With a seemingly endless range of strategies and funds to select from, today’s ETF investors face an abundance of choice. How can they best decide among all these options?
One way is to narrow down the criteria they use to make decisions.
In the passive space investors have to make two choices. First, deciding on the right index and second, deciding on the right passive product. That is a lot of information to sift through.
The good news is that the relative importance of these choices is not the same.
In a recent analysis, we found choosing the right ETF for a given index generally accounts for a performance difference of only a few basis points per annum for the most developed and liquid markets. Choosing the right index on the other hand can result in up to a 500 basis point differential.
We therefore believe it makes sense for investors to put more effort into picking the right index and less into choosing a passive product.
Here a look at historical performance.
In our analysis we found that the newest generation of factor indices – those that refine an index by focusing on securities with certain characteristics – have shown strong outperformance over the past two decades.
Just to take one example within the MSCI USA universe, we found the low volatility factor had the highest Sharpe ratio during this time, translating into a historical excess return of around 250 basis points per annum. Other factors including value, momentum, size, yield, or quality, have also proven successful at capturing risk premia.
For investors, factoring in the factors can be an excellent way to narrow down their options, and make the right choices for their needs.