DEUS: Multifactor Russell 1000 ETF Falls Short, Sell

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Tero Vesalainen Investment Thesis This article explains why I don't recommend investors buy the Xtrackers Russell US Multifactor ETF (NYSEARCA:DEUS), a factor fund that seeks to improve on the market-...

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seeks to improve on the market-cap-weighted iShares Russell 1000 ETF (IWB). While claiming to take a \"comprehensive\" approach, my analysis reveals a strong lean toward less volatile and smaller value stocks at the significant expense of growth and quality. As a result, I believe shareholders will experience inconsistent and ultimately lower total returns compared to its benchmark. DEUS is a \"sell,\" and I look forward to detailing why below. DEUS Overview Strategy Discussion According to its prospectus, DEUS follows a \"proprietary rules-based multifactor selection and weighting process designed to increase the Underlying Index's exposure, relative to the starting universe, to companies demonstrating the following factors\":  Quality Value Momentum Low Volatility Size  The prospectus uses several metrics to calculate scores for each of these factors. For example, quality is measured by a company's return on assets, asset turnover, and accruals. Value is measured with ratios like cash-flow yield, earnings yield, and sales to price. Trailing 11-month price returns determine the momentum score, and finally, the Index provider prefers smaller and less volatile stocks. The approach is complex but does not factor into growth, sentiment, or diversification. Furthermore, one should not assume these factors are equal-weighted. I don't expect that, as different models overweight specific characteristics depending on the market environment and historical patterns. However, seeing which factors a model favors most is always interesting. It's not disclosed, but it's also easy to figure out by performing a fundamental analysis of our own. I'll do that shortly, but let's first look at DEUS's record. DEUS Performance DEUS launched on November 24, 2015, and has a 0.17% expense ratio and $162 million in assets under management. Portfolio Visualizer provides returns since December 1, 2015, and as shown, DEUS has delivered a 10.76% annualized return since compared to 13.39% for IWB. It also experienced higher volatility and a 27.31% drawdown in Q1 2020, 3% worse than IWB. Portfolio Visualizer Ignoring the growth factor did not serve DEUS shareholders well over the last few years. Investors and analysts know how difficult it is to predict which factors the market will favor next, so it's prudent to acknowledge this and prepare for multiple environments. Instead, DEUS limits itself. It only outperformed its benchmark one time (2022) between 2016 and 2023. Portfolio Visualizer Other factor ETFs fared better despite not including the growth factor in their models. For example, the Franklin LibertyQ U.S. Equity ETF (FLQL) only considers quality, value, and momentum but has easily outperformed DEUS since May 2017. As shown below, an initial $10,000 investment in FLQL would grow to $24,803 (148.03% total return) compared to $20,357 (103.57% total return) for DEUS. Portfolio Visualizer In addition, DEUS outperformed IWB three times between 2018 and 2023, and if it weren't for a 10.07% lag in 2020 during the pandemic, its annualized returns would likely be higher than IWB's rather than slightly lagging (13.35% vs. 13.64%). These results are terrific for an ETF that doesn't even factor growth into the equation. DEUS Analysis Sector Allocations and Top Ten Holdings DEUS overweights the Industrials sector by 9.59%, a setup that could be problematic, given that hedge funds are dropping stocks in this sector at a record pace. In a nod to the low volatility factor, DEUS also overweights Utilities by 3.32%, with the offset mostly in Technology, which DEUS underweights by 15.95%. Morningstar DEUS's top ten holdings are shown below, totaling 7.59% of the portfolio. McKesson (MCK) is the largest holding at 1.25%, but unfortunately, the only thing we can learn from this list is that DEUS is well-diversified and avoids mega-cap stocks. That's the \"size\" factor in action, so at the very least, we can expect DEUS to provide a very different look at the Russell 1000 Index. Xtrackers DEUS Fundamental Analysis The following table highlights selected fundamental metrics for DEUS's top 25 sub-industries, which cover 50.28% of the portfolio. These metrics represent all five factors used in DEUS's model plus growth and sentiment, which you should also consider. The Sunday Investor Here are four observations to consider: 1. Using the summary metrics at the bottom, we can see how DEUS strongly emphasizes size, low volatility, and value factors. Its $61,261 weighted average market cap is less than 10% of its benchmark, its 0.99 five-year beta is ultra-low when considering that small caps are typically more volatile than large caps, and its 20.77x forward earnings valuation (16.70x harmonic average) represents a 20-25% discount off IWB and FLQL. 2. DEUS underweights Apple (AAPL), NVIDIA (NVDA), and Amazon (AMZN) by a combined 14.77%. These stocks have a 1.36 average five-year beta and trade at 37.91x forward earnings, so allocating just 0.23% to these stocks is a very efficient way to gain exposure to the size, low volatility, and value factors. However, by emphasizing these factors, DEUS sacrifices quality. Consider how 48 of IWB's top 50 holdings have \"A+\" Seeking Alpha Profitability Grades. The result is an 8.34/10 profit score that ranks #227/251 in the large-cap blend category. Furthermore, DEUS has a 1.22 weighted average debt-equity ratio and a 6.46 weighted average debt-free cash flow ratio, which are higher than IWB's 1.17 and 5.21 figures. Less ability to service debt could become burdensome if interest rates stay high for longer, as is BlackRock's expectation per its mid-year outlook. 3. DEUS's constituents have gained 22.42% over the last year compared to 27.13% for IWB, suggesting DEUS's model does not emphasize the momentum factor well. Its holdings also have a relatively low 5.98/10 EPS Revision Score, indicating Wall Street analysts aren't as bullish on its selections compared to the broader market. 4. Lastly, DEUS features only 5.09% and 8.51% one-year estimated sales and earnings per share growth rates, which are about 3-4% worse than IWB and FLQL. As I mentioned, the model does not consider the growth factor, but to be truly comprehensive, it should. Weakness in the growth factor led to relatively weak historical returns, so unless you expect a long-term shift toward value stocks, DEUS will likely continue to lag its benchmark. Investment Recommendation  DEUS is a multifactor ETF attempting to outperform the Russell 1000 Index by emphasizing five factors: quality, value, momentum, low volatility, and size. However, my analysis revealed a strong preference for the value, low volatility, and size factors at the significant expense of quality and, to a lesser extent, momentum. DEUS also ranks below average on growth and sentiment, and given how its model does not even consider these factors, I expect that will continue. Overall, I think a multifactor strategy can work, but DEUS executes it poorly, so for that reason, I've assigned it a \"sell\" rating. Thank you for reading, and I look forward to your comments below.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"-1","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2455452989"}