VONE - Unraveling The Merits Of Invesco: Why OMFL Is A Great ETF

2023-10-20 10:37:12 ET

Summary

• The Invesco Russell 1000 Dynamic Multifactor ETF is an actively-managed fund that invests in companies listed on the Russell 1000 index.
• The fund uses an economic cycle-based management approach, delivering impressive returns with low volatility.
• The ETF's allocation is based on four economic scenarios, focusing on different types of stocks depending on the phase of the economic cycle.

The Invesco Russell 1000 Dynamic Multifactor ETF (OMFL) is an actively-managed fund-guided by specific parameters-that invests at least 80% of its assets in companies listed on the Russell 1000 index. What makes the fund standout is its economic cycle-based management approach that over the years has delivered impressive returns while maintaining relatively low volatility.

Having thoroughly examined this fund and the suite of Invesco's Dynamic Multifactor ETFs, I believe it represents a solid long-term investment, striking a balance between diversification, passive management, and active management. In my view, compared to an ETF that solely replicates the Russell 1000, it is better suited to navigate the current economic uncertainties. Unlike a fully active ETF, I find it more predictable and backed by a sound investment strategy.

The fact that its "sibling" ETF, which invests in Russell 2000 companies, has also performed exceptionally well over time, beating the index but maintaining a similar volatility, strengthens my belief in the robust foundation of Invesco's Dynamic Multifactor funds. That's why I consider OMFL a valid investment for long-term capital accumulation, perfectly poised to harness the historical strength of large-cap companies combined with the growth potential of mid-cap firms.

Characteristics of the ETF

The following highlights the main features of OMFL:

The allocation does not happen proportionally based on market cap for all the Russell 1000 companies, nor is it entirely discretionary. The managers identify four scenarios:

• Recovery - Growth is below trend but accelerating. In this phase, the fund will mainly focus on larger companies and value stocks;
• Expansion - Growth is above trend and accelerating. Here, the focus is on larger companies, value stocks, and stocks with positive momentum;
• Slowdown - Growth is above trend but slowing down. More emphasis is placed on low volatility and high-quality stocks;
• Contraction - Growth is below trend and declining. More weight is given to low volatility, high-quality stocks that also exhibit positive momentum.

Growth is measured using macroeconomic indicators that tend to predict economic activity rather than merely describing existing trends. Surveys from manufacturing companies and consumers, monetary policy conditions, real estate market activity, and labor market data are considered. This data is then cross-referenced with market sentiment, all of which is then fed to an algorithm that determines the current phase of the economic cycle.

To determine a company's quality, value, momentum, volatility, and size, a scorecard is used which assigns a score for each of these attributes for every single company in the reference index. Citing from the prospectus :

• "Value - A company's value factor score is based on an equally-weighted composite of cash flow yield, earnings yield, and sales to price ratio, calculated based on the company's total market capitalization and information reported in the company's most recent annual financial statement as of the last business day of the prior month.

• Momentum - A company's momentum factor score is based on historical total return over the 11 months ending on the last business day of the prior month.

• Quality - A company's quality factor score is based on a composite of three measures of profitability (return on assets, change in asset turnover and accruals) and a single measure of leverage, calculated as the ratio of operating cash flow to total debt based on information reported in the company's most recent annual financial statement.

• Low Volatility - A company's volatility factor score is based on the standard deviation of weekly total returns to a company's stock price over the trailing five years ending on the last business day of the prior month.

• Size - A company's size factor score is based on total market capitalization as of the last business day of the prior month. An initial weight for each security is determined from the product of the security's multi-factor score and its weight in the Parent Index ."

Fund Allocation

Currently, the fund holds 727 securities in its portfolio, and the top 10 holdings account for just over 8% of the fund. Concerning the sizes of the companies it is exposed to, the distribution is as follows :

• 21.75% large-cap (4.45% value, 10.51% blend, 6.79% growth)
• 61.07% mid-cap (18.06% value, 26.64% blend, 16.37% growth)
• 17.18% small-cap (4.84% value, 8.79% blend, 3.55% growth)

Below is a display of the current top 10 holdings.

Performance and Benchmark Analysis

Even though the index this fund is intended to replicate is officially the Russell 1000 Invesco Dynamic Multifactor Index, it's evident that the most direct benchmark is the classic Russell 1000. Comparing their results shows that, from inception to date, Invesco's economic cycle-based strategy has proven its merit.

Following is a comparative performance data (Data source: TradingView):

As can be observed, the past year and especially the last six months have been less favorable periods for Invesco's ETF. This can be partly attributed to the high turnover, which, according to the most recent prospectus, was 336% in the last fiscal year relative to the fund's assets; a high turnover implies high transaction costs, impacting the overall index performance. It can also partly be ascribed to the fact that the fund suffered more than the Russell 1000 during the recent stock price drop that coincided with the Treasuries yield rally, due to a different sector allocation.

Below is an image comparing the sector allocation of the iShares Russell 1000, which passively and physically tracks the entire index, against that of the Invesco Russell 1000® Dynamic Multifactor ETF. It's particularly noticeable how Invesco's ETF is more exposed to industrial stocks, while iShares leans more towards tech.

It's clear that Invesco's ETF is more heavily weighted towards industrial stocks and less so in tech. When comparing the performance of various sectors in 2023, which I did using the dedicated tool from Fidelity, it becomes evident that tech emerged as the top performer during this period, whereas industrial stocks underperformed.

Alternatives

It's impossible to find a fund exactly like OMFL, as there are no other funds with a semi-active strategy on the Russell 1000. Therefore, we have three kinds of alternatives: other funds from the Dynamic Multifactor family of Invesco, funds that only invest in the growth or value component of the Russell 1000, or funds that invest in the Russell 1000 companies in an entirely active or passive manner.

Below, I present a comparison table with data from ETF.com.

Funds that offer a lower TER (Total Expense Ratio) do not provide the same strategy as OMFL, and at the same time, those with a higher TER do not offer advantages that lead me to believe they are qualitatively superior to OMFL.

It's interesting to note that the Invesco Russell 2000® Dynamic Multifactor ETF has also outperformed the Russell 2000 in the last five years, confirming that the strategy based on the economic cycle has solid foundations.

Conclusions and Final Thoughts

My analysis leads me to believe that Invesco has managed to strike an ideal balance between a wholly passive fund and a fully active one. On one hand, we are not at the mercy of managers, hoping they make the right choices. On the other, we do not lose sight of the importance of allocating our portfolio funds based on the economy's progression and various sectors. By adeptly combining these two factors and ensuring exposure to over 700 companies currently, I believe OMFL is an excellent ETF to accumulate over time.

I don't think it is particularly exposed to a short-term rally, nor are there currently elements that would allow it to grow exponentially within a few months. I believe it offers an opportunity to navigate an uncertain economic phase rationally, quickly responding to the evolving context we are in. Examining the alternatives, I haven't found any ETFs that provide me with the same assurances.

Potential Risks of the Analysis

Please consider the following risks:

• Being an ETF without diversification constraints, if the management chose to focus heavily on a specific sector or a handful of securities due to an erroneous algorithm recommendation, the fund might underperform the Russell 1000 for a period.
• Sometimes macroeconomic data and market trends diverge, potentially leading to erroneous moves by an ETF that invests based on the economic cycle.
• In the event of a recession in 2024, I am convinced that OMFL could outperform the Russell 1000, but this wouldn't save investors from a negative performance.

Honestly, I have no reason to believe that the managers will decide to significantly increase the risk of concentration on a few stocks in the future. Moreover, I prefer to keep my portfolio tethered to the real economy, even if sometimes this might lead to missing a bullish rally due to excessive market exuberance. Considering all the risks, I still believe there are ample reasons to regard this Invesco fund as a solid ETF to accumulate over time.

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