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A Multi-Factor Approach To Developed Markets

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August 15, 2016 1:41 pm
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A Multi-Factor Approach To Developed Markets

Foreign equities, even some hailing from developed markets, have a tendency to be more volatile than their U.S. counterparts. Combine that with the perception that global equity market volatility is high this year, and it is easy to understand why many investors are extending their preference for low volatility strategies beyond confines of U.S. borders.

Investor Sentiment

The other side of the low volatility equation is that investors' enthusiasm for that factor is also stoking concern that strategies seeking to damp volatility are overvalued and perhaps too crowded a trade. Investors can use multi-factor exchange-traded fund to access the low volatility while not exposing themselves to risks associated with single factor isolation.

Investors seeking developed markets exposure with some volatility reduction capabilities can consider the SPDR MSCI EAFE StrategicFactors ETF (SPDR Index Shares Fund (NYSE: QEFA)), which is the ex-U.S. developed markets counterpart to the SPDR MSCI World Strategic Factors ETF (SPDR Index Shares Fund (NYSE: QWLD)) recently highlighted in this space.

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A Closer Look

QEFA, which recently turned 2 years old, follows the MSCI EAFE (Europe, Australasia, Far East) Factor Mix A-Series Index. The ETF's geographic lineup is similar to traditional EAFE approaches with the U.K., Japan and Switzerland dominating at the country level. Those countries for about 58 percent of the ETF's weight.

A primary advantage of multi-factor ETFs such as QEFA is that these funds help lower the burden of factor timing. With the benefit of hindsight, investors now that the low volatility and quality factors are working this year, but there are times when some factors fall out of favor while others outperform. Forecasting shifts in factor trends can be difficult and multi-factor ETFs aim to ease that burden.

Financial services stocks are QEFA's largest sector weight at almost 18.8 percent, but the ETF has some quality and low volatility hallmarks as consumer staples and healthcare names combine for about 32 percent of the fund's weight.

“The SPDR StrategicFactors suite seeks to track indices that blend low volatility, quality and value exposures together in a single strategy. The combination of one risk-based factor aimed at reducing absolute risk levels (low volatility) with two return-based factors (value, which is cyclical, and quality, which is defensive) creates a balanced, diversified exposure that may provide a better buy-and-hold core exposure than traditional market cap-weighted strategies, assisting investors with constructing portfolios that are better suited for today’s equity market conditions,” said State Street Vice President David Mazza in a recent note.

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