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Blog Posts — September 29, 2022

BlackRock and Qontigo’s collaboration: iShares multi-factor ETFs track STOXX indices to deliver consistent, risk-managed exposure for a portfolio’s core

Last June, BlackRock revitalized its multi-factor product suite with the relaunch of the iShares U.S. Equity Factor ETF (LRGF) and iShares International Equity Factor ETF (INTF). We sat down with Lukas Smart, Head of US iShares Sustainable and Factors Product Segments, and Arun Singhal, Qontigo’s Global Head of Index Product Management, to hear about the revamped strategies and the collaboration between the two firms. 

Lukas, what were the drivers behind the relaunch of the two Equity Factor ETFs? 

Lukas Smart: “The relaunch of LRGF and INTF has come at a key moment in markets. This year’s downturn has shown investors the challenges of taking on risk in the core of their portfolios. A lot of investors are seeking above-market performance after fees, but they want to do so in a way that manages risk. In that sense, we’ve seen increasing interest in multi-factor products.
With that feedback in mind, we revitalized our multi-factor suite with enhanced underlying indices from Qontigo that offer consistent factor exposure but also manage risk relative to the market.
We particularly wanted investors to be very comfortable holding a modern factor strategy in the core of their portfolios, so we have also significantly dropped the expense ratio of LRGF and INTF, which are now the lowest-cost multi-factor products in their respective markets.”

And what makes the new strategies stand apart from other existing factor-based indices? 

Arun Singhal: “The ETFs track, respectively, the new STOXX® U.S. Equity Factor Index and the STOXX® International Equity Factor Index. The aim of the STOXX Equity Factor indices is to offer systematic and diversified access to a portfolio that tilts towards five historical drivers of returns: Quality, Value, Momentum, Low Size and Low Volatility.
The indices select stocks through an optimization process that maximizes the allocation to a multi-factor alpha signal, while limiting undesirable exposures or deviations from the benchmark that are very common with existing factor strategies. This is the way to manage the risk that Lukas was referring to, and it includes constraints around sector, countries, individual companies and single-factor exposures, and controls for turnover, beta and tracking error relative to the broad market.”

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With these ETFs, Qontigo and BlackRock are building up on a collaboration that dates to 2016. What underpins this partnership?

Lukas: “Both companies’ flexible and client-first approach is what made this collaboration possible. Qontigo’s STOXX indices have set a global footprint that results in outstanding product development, and their sophisticated portfolio construction and risk analytics via Axioma was fundamental to strengthen our leading position in factor solutions. We are very excited to have combined our complementary capabilities to the benefit of our clients.”

Arun: “Thanks to our open architecture we were able to align BlackRock’s objectives for this project. Qontigo’s powerful combination of innovative index construction and Axioma’s industry-leading factor capabilities and portfolio analytics have been key to capture the nature of BlackRock’s requirements. I agree with what Lukas just said, this is a great fit that sets a new standard in factor investing.” 

Let’s dive deeper into the strategy. The indices target five factor styles with a multi-factor approach. What are the benefits of doing that? 

Lukas: “Investors want to link their portfolios to well-known, fundamental metrics and quantifiable indicators academically proven to drive returns and reduce risk, and which have historically been used by active managers. But individual factors often exhibit market cyclicality and can vary meaningfully from the broad market. Diversified exposure across factors can be prudent to mitigate long periods of underperformance from a given individual factor and can be shown to enhance risk-adjusted performance.”

Arun: “That’s right. Multi-factor exposure provides long-term potential outperformance in different kinds of markets, while balancing short-term market cyclicality.
I would also add that advancements in data and technology have afforded investors greater access to factor-based strategies and enable us to accurately hone in on that potential for long-term enhanced returns. In using Qontigo’s proprietary risk models and portfolio optimization software, we can calibrate the multi-factor alpha signal to obtain precisely the diversification that Lukas is describing. In our backtesting analysis, the Equity Factor indices have shown consistent multi-factor exposures over time and attractive risk/return profiles across geographies.”

How has investors’ interest in factor investing held up, given the long underperformance of Value, and very strong gains from the broader market until last year? 

Arun: “I’d say there has been a lot of debate around the viability of factor investing, and that is reflective of the increasing interest and deeper scrutiny of these strategies. Interest in factor-based methodologies has not slowed down. On the contrary, investors are demanding more, better, risk-adjusted ways of accessing factor-based premia. The new STOXX Equity Factor indices are a result of a common journey with clients and partners.”  

Lukas: “That’s what we are seeing from client flows too. Investors continue to demand factor strategies either for risk-management or alpha-generation objectives. This is true regardless of the broader market backdrop.
And, of course, then there is the efficient way of accessing these time-tested strategies through an ETF. It’s convenient, it’s transparent and it’s low cost. We can take exposures in the core of our portfolios, strategically seek outperformance, or implement tactical views with factor ETFs.”

You highlight risk management. Why is it important for investors to have factor diversification from that perspective?

Lukas: “Factor investing is all about accessing differentiated sources of risk and returns. We must also be very cognizant of what role an investment plays in a portfolio. Integrating factors in a single investment allows us to seek outperformance from all of the factors, which means, for a similar level of performance, we don’t have to lean into any one factor as much. This means that, for a core exposure, we can improve our risk-adjusted returns. There are also operational benefits for the investor with an integrated solution at the core of the portfolio, in limiting overhead in rebalancing with a single ticket.”

Arun: “Unintended bets and excessive tilts, but also tracking error, turnover and transaction costs are important considerations when you are seeking an efficient, and as Lukas said, well-balanced factor strategy that can deliver over time. So, we need an optimizer, we need robust risk models, and we need quarterly rebalancing. We can combine all of this in a passive strategy that offers the investor control over the different variables.”

Lukas: “Indeed, it is about risk control and about producing an effective strategy. You can extract the true premia of factor styles by using ‘smart’ indices that make factors work for your portfolio. This is what we seek to deliver.”