What is AFSM? (Pros, Cons, and Strategies)

If you're looking to diversify your portfolio with small-cap stocks that leverage a factor-based investment approach, AFSM might be the ETF for you. The First Trust Active Factor Small Cap ETF, known as AFSM, has been gaining attention for its unique investment strategy. Today, we'll explore what AFSM is, along with its advantages and disadvantages, and outline some strategies for investing in it.

What is AFSM?

AFSM is an actively managed ETF that focuses on small-cap stocks in the U.S. market. The acronym AFSM stands for First Trust Active Factor Small Cap ETF. Unlike traditional ETFs that passively track an index, AFSM employs a factor-based management approach to select stocks actively.

Key Features of AFSM

• Active Management: AFSM doesn't just follow an index; it actively selects small-cap stocks based on various factors like value, momentum, and quality.
• Factor-based Strategy: The ETF employs a factor-based investment strategy, which involves focusing on specific financial metrics such as price-to-earnings ratio, return on equity, or market momentum.
• Exposure to Small Caps: AFSM predominantly invests in small-cap companies, which are often overlooked but have significant growth potential.

AFSM Composition

AFSM comprises a diverse array of small-cap stocks selected based on their alignment with specific financial factors. Unlike large-cap ETFs, AFSM's portfolio is more dynamic and tends to react quicker to market changes.

Typical Holdings

AFSM typically includes stocks from various sectors, such as industrials, consumer discretionaries, and financials. The holdings are chosen based on their performance against several key factors, ensuring a balanced yet effective diversification.

Pros of AFSM

Potential for High Growth

Small-cap stocks generally have higher growth potential compared to large-cap stocks. The active factor-based selection strategy enhances this potential by choosing stocks with strong financial metrics aligned with growth, value, and momentum.

Factor Diversification

The factor-based strategy diversifies risk by focusing on multiple financial metrics. This reduces dependency on a single market or economic trend, offering a more stable investment environment.

Active Management

The active management aspect allows for nimble adjustments in the portfolio. This flexibility helps in taking advantage of market opportunities and mitigating risks more effectively than a passive strategy.

Cons of AFSM

Higher Expense Ratio

Active management typically comes at a cost. AFSM has a higher expense ratio compared to passive small-cap ETFs, which might eat into your returns over the long term.

Increased Volatility

Small-cap stocks are generally more volatile than large-cap stocks. While this volatility can lead to high returns, it also increases the risk.

Limited Dividend Yield

Unlike dividend-focused ETFs, AFSM may not provide a significant dividend yield. Small-cap companies often reinvest profits back into the business rather than paying substantial dividends.

AFSM Investment Strategies

Investing in AFSM requires a careful strategy given its focus on small-cap stocks and active factor-based management. Below are some strategies that can help optimize your investments.

Long-term Growth Strategy

Given its potential for high growth, AFSM is more suited for long-term investment horizons. Holding the ETF for several years can help mitigate short-term volatility and capitalize on the small-cap growth potential.

Dollar-Cost Averaging

Investing a fixed amount regularly into AFSM can average out the purchase cost, reducing the impact of market volatility. This strategy is particularly useful for navigating the ups and downs typical of small-cap stocks.

Combine with Defensive Assets

Because AFSM focuses on more volatile small-cap stocks, consider balancing your portfolio with more defensive assets like bonds or large-cap ETFs. This can reduce overall portfolio risk while allowing you to benefit from AFSM's growth potential.

Focus on Factor Rebalancing

Given the ETF's factor-based strategy, it’s essential to regularly review how the investment aligns with your financial goals. Rebalancing your investment based on shifting market conditions and the performance of different factors can optimize returns and manage risk.

Conclusion

AFSM - the First Trust Active Factor Small Cap ETF - offers a unique approach to investing in small-cap stocks through active management and a factor-based strategy. While it comes with its share of risks, including higher volatility and expense ratios, its potential for high growth and diversified factor approach make it an attractive option for long-term investors looking to diversify their portfolios.

Whether you're new to investing or a seasoned investor, understanding the pros, cons, and effective strategies for AFSM can help you make well-informed decisions, aligning with your financial goals.