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Factor investing Gain exposure towards systematic equity factors

Factor investing

Our wide range of Exchange Traded Funds (ETFs) offer access to single equity factor indices developed by leading financial index provider MSCI. This unique range of Factor ETFs aims to equip investors with tools to tilt their portfolio strategies towards factors within tactical or strategic asset allocation models.

The phenomenon of factor investing (also known as 'smart beta' investing or 'alternative beta' investing) has received a lot of attention amongst investors and the broad media. Factor investing has been researched continuously since the 1970s, with academic researchers identifying that value, quality, low volatility and yield all tend to outperform the market portfolio in the long term. Different explanations can be found in literature, ranging from behavioural economics to corporate finance to statistical modelling.

Many studies document that indeed investment strategies based on these factors would all have beaten the World index. In essence, factors can be thought of as a consistent characteristic that is critical in explaining the risk and return profile with a group of related securities. The four-decade run of outperformance by the MSCI factor indices1 proves that substantial and persistent factor premia have been present. But it also shows that the factor-based strategies have steadily been corrected over time (i.e. periods of relative overperformance interchange with periods of relative underperformance), indicating that there is no free lunch.

The different behaviours of each of the following factors should lead investors to consider a wider range of factor investment opportunities in their portfolios. The successful implementation of factor investing requires detailed understanding of what it is about- the upside as well as downside risks.

Figure 1 shows the positioning of factor investing highlighting its presence between market beta and pure alpha. Factor investing is actually about getting exposure to rules-based, transparent and high-capacity strategies, where the selected stocks meet certain eligibility criteria, and are weighted proportionally to the factor exposure, e.g. the value stocks receive more weight with lower valuation ratios. These strategies typically under-represent and tilt away from the market, so investors may benefit from diversification, but they also face other factor-related risks.

Factor Beta Positioning

A market capitalization weighted index (market beta) reflects the available opportunity set of equity investments. If an investor wants to understand how equity markets perform, the best measurement is the market cap weighted benchmark. The market beta portfolio is also a natural benchmark for any other strategies, including factor investing or pure alpha investments.

The very DNA of factor investing is to provide tilts away from market capitalization weighted benchmarks, by following a standardized, disciplined, transparent and rules-based process of stock selection.

Figure 2 shows the actual multi-step process required to construct a factor-exposed index. This process defines a rigorous portfolio construction, with stocks that best qualify for the factor exposure.

The four main factor exposures demanded by investors focus on

  • yield,
  • low volatility,
  • value
  • and quality. 

These strategies have very intuitive appeal on the one hand, and they are well researched and backed by empirical studies in the financial literature on the other hand. For example, the total shareholder yield strategy aims to select these companies that return capital - either through dividend payments or buyback programs - to their shareholder. To achieve this objective, this factor strategy will screen in the entire universe stocks that consistently deliver shareholder value. It will then rank the companies in view of the shareholder yield, select top companies meeting certain threshold, and finally the strategy will overweight (or tilt towards) the most valuable stocks generating shareholder value.

Indexation of Factor Indices

Addition of alternative beta to the portfolio requires better understanding of the factor exposures and their properties. Each factor strategy has its own objective which determines its application in the portfolio.  

The value factor looks for relatively undervalued stocks as measured by fundamental company metrics (e.g. Price-to-Book Ratio, Price-to-Earnings Ratio or Price-to-Sales Ratio etc.). Numerous studies have demonstrated that value stocks tend to outperform their peers in the long-term. The outperformance can be rationalised by the fact that value investors take on additional risk by investing in cheap stocks, and expect higher return for risk-taking. Value stocks are mostly looked for when financial markets experience off-equilibrium valuations.

The low volatility factor selects companies whose stock market price variation is low and hence help to reduce portfolio risk. Low volatility stocks tend to outperform high volatility stocks; this is known as 'the low volatility anomaly', as it contradicts the conventional financial wisdom of risk-return trade-off. However, low volatility stocks prove to be in high demand when uncertainty around financial markets increases, leading to their more robust market behaviour. 

The quality factor provides exposure to a portfolio of boring stocks. Quality companies are characterized by durable business models which should remain profitable, regardless of the business cycle. In addition, quality stocks tend to have modest variability in earnings, e.g. utility companies. High quality stocks, as selected by accounting criteria (e.g. profit margin, earnings growth, return on equity, debt-to-equity), tend to outperform low quality stocks in the long-term. They are particularly in demand when financial markets are expected to experience turbulence.

The yield strategies are designed to capture the performance of companies that return above-average cash to shareholders either by paying dividends or through share buybacks. The excess cash can either be reinvested to finance further company growth, or it can be partially shared with the shareholders. Many yield-focused strategies select companies that have balanced pay-out ratios and have proven to generate persistent shareholder value in the long-term.   

Every factor strategy represents exposure to systematic sources of risk expressed through the factor load (2).

Figure 3 shows the historical factor loads of the four factor indices. This chart is a standard way to evaluate the factor load of specific strategies (3). In this framework, every investor must first assess the role of factor investing and what it aims to achieve through the investment. For example, the quality companies have a relative negative tilt towards financial leverage defined as debt-to-equity ratio. This implies that quality companies use relatively low level of debt to finance increased operations, investments and business activities. While highly leveraged companies may have potential to generate higher earnings in expansive economy, then the cost of debt financing might turn excessively high with the economic downturn.  

Factor Load of Factor Indices

For many years, factor-based investment strategies have not been widely accessible and rather exclusive to a small group of investors. The recent increase of interest and demand has led many of the factor strategies to become 'indexed' and widely recognized and well established index providers (e.g. FTSE, MSCI, STOXX etc.) have engineered replicable factor indices.

With the rise of passive investments (e.g. Exchange Traded Funds), the access to value, volatility, quality and yield has never been easier than today, and there are many good reasons to consider them as an addition to a portfolio (see summary in Figure 4.)

Traditionally, portfolio allocation has been defined as a core-satellite approach, where core exposure was covered by market beta portfolios and satellite investments were covered by alpha investments. With the emergence of factor indices, the new core-factor-satellite investment approach develops, where the factor beta investments can be accessed through investible factor indices. Implementation of factor investing is generally governed by the investor's constraints (risk budgets, investment horizon, costs etc.) and can vary from a dynamic allocation (higher return and higher risk), a defensive allocation (moderate return and lower risk), or a balanced allocation (something in between). 

Core-Factor-Satellite Asset Allocation

The core-factor-satellite framework offers a number of ways to implement factor allocations in a portfolio. The implementations can focus on addition of one preferred factor, or combining two or more factors in addition to market beta, as shown in Figure 5.

The factor exposures differ in their properties and their behaviour over different business cycle phases. For example, value and yield are more pro-cyclical, whilst low volatility and quality are more counter-cyclical. Most importantly, regarding diversification, combining factors historically could have helped offset the downside risk of the market portfolio, or could have help achieving higher participation in the upside market.

Multi-factor strategies have historically demonstrated four key benefits:

  • diversification
  • transparency
  • cost-efficiency
  • and flexibility (4).

In general, the implementation of factor investing depends on the investor's objectives and constraints.

Factor-based Investment Examples

Factor beta investing products in focus

Fundname ISIN Replication Fee Last NAV
Currency
Fact sheet

UBS ETF (IE) MSCI World Select Factor Mix UCITS ETFIE00BFWMMG89

Physical

0.46%

0.00 USD

pdf

Fund description

The fund generally invests in the MSCI World Select Factor Mix Index USD. The relative weightings of the companies correspond to their weightings in the index.The investment objective is to replicate the price and return performance of the MSCI World Select Factor Mix Index USD net of fees. The stock exchange price may differ from the net asset value.

UBS ETF (LU) MSCI EMU Select Factor Mix UCITS ETFLU1804202403

Physical

0.34%

9.941 EUR

pdf

Fund description

The fund generally invests in the MSCI EMU Select Factor Mix Index EUR. The relative weightings of the companies correspond to their weightings in the index.The investment objective is to replicate the price and return performance of the MSCI EMU Select Factor Mix Index EUR net of fees. The stock exchange price may differ from the net asset value.

UBS ETF (LU) J.P. Morgan EM Multi-Factor Enhanced Local Currency Bond UCITS ETFLU1720938841

Physical

0.47%

16.0594 USD

pdf

Fund description

The UBS ETF – J.P. Morgan EM Multi-Factor Enhanced Local Currency Bond UCITS ETF sub-fund aims to track, before expenses, the price and income performance of the J.P. Morgan Emerging Market Enhanced Multi-Factor Local Currency Bond Index (this sub-fund's "Index").The UBS ETF – J.P. Morgan EM Multi-Factor Enhanced Local Currency Bond UCITS ETF sub-fund will take an exposure on the components of its Index.

UBS ETF (IE) MSCI USA Select Factor Mix UCITS ETFIE00BDGV0308

Physical

0.30%

21.1653 USD

pdf

Fund description

The investment objective is to replicate the price and return performance of the MSCI USA Select Factor Mix Index net of fees. The stock exchange price may differ from the net asset value.The fund generally invests in US stocks which are contained in the MSCI USA Select Factor Mix Index.

UBS ETF (IE) MSCI USA Select Factor Mix UCITS ETFIE00BDGV0415

Physical

0.30%

21.8041 USD

pdf

Fund description

The investment objective is to replicate the price and return performance of the MSCI USA Select Factor Mix Index net of fees. The stock exchange price may differ from the net asset value.The fund generally invests in US stocks which are contained in the MSCI USA Select Factor Mix Index.

UBS ETF (IE) MSCI USA Select Factor Mix UCITS ETFIE00BDGV0852

Physical

0.40%

16.7304 GBP

pdf

UBS ETF (LU) J.P. Morgan EM Multi-Factor Enhanced Local Currency Bond UCITS ETFLU1720938924

Physical

0.47%

16.9259 USD

pdf

Fund description

The UBS ETF – J.P. Morgan EM Multi-Factor Enhanced Local Currency Bond UCITS ETF sub-fund aims to track, before expenses, the price and income performance of the J.P. Morgan Emerging Market Enhanced Multi-Factor Local Currency Bond Index (this sub-fund's "Index").The UBS ETF – J.P. Morgan EM Multi-Factor Enhanced Local Currency Bond UCITS ETF sub-fund will take an exposure on the components of its Index.

UBS ETF (IE) MSCI USA Select Factor Mix UCITS ETFIE00BDGV0746

Physical

0.40%

16.3357 EUR

pdf

UBS ETF (IE) MSCI USA Select Factor Mix UCITS ETFIE00BDGV0C91

Physical

0.40%

15.8479 CHF

pdf

UBS ETF (LU) Factor MSCI EMU Quality UCITS ETFLU1215452332

Physical

0.38%

12.0594 GBP

pdf

UBS ETF (IE) Factor MSCI USA Low Volatility UCITS ETFIE00BWT3KJ20

Physical

0.35%

21.6834 EUR

pdf

Fund description

The fund generally invests in US large and mid cap stocks which are contained in the MSCI USA Select Dynamic 50% Risk Weighted 100% hedged to EUR index. The relative weightings of the companies correspond to their weightings in the index.The investment objective is to replicate the price and return performance of the MSCI USA Select Dynamic 50% Risk Weighted 100% hedged to EUR index net of fees. The stock exchange price may differ from the net asset value.The purpose of the Currency Hedge is to limit the profit or loss generated from foreign exchange exposure when holding an US Dollar denominated asset in a currency other than US Dollars.The fund is passively managed.

UBS ETF (LU) Factor MSCI EMU Low Volatility UCITS ETFLU1215455350

Physical

0.38%

11.7858 GBP

pdf

UBS ETF (LU) Factor MSCI EMU Prime Value UCITS ETFLU1215453819

Physical

0.38%

10.8541 GBP

pdf

UBS ETF (LU) Factor MSCI EMU Total Shareholder Yield UCITS ETFLU1215456754

Physical

0.38%

10.1808 GBP

pdf

UBS ETF (LU) Factor MSCI EMU Total Shareholder Yield UCITS ETFLU1215456325

Physical

0.38%

16.1341 CHF

pdf

UBS ETF (IE) Factor MSCI USA Prime Value UCITS ETFIE00BX7RRC57

Physical

0.35%

16.8477 CHF

pdf

Fund description

The fund generally invests in US large and mid cap stocks which are contained in the MSCI USA Prime Value 100% hedged to CHF index. The relative weightings of the companies correspond to their weightings in the index.The investment objective is to replicate the price and return performance of MSCI USA Prime Value 100% hedged to CHF Index net of fees. The stock exchange price may differ from the net asset value.The purpose of the Currency Hedge is to limit the profit or loss generated from foreign exchange exposure when holding an US Dollar denominated asset in a currency other than US Dollars.The fund is passively managed.

UBS ETF (LU) Factor MSCI EMU Low Volatility UCITS ETFLU1215455277

Physical

0.38%

20.1532 USD

pdf

UBS ETF (IE) Factor MSCI USA Quality UCITS ETFIE00BXDZNK39

Physical

0.35%

16.5981 GBP

pdf

Fund description

The fund generally invests in US large and mid cap stocks which are contained in the MSCI USA Quality 100% hedged to GBP Total Return Net index. The relative weightings of the companies correspond to their weightings in the index.The investment objective is to replicate the price and return performance of the MSCI USA Quality 100% hedged to GBP Total Return Net Index net of fees. The stock exchange price may differ from the net asset value.The purpose of the Currency Hedge is to limit the profit or loss generated from foreign exchange exposure when holding an US Dollar denominated asset in a currency other than US Dollars.The fund is passively managed.

UBS ETF (IE) Factor MSCI USA Low Volatility UCITS ETFIE00BXDZNF85

Physical

0.35%

14.6282 GBP

pdf

Fund description

The fund generally invests in US large and mid cap stocks which are contained in the MSCI USA Select Dynamic 50% Risk Weighted 100% hedged to GBP Total Return Net index. The relative weightings of the companies correspond to their weightings in the index.The investment objective is to replicate the price and return performance of the MSCI USA Select Dynamic 50% Risk Weighted 100% hedged to GBP Total Return Net index net of fees. The stock exchange price may differ from the net asset value.The purpose of the Currency Hedge is to limit the profit or loss generated from foreign exchange exposure when holding an US Dollar denominated asset in a currency other than US Dollars.The fund is passively managed.

UBS ETF (LU) Factor MSCI EMU Total Shareholder Yield UCITS ETFLU1215456671

Physical

0.38%

17.0923 USD

pdf


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