The Invesco Russell 1000® Dynamic Multifactor ETF (BATS:OMFL) is one of the funds that offer a rule-based approach based on financial and market metrics while weighing them according to economic conditions. This creates an opportunity for dynamic allocation that cannot be seen in popular benchmarks, such as the S&P 500 or the Russell 1000 indexes.

However, as always, there is also a risk of underperformance. That has been the case in 2024 so far, as OMFL has lagged benchmarks and the peer group in a market led by big tech names. That said, the fund remains an option for investors looking for value and diversification toward smaller capitalization companies.

ETF Description & Highlights

OMFL is an exchange-traded fund that tracks the Russell 1000 Invesco Dynamic Multifactor index, which applies a rule-based methodology to re-weight the original constituents of the Russell 1000 index according to economic cycles and market conditions.

A multifactor score is calculated for each stock, based on five metrics: 1) Value (applying the three following metrics, cash flow yield, earnings yield, and price to sales ratio); 2) Size (based on total market capitalization); 3) Quality (according to profitability measures, such as ROA, and leverage); 4) Low Volatility (using the standard deviation of weekly total returns over the past five years); and 5) Momentum (returns over the trailing eleven months).

Stocks that cannot meet specific thresholds are excluded from the index, while the eligible stocks are then weighted using a combination of these five metrics that vary according to which economic cycle of the overall market is prevalent: recovery, expansion, slowdown, and contraction. The index and the ETF are also reconstituted and rebalanced monthly to adjust to changes in these economic indicators.

As a result of the index methodology, as of Jul 1st, 2024, OMFL's stock composition is concentrated on 422 companies, with an average market cap of $10.2 billion and nearly 98% of total assets composed of mid and small caps, as opposed to the Russell 1000, here represented by the iShares Russell 1000 ETF (IWB), where 75% belong to large and mega caps. It is also notable, OMFL's extremely high turnover rate of 350%, driven by its portfolio's monthly rebalance.

OMFL's top ten holdings (Hewlett Packard Enterprise, Synchrony Financial, Skyworks, Best Buy, Southwest Airlines, Steel Dynamics, Molina Healthcare, Marathon Oil, Everest Group, and Cardinal Health) represent only 7% of total assets and are well-diversified across sectors, unlike the Russell 1000, where the top ten holdings account for 33% of the index and are mostly big tech names, similar to the S&P 500.

The table below compares IHDG with other ETFs with allocations within the 1000 largest U.S. companies. ONEO follows a momentum-driven strategy, DEUS and GSLC apply multifactor methodologies, COWZ has a concentrated portfolio based on cash flow yield, while JQUA and PRF have a fundamental approach.

From a sector allocation perspective, OMFL's largest allocation is to the financial sector, with 21.1% of total equities, followed by consumer cyclical with 19.0%, industrials 13.9%, technology 8.2%, energy 7.4%, consumer defensive 6.9%, healthcare 6.6%, materials 5.9%, utilities 4.7%, communication services 3.3%, and real estate 2.9%. Relative to the Russell 1000 index, OMFL is overweight in financials (+8.8%), consumer cyclical (+8.6%), and industrials (+5.6%), but heavily underweight in technology (-24.2%) and in communication services (-5.8%) and healthcare (-4.9%) as well.

Compared to its peers, OMFL is overweight in financials (+12.3%) and consumer cyclical (+5.1%), while underweight primarily in technology (-11.3%). This suggests to me that OMFL's portfolio is likely positioned for a recovery, given its exposure to financials, consumer cyclicals, and industrials, but still looking to avoid high multiples areas of the market, such as technology.

Such an underweight allocation to high-multiple technology and communications services, combined with higher exposure to financials and cyclical sectors, gives OMFL a P/E ratio of 11.7x, which is substantially lower than the Russell 1000 index's P/E ratio of 22.0x, while growth metrics such as earnings and sales growth are relatively lower as well.

As introduced earlier, the peer group is composed of a mix of multifactor, momentum, and fundamental ETFs. This has resulted in lower valuation multiples on average, notably the P/E ratio compared to the benchmark. Despite that, the peer group's P/E ratio of 14.4x is still more than 20% above OMFL's multiple, as expected, given OMFL's underweight exposure to technology.

Short-Term Underperformance

2024 has been quite a difficult year for OMFL, with a total return of 2.2% year to date versus the Russell 1000 index and the peer group's gains of 15.5% and 8.8%, respectively. This weak return this year impacted OMFL's accumulated performance over longer time frames, as the fund now lags the Russel 1000 index and the peer group over the past three years.

Although OMFL's allocation is expected to be quite dynamic, given its monthly rebalances, the figure below shows that its overall portfolio profile has not changed much, as it has remained between value and blend styles since 2020. In my view, the reason for OMFL's short-term underperformance is driven by its value style allocation in 2024, while the Russell 1000 index has been more skewed to growth since 2023. On top of that, OMFL's concentration on mid and small caps has likely played a key role, as large and mega caps have led the stock market's gains year to date.

While OMFL's focus on lower capitalization companies coupled with its value style has not been a good setup for performance, the fund has managed to keep pace with the Russell 1000, except for 2024, of course. That said, although the environment may continue to be challenging for small caps, as interest rates are expected to remain at elevated levels for longer, my view is that OMFL is a name to keep on the watch list for those who are looking to diversify their portfolio toward value and mid to small-cap companies.