OMFL: What’s next for this unpredictable multi-factor fund? (BATS:OMFL)

investment thesis

The Invesco Russell 1000 Dynamic Multifactor ETF (BEAT: OMFL) quickly gained a reputation for being unpredictable. Last year the portfolio’s annual turnover skyrocketed to 350% and although we warned against this in April 2023 review of the fund, I’m still surprised by the fund’s extreme fall from grace. Since its launch in November 2017, OMFL has lagged behind the iShares Russell 1000 ETF (IWB) by 7%, completely wiping out its 33% advance since April 3, 2023, the date my original review was published.

However, OMFL is not destined to fail. September marks the second month in a row that his core portfolio has been on solid footing, and if you’ve been able to hold out this long, I’m asking for a little more patience. OMFL currently ranks well on most factors, and while I can’t make any promises, I’m cautiously optimistic its model has settled. either in the “slow down” phase or in the “contraction” phase, meaning his high-quality selections should stick around for the short term. I look forward to providing an update below on the fundamentals of OMFL and comparing it to four alternatives that you may find more suitable.

OMFL overview

OMFL tracks the Russell 1000 Invesco Dynamic Multifactor Index, selecting US stocks based on an ownership model’s assessment of the current economic cycle. The indicators assessed include:

• manufacturing business inquiries
• monetary conditions
• housing activity
• return on equity and fixed income

Production is a determination of the current economic regime: recovery, expansion, slowdown or contraction. The model then outlines certain factors based on this determination as follows:

An important feature is how free the model is to move back and forth between business cycles. For example, it could determine that the economy is in recovery mode one month, expanding the next, and then returning to recovery for the third month. This is not how real cycles work, and the high turnover rates of the OMFL over the past four years illustrate the high sensitivity of the model.

Imagine your portfolio manager asked you to review your entire portfolio because they were 51% confident that the economic regime had changed. Would you follow this advice? I hope not, but OMFL is and is the source of the excessive portfolio turnover rates mentioned above. However, the best I can do is evaluate OMFL’s current portfolio to identify its strengths and weaknesses, and make an educated guess as to how high the turnover in the portfolio is likely to be in the future. This review might help some readers, but at the same time, I understand that readers are probably fed up with OMFL’s lack of consistency.

OMFL analysis

The current economic regime

Based on my analysis of OMFL’s current portfolio, I am convinced that its model has determined that we are in either the slowdown or contraction phase of the business cycle. I rely on the following:

1. OMFL’s weighted average market cap of $853 billion is slightly higher than IWB’s $841 billion. This observation eliminates recovery and expansion phases as possibilities because they emphasize the size factor.

2. OMFL trades at 25.78x forward earnings compared to 22.20x for IWB. This observation also eliminates the recovery and expansion phases because they emphasize the value factor.

3. OMFL’s Sector Adjusted Profit Score of 9.76/10 is much higher than IWB’s score of 9.16/10. Backed by weighted average net margins that are 1.37% higher (21.44% vs. 20.07%), it is evident that the quality factor is accentuated.

4. OMFL’s five-year beta is currently 0.98, compared to 1.07 for IWB. This lower beta indicates that the model emphasized the “low volatility” factor, albeit to a limited extent. Deceleration and contraction phases are the two remaining possibilities.

5. Momentum acts as a tiebreaker, but if the model emphasizes this factor it is a bit of a problem. To illustrate, consider these statistics based on current holdings of OMFL and IWB.

Compared to IWB, OMFL constituents have poorer long-term results (eg five- and ten-year total returns) but better short-term results, such as a one-year price return that is 8 .54% more (37.53% vs. 28.99%). . OMFL’s short-term momentum characteristics also look better than the SPDR S&P 500 ETF Trust (SPY) and the JPMorgan US Quality Factor ETF (JQUA), and since his model is based on more recent price movements, I am inclined to believe that the OMFL model has emphasized this factor. Therefore, the model has probably determined that we are in the contraction phase, although a slowdown is possible.

That would largely agree with the assessment of The Conference Board, the nonprofit organization that conducts the popular consumer confidence survey. The the last poll indicates that consumers have concerns about the labor market, while the Conference Board expects GDP growth to slow in 2024, writing in Summary August 2024:

Despite recent financial market fluctuations, the US is probably not on the brink of recession. However, the economy is expected to lose momentum in the second half of 2024 as high prices and rising interest rates weigh on domestic demand. Real GDP growth rose by an unexpected 2.8 percent quarterly annualized in Q2 2024. But there were some signs of weakness, especially as consumers cut back on spending on services, a key contributor to real GDP growth in the last two years. Consumers and businesses will continue to cut spending and investment going forward, suggesting economic growth slowed to 0.6% annually in Q3 2024.

Can things change?

It is possible that the model will switch to the expansionary phase regime it adopted in early July, and while I think it is unlikely, the potential impact is considerable. This change would cause OMFL to select volatile small-cap stocks that have performed significantly over the past decade. As shown below, the small-cap asset class has lagged the SPY by 12.65% in 2020 and has trailed 7-10% per year in 2017, 2018, 2019, 2023 and 2024 YTD.

Total returns aside, the asset class is also quite risky. Over the past 20 years, small-cap stocks have been about 30% more volatile than S&P 500 stocks, based on the percentage difference between the annualized standard deviation numbers (19.68% vs. 15.03%). Importantly, the added risk was not beneficial. The asset class had a Sortino ratio of just 0.62, a common measure of risk-adjusted returns, compared to 0.90 for SPY.

OMFL Fundamentals by Top 25 Holdings

The following table highlights selected fundamentals for OMFL’s top 25 stocks, which total 64.01% of the portfolio. Summarized below are values ​​for IWB, SPY, JQUA and the BlackRock US Equity Factor Rotation ETF (DYNF). DYNF also emphasizes specific factors (quality, value, size, volatility, momentum), so it will be interesting to see if the two models agree.

OMFL is a high quality fund and the portfolio also offers excellent one year estimated sales and earnings growth of 10.74% and 16.74% respectively. Compared to IWB, this growth is driven by overweighting stocks such as Meta Platforms (THE TARGET) and Eli Lilly (LLY) with 2.53% and 1.29% and underweight Apple (AAPL) with 2.63%. However, I caution that quality and growth come at a significant price. OMFL trades at 25.78x forward earnings, which is 3-3.5 points more expensive than IWB and SPY. At 21.91 times forward earnings, estimated earnings growth of 10.24% and a five-year beta of 0.98, JQUA is more suitable for quality investors, while DYNF seems to have it all. Its growth and value metrics are excellent and Its constituents’ net and free cash flow margins are great, but the problem is its poor diversification. DYNF allocates 81.56% of its portfolio to just 25 stocks, with high allocations to just two sectors: financials and technology.

Finally, I want to highlight OMFL’s excellent earnings momentum features. Top holdings like Berkshire Hathaway (BRK.B), meta platformsand Amazon ( AMZN ) have high EPS revision scores, which we derived from Looking for Alpha Factor Ratings. OMFL’s overall score of 6.85/10 ranks 37/661 among all Size & Style ETFs I track and complements a solid 7.51/10 Momentum score that ranks 63/661. These scores should line up because the last thing you want is to buy a group of stocks with great price momentum but low or negative earnings revisions. Fortunately, I don’t see this risk with OMFL.

Investment recommendation

OMFL is not suitable for most investors. Its pattern is unpredictable and frequently shifts between economic regimes that emphasize completely different factors, resulting in excessive turnover. However, I am optimistic that the pattern will settle into the slowdown or contraction phases where it favors quality, low volatility and possibly momentum. Although expensive in terms of value, this setup results in a well-diversified portfolio of less volatile large-cap stocks with excellent earnings momentum. However, OMFL may change holdings again, and since I have no information on the current confidence level of its model, I suggest proceeding with caution or avoiding it altogether. Therefore, I’ve only assigned OMFL a “hold” rating, and I look forward to answering any questions you may have in the comments below. Thank you for reading.