Better Index Investing: The Benefits of Multi-Factor Security Selection

Yaz Romahi, portfolio manager and CIO for Quantitative Beta Strategies, explains his approach to security selection and the benefits of multi-factor screening.

How would you summarize your approach to security selection?


There are a number of sources of equity returns beyond growth itself. These include factor exposures such as value, size, momentum and quality (or low volatility, which is closely related). When creating a diversified factor portfolio, we seek to build up the constituents with exposure to these sources of return.

Our bottom-up stock filter scores each company based on a combination of these return factors to determine whether it is included in the index. These factors provide access to a broader, more diversifying source of equity returns. The low correlation of these factors to one another complements our risk-based diversification.


Source: J.P. Morgan Asset Management. For illustrative purposes only. Past performance does not guarantee future results.

How do you determine the weighting that is applied to each factor in the screening process? Do they get equal weighting at all times?


They tend to be fairly stable and consistent. This helps us to manage risk. Although the performance of individual factors can often be indicated by a number of features of the market, we believe maintaining broad factor diversification allows us to balance our allocation and reduce volatility over the long term.

Can you describe the interplay between factors?


While the core value proposition of a factor in a multi-factor framework is its low correlation to the market and to other factors, there are some factors that pair especially nicely. Value and momentum are one such example. When a stock gets more expensive, its valuation metrics typically deteriorate at exactly the time when its price chart looks most appealing from a momentum point of view. This would lead not only to offsetting the need to trade, but also to some negative correlation between the factors, creating a smoother ride in the portfolio. Quality and size are another such pairing. The highest-quality (and lower-volatility) stocks are often the larger, blue-chip names.

How often do you refine your methodology?


Our ETFs are passively managed to track indices that we have designed in partnership with FTSE/Russell. The principles by which the indices are constructed are not simply a response to a particular investment fad, but the time-tested result of decades of research and insights. We retain the flexibility to adjust this investment process as we find ways to refine our implementation. One example of such a change is in relation to the timing of rebalancing in our international product line—these launched in 2014 with a monthly rebalance schedule, but we reverted to a quarterly rebalance once we had conviction that this slower pace of trading could still deliver the factor exposures—and returns—intended.

Learn more about J.P. Morgan’s Equity ETFs here .


DISCLOSURES
Investing involves risk, including possible loss of principal. Diversification does not guarantee investment returns and does not eliminate the risk of loss.
Investment returns and principal value of an investment will fluctuate so that an investor's shares, when sold or redeemed, may be worth more or less than their original cost. ETF shares are bought and sold throughout the day on an exchange at market price (not NAV) through a brokerage account, and are not individually redeemed from the fund. Shares may only be sold or redeemed directly from a fund by Authorized Participants, in very large creation/redemption units. For all products, brokerage commissions will reduce returns.
Opinions and statements of market trends that are based on current market conditions constitute our judgment and are subject to change without notice. These views described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Past performance is no guarantee of future results. Investment returns and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. ETF shares are bought and sold throughout the day on an exchange at market price (not NAV) through a brokerage account, and are not individually redeemed from the fund. Shares may only be redeemed directly from a fund by Authorized Participants, in very large creation/redemption units. For all products, brokerage commissions will reduce returns.
J.P. Morgan Asset Management is the marketing name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide.