Tilting - A Different Approach to Indexing

Posted by FlexShares on May 8, 2017 8:35:29 AM
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Traditional market cap weighted indexing, such as with ETFs that track benchmarks like the S&P 500, attempt to replicate the holdings and weightings of the index. The stocks having the most weight in the index have the most weight in the ETF.

With the growth of strategic beta and factor investing, the use of tilting can enhance exposure to markets like U.S. equities, developed markets, emerging markets, and others, with a focus on the portions of these market segments that have the possibility of adding the most value for investors through an alternative weighting methodology.

Why tilting?

Tilting provides a vehicle for investors to invest in an index product with a focus on a market segment like the total U.S. stock market, using the tilting methodology to add value over time.

Factor investing is one of the hallmarks of strategic beta. Factors are sub-sets of an index or market segment that are carved out, including the creation of a new benchmark. Factor investing is about using a rules-based strategy to enhance the performance of an ETF. Factor titling is an example of how factors can be used to enhance the benefits of indexing, and a way for financial advisors to add value to their clients within the framework of an asset allocation strategy that fits their situation.

Here at FlexShares we've teamed with Morningstar® and have incorporated several of their tilted indexes into our ETFs. The depth of their research and expertise in this area makes them a great partner as we seek to offer innovative ETF solutions for financial advisors and their clients.

An example

Our FlexShares Morningstar® U.S. Market Factor Tilt Index Fund (TILT) provides a good example of how this works.

The ETF tracks the Morningstar® U.S. Market Factor Tilt Index, a benchmark Morningstar® developed to invest in the U.S. stock market, while giving the portfolio an emphasis or tilt toward small cap and value stocks. Research by Eugen Fama and Ken French has shown that size and value were important factors, with a combination of beta and exposure to these factors, in adding value to portfolios over time.

Morningstar® follows a four-step process in building and reconstituting the index:

  • Define the investable universe
  • Define the total market portfolio
  • Assign value scores and classify stocks by style
  • Apply a proprietary factor tilt

Morningstar® rebalances the index four times per year and it is reconstituted twice each year. To learn more about this process, read Alternative Tilting.

We offer several other factor tilt index ETFs using Morningstar's® methodology, including:

Summary

Factor investing is not new, but the growth of factor-based models and ETFs in recent years has provided enhanced tools for investors and financial advisors to fine-tune their investment strategies. Factor tilting enhances the already solid concept of indexing and builds on the benefits of this approach.

Please contact us at 855- FLEXETF (855-353-9383) or visit FlexShares.com to learn more. We think you will be impressed by what you see there.

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An investment in the FlexShares Morningstar® U.S. Market Factor Tilt Index Fund (TILT), FlexShares Morningstar® Developed Markets ex-US Factor Tilt Index Fund (TLTD) and FlexShares Morningstar® Emerging Markets Factor Tilt Index Fund (TLTE) is subject to numerous risks including loss of principal. Highlighted risks: concentration (may invest 25% or more of assets in a single industry/sector); currency (foreign currencies may fluctuate in value relative to the U.S. dollar, adversely affecting the Fund's investments); emerging markets (countries potentially less liquid and subject to greater volatility); foreign securities (TLTD & TLTE typically invest at least 80% of assets in ADRs and GDRs); small cap stock (smaller-company stock may be subject to more abrupt/erratic market movement than larger companies); value investing (possibility that an investment in companies whose securities are believed to be undervalued may not appreciate in value as anticipated).

Investment in FlexShares Currency Hedged Morningstar® DM ex-US Factor Tilt Index Fund (TLDH) and FlexShares® Currency Hedged Morningstar® EM Factor Tilt Index Fund (TLEH) is subject to commodity exposure risk, the risk of investing in economies that are susceptible to fluctuations in certain commodity markets. The Funds enter into foreign currency forward contracts designed to offset the Funds' currency exposure of non-U.S. dollar denominated securities included in the Underlying Indices against the U.S. dollar, which may not be successful. Investments in foreign and emerging market securities involve certain risks such as currency volatility, political and social instability and reduced market liquidity. The Funds' investments are concentrated in the securities of issuers in a particular market, industry, sector or asset class. The Funds may be subject to increased price volatility and may be more susceptible to adverse economic, market, political or regulatory occurrences affecting that market, industry, sector or asset class. The Funds may also invest in derivative instruments. Changes in the value of the derivative may not correlate with the underlying asset, rate or index and the Funds could lose more than the principal amount invested. See prospectus for full description of risks.

The Morningstar® U.S. Market Factor Tilt Index, Morningstar® Developed Markets ex-US Factor Tilt Index, Morningstar® Emerging Markets Factor Tilt Index are the intellectual property (including registered trademarks) of Morningstar® and/or its licensors ("Licensors"), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by Morningstar® and its Licensors and neither of the Licensors shall have any liability with respect thereto.

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