on key dimensions of higher expected returns—small cap stocks, value stocks, and high profitability stocks—and employing strategies to minimize unnecessary trades and transaction costs, multifactor ETFs can help investors efficiently capture asset class returns within a single, integrated fund. 

Factor premiums can be volatile

The framework for expecting positive size, value, and profitability premiums is valuation theory, which posits that a stock’s price reflects the company’s expected future cash flows discounted to present value. The discount rate equals an investor’s expected return. Therefore, as long as stocks have different expected returns, those with lower prices and higher expected cash flows should have higher expected returns. This holds regardless of whether realized premiums have been positive or negative in the recent past.

While we expect the market, size, value, and profitability premiums to be positive, we also recognize that these premiums can be volatile and may sometimes be negative. Though a negative premium can be disappointing, it is not unprecedented.

Furthermore, the three premiums—size, relative price, and profitability—do not move in lockstep, and they have tended not to be negative at the same time. While a positive premium is never guaranteed, the odds of realizing one are decidedly in your favor and improve the longer you stay invested. We believe that multifactor investing, using an integrated approach, gives investors the opportunity to capture the performance of premiums if they maintain discipline.⁴

How can multifactor ETFs benefit investors over the long term?

Since there is no reliable way to time equity markets or factors successfully, multifactor ETFs are designed to maintain a consistent focus on the long-term drivers of expected returns in all market environments. By consistently targeting each premium, investors will be positioned to capture the premiums when they are positive.

Furthermore, premiums can materialize quickly, so you want to be positioned to capture them when they show up. The period leading up to and shortly after the start of the 21st century—the so-called dot-com era—provides a good example, as growth stocks beat value stocks over most trailing periods from one to 20 years ending March 31, 2000. 

Investors might have questioned value strategies, wondering whether, in the dot-com era, expected returns were still related to the price paid for a stock. Those who capitulated to this line of reasoning may have regretted their decision a mere 12 months later, after the dot-com crash, because value stocks strongly outperformed the growth stocks over every trailing period from one to 20 years ending March 31, 2001.

Changing course after a disappointing spell for known premiums can lead to missed opportunities. When those drivers of outperformance have turned around in the past, disciplined investors in multifactor ETFs who pursue the premiums have been rewarded. A key to successful long-term investing is sticking with your approach—even through difficult periods—so that you are there for the good times, too.

In September, John Hancock and Dimensional celebrated the 10th anniversary of the launch of John Hancock's Multifactor ETF suite. Dimensional, which serves as subadvisor for the suite, has been a leader in multifactor investing, transforming rigorous theoretical and empirical research into value-added, systematic investment solutions. Click here to learn more about this milestone and our partnership with Dimensional.