Factor investing remains one of the most popular investing strategies this decade. Fidelity offers several factor-based equity ETFs that rely on its “three S” approach.
The firm brings over five decades of factor investing experience to bear in their strategies. Fidelity offers a total of 15-factor strategy ETFs, including two fixed income and 13 equity offerings. The Fidelity factor-based ETF suite encompasses a total of $6.9 billion in AUM as of 02/29/2024, according to the fund fact sheets.
Factor investing entails collating securities that share common characteristics. These characteristics, or factors, include things like how profitable a firm is, how expensive a stock is, or how volatile a stock’s performance is, to name a few. The idea behind factor investing is that owning stocks with these shared attributes may contribute to alpha generation — returns above the market.
It’s no wonder factor investing continues to attract investors, given the wide range of strategies and use cases. Defensively minded investors who are uncertain of the extended bull market might prefer quality and low volatility factors. Meanwhile, investors who believe markets might continue to climb higher might be interested in momentum.
Fidelity’s equity factor ETF portfolios are built utilizing quantitative techniques that screen the universe of stocks and score them based on their exposure to the targeted factors. However, they take factor investing one step further. Fidelity employs a “three S’s” approach in their portfolio construction process, seeking to control for potential unintended risks while delivering broad exposure to the intended factor.
Size
When building a factor-based portfolio, allocating to securities based on their factor exposure inherently skews toward relatively smaller market cap stocks.
Take the “Magnificent Seven” for example. Because factor strategies do not typically weight stocks based on the size of the company, the exposure in these mega cap stocks would likely be reallocated to smaller companies. This reallocation naturally introduces a small size bias as relatively smaller companies see more representation.
To erase this tilt toward smaller caps, Fidelity constructs size-neutral portfolios. These portfolios mimic the weighted average market cap of the original selection universe at each rebalance. This minimizes small size bias and controls for unintended risks.
Sector
Similar to the small size bias, factor investing often introduces sector bias. Different sectors lend themselves to specific factors such as tech and quality strategies or energy and value strategies. Fidelity works to neutralize these biases by mimicking portfolio sector weights to the sector weights of the selection universe at each rebalance. Not only does it reduce unintended tilts, but it also creates a broader, more diversified factor-based portfolio.
Security
Concentration risk within equities remains high on investors’ minds. Factor strategies are not immune to potential concentration risk. Overweighting securities that have the highest factor scores may lead to outsized positions. While this might sound attractive, this approach is not without risk.
The factor-based ETFs that utilize the three S strategy seek to counteract this added risk. They do so by overweighting securities equally within each individual sector. In other words, rather than simply overweighting stocks that have the highest exposure to a factor, Fidelity overweights each stock by the same amount across sectors. This method leads to a broader exposure, enhances portfolio diversification, and minimizes concentration risks.
Overall, the “three S” approach strikes a balance between offering investors targeted factor exposures while limiting potential unintended risks.
Fidelity offers five factor-based equity ETFs that employ the “three S” strategy to neutralize tilts and concentration risk: the Fidelity Low Volatility Factor ETF (FDLO), the Fidelity Value Factor ETF (FVAL), the Fidelity Quality Factor ETF (FQAL),and the Fidelity Momentum Factor ETF (FDMO).
The company also offers a number of other equity factor-based ETFs, which utilize different strategies, apart from the “three S” approach, seeking to obtain their individual factor investing objectives.
Fidelity Investments® is an independent company, unaffiliated with VettaFi. There is no form of legal partnership, agency affiliation, or similar relationship between VettaFi and Fidelity Investments, nor is such a relationship created or implied by the information herein. Fidelity Investments has not been involved with the preparation of the content supplied by VettaFi and does not guarantee or assume any responsibility for its content.
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