Momentum ETFs have undergone a major rotation to value at the end of May leaving major portfolio construction questions for investors who have used these strategies as growth proxies in recent years.
Amazon, Apple and Microsoft are just three of a number of growth stocks that have been removed from BlackRock’s US momentum factor ETFs and been replaced by value names such as JP Morgan, Berkshire Hathaway and Bank of America.
According to research conducted by CFRA, the $2bn iShares Edge MSCI USA Momentum Factor UCITS ETF (IUMF) and its US-listed equivalent is constructed in part using performance data one month before rebalancing.
Each security is weighted by a combination of a momentum score and the market capitalisation weight of the stock within the parent MSCI USA index.
As a result, IUMF now has a 32.5% weighting to financials, up from 1.5% prior to the rebalance, representing a dramatic shift in the characteristics of the ETF.
In the build-up to the rebalance, CFRA predicted there would be a shift to financials however the firm said it “underestimated how heavily weighted” IUMF would be to the sector.
Financials have been on a tearaway this year driven by the shift to value-orientated stocks following the Pfizer vaccination announcement last November.
Highlighting this, the SPDR MSCI World Financials UCITS ETF (WFIN), which is comprised of 231 large and mid-cap financial stocks, has returned 27.1% since the start of the year versus 11.9% for the Xtrackers MSCI World UCITS ETF (XDWD).
Along with the huge increase in financials, energy stocks have once again been included and now account for 1.9% of IUMF.
This is in stark contrast to the information technology sector that has seen its exposure slashed by over half from 42% to 18% as names such as Adobe Systems and NVIDIA were removed.
Todd Rosenbluth, head of ETF and mutual fund research at CFRA, stressed it is crucial investors look inside smart beta ETFs because the underlying portfolios are not as static as many expect.
“Investors have used momentum ETFs as an alternative to growth strategies in recent years, but with value stocks in the financial sector leading the US equity markets in 2021 investors might now be overexposed to value,” Rosenbluth added.
The question now is whether the stocks that are now in IUMF can continue their strong performance in recent months.
“IUMF looks very different from a month ago,” he continued. “The ETF’s prospects will be driven by its new portfolio, which is why we do not solely rely on the fee or past performance.”
Off the ropes: Value’s dramatic comeback
IUMF, itself, has struggled so far in 2021 returning just 5.7% since the start of the year versus 12.1% for the iShares MSCI USA UCITS ETF (CSUS) which tracks its parent benchmark.
This was due to its heavy weightings to tech, consumer discretionary and healthcare; three sectors that made up 74% of the ETF and have struggled in recent months following the outperformance of cyclicals.