XLG - OMFL: Top Performing Business Cycle Investing Fund

2023-06-13 08:28:21 ET

Summary

• The Invesco Russell 1000 Dynamic Multifactor ETF (OMFL) outperforms the iShares Russell 1000 ETF (IWB) in both bull and bear markets.
• OMFL dynamically adjusts its factor weights based on the current economic cycle, making it more aggressive during Recovery and Expansion phases and more defensive during Slowdown and Contraction phases.
• The fund's 5-year average return of 13.8% per annum ranks it in the top percentile compared to the Large Blend category on Morningstar.

Recently, I wrote a review of the Invesco International Developed Dynamic Multifactor ETF ( IMFL ), noting it was a solid multi-factor fund that dynamically adjust its factor weights depending on the current phase of the economic cycle. The IMFL fund is more aggressive during Recovery and Expansion phases and more defensive during Slowdown and Contraction phases.

This article covers IMFL's domestic sibling, the Invesco Russell 1000 Dynamic Multifactor ETF ( OMFL ). The OMFL is based on the same underlying investment strategy as the IMFL with the only difference being the investment universe.

From its 5 years of performance history, the OMFL ETF appears to be clearly superior compared to a passive ETF like the iShares Russell 1000 ETF ( IWB ). It outperforms the IWB ETF in both bull (2019 to 2021) and bear markets (2022).

I am excited to see that the OMLF ETF uses many of the same 'business cycle investing' concepts that I employ in my personal portfolio; i.e. the OMFL ETF takes risks during Recovery and Expansion phases and reduces risks during Slowdown and Contraction phases. I rate the OMFL ETF a Buy .

Fund Overview

The Invesco Russell 1000 Dynamic Multifactor ETF is an exchange traded fund that gives investors exposure to dynamic 'factor investing' expressed via the Russell 1000 universe.

The OMFL ETF has $474 million in assets and charges a 0.29% total expense ratio.

Strategy

The OMFL ETF tracks the Russell 1000 Invesco Dynamic Multifactor Index ("Index"). The index begins with the Russell 1,000 universe, the largest 1,000 companies in the U.S. Invesco assigns a multi-factor score on each constituent in the universe based on the extent to which the security exhibits a factor relative to the other constituents. The factors considered are: Value, Momentum, Quality, Low Volatility, and Size.

Then depending on Invesco's assessment of the current phase of the business cycle: Recovery, Expansion, Slowdown, or Contraction, the manager will recommend a certain configuration of securities to be included in the index and fund during its monthly rebalancings.

For example, the Recovery phase will emphasize stocks with Size and Value factors, while a Contraction phase will emphasize stocks with Momentum, Low Volatility and Quality factors. Figure 1 shows an illustration of OMFL's strategy implementation.

Portfolio Holdings

Figure 2 shows the current sector allocations of the OMFL ETF. The fund's largest sector allocations are Health Care (21.7%), Information Technology (17.0%), and Financials (13.8%).

Compared to the Russell 1000, as modelled by the iShares Russell 1000 ETF ("IWB"), the OMFL ETF is overweight Health Care (21.7% vs. 13.3%), Consumer Staples (13.3% vs. 6.3%), Energy (9.9% vs. 4.3%). It is underweight Information Technology (17.0% vs. 26.8%) and Consumer Discretionary (6.4% vs. 10.5%) (Figure 3).

OMFL Positioned Defensively

Analyzing the OMFL ETF via the lens of factor weights, we can see that OMFL ETF is currently overweight the Size, Momentum, Low Volatility and Quality factors as of March 31, 2023 (Figure 4). This suggest the OMFL ETF is currently positioning for a Contraction, as per Figure 1 above.

Similar to the IMFL ETF, the OMFL ETF is aligned with my personal assessment of the macroeconomic environment, which is tilted defensively as I believe we are on the cusp of an imminent recession. In recent writings, I have recommended investors take a 'barbell approach' by owning megacap companies as represented by the Invesco S&P 500 Top 50 ETF ( XLG ) while holding ample amounts of cash.

Distribution And Yield

The OMFL ETF pays a nominal quarterly distribution with trailing 12 month distribution of $0.21 / share or 0.5% yield (Figure 5).

Returns

Figure 6 shows The OMFL ETF's performance history. After a modest start in 2018, the OMFL ETF has been on a tear, with strong performance in 2019 to 2021. Although 2022 was a down year, with a 13.9% decline, the OMFL ETF has once again delivered strong returns so far in 2022, with YTD returns of 8.5% to May 31, 2023.

Impressively, the OMFL ETF has outperformed or equaled the passive IWB ETF every calendar year since inception, so it is not just a bull or bear market strategy (Figure 7).

In fact, OMFL's 5Yr average return of 13.8% per annum to May 31, 2023 ranks it in the top percentile compared to the Large Blend category on Morningstar, with more than 1,100 peer funds!

Business Cycle Investing In Action

In my opinion, the main insight / innovation of the Invesco investment management team is to combine ' factor investing ' with ' business cycle investing '. By correctly recognizing the current phase of the business cycle, the Invesco team is able to tilt the portfolio to capture investment alpha.

For example, during the Expansion phase, risk appetites are high and investors reward Momentum stocks. However, during Slowdown and Contraction phases, investors are fearful and reward Low Volatility stocks.

This is essentially what I try to do in my personal portfolio. I analyze macroeconomic conditions and try to position my personal portfolio to take or avoid risk. I am extremely excited to find a low-cost ETF that follows essentially the same investment process.

Conclusion

While I am still new to the Invesco Dynamic Multifactor ETFs (OMFL and IMFL), I am excited to see they follow many of same macroeconomic-driven investment principles that I use in my personal investments. I personally believe there are times to be aggressive and times to be defensive, and OMFL does this via emphasis of different performance factors.

When the economy is in Recovery and Expansion, the fund emphasizes aggressive factors like Value and Momentum; when the economy is in Slowdown or Contraction, it is defensive and emphasizes Low Volatility and High Quality.

I will look to add the OMFL ETF to my core equity holdings (currently long the XLG ETF and Schwab U.S. Dividend Equity ETF) and will use the OMFL ETF as a benchmark to compare quantitative factor funds going forward.

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