ETF issuers should start approaching product development differently with a more “pure” strategy for rules-based factor investing now warranted, according to Gregg Guerin, senior product specialist at First Trust.

Speaking at ETF Stream’s ETF Ecosystem Unwrapped event, Guerin explained that arbitrarily limiting ETFs to singular factors or factor-specific indices could potentially limit returns.

“For example, in one of the best value rallies ever, growth stocks have done pretty well,” he said, referring to US stocks and their recovery in the past 12 months. “Every question we get is about value or growth, but we think these factors can move pretty well together.”

With a bullish outlook now for the US economy, and in-house expectations of 25% potential upside in 2021, Guerin explained how a broad-based approach could help well-designed ETFs to capture overlooked upside.

“We believe the magnitude of the recovery, and the impact of government stimulation, means in the short run stocks will run,” he said.

“This idea of value vs growth, when you really dig into it a lot of counterintuitive arguments come up. Maybe having both is always a pretty good idea. We know what caused the recovery, the vaccine announcement – which was one of the most unpredictable things in stock market history.”

As such, Guerin explained to the audience how issuers should acknowledge how these factors are now behaving. To best capture these factors and build strategies with a better chance of outperforming the competition, he advocated a strict rules-based approach for portfolio construction.

“Remember ETFs are basically transparent tradeable bundles of risk, we think of them as shipping containers,” Guerin continued. “For example, if we look at indexes against ETFs, over 12 months, the S&P 500 Value index was up 53%. Our cloud computing ETF was up 76% over the same period!”

This approach could be of interest to ETF providers looking to capture ESG inflows, as Guerin’s data work unveiled: “When you use a rules-based process like this for portfolio creation, fascinating things come up. For example, we take the MSCI All Country ESG Leaders index and put it through our process to take out the best 50 ranked securities.

“What is remarkable is it produced an ETF of holdings with a higher ESG ranking than the index itself, in fact, it has a higher ESG score than any other ESG index-focused ETF. Which is fascinating as we were just looking for high quality, low volatility companies!"