Risk Factor Investing: It’s Not All About The Upside

Matthias Hoppe, senior vice president and portfolio manager, Franklin Templeton Solutions comments on Risk Factor Investing. 

Since the financial crisis there has been a sea change in investors’ attitudes to their portfolios. These days, it seems to us, investors are not looking for portfolios to take a lot of risk to generate a high-digit positive return. Instead they are looking for solutions that have the potential to offer some stability within a certain level of risk. Increasingly, we recognise that many investors seem less concerned about whether portfolios outperform a benchmark, and are focusing more on the outcome they can expect from their investments.

These considerations, coupled with challenges inherent in the current investment environment, poses the potential to disrupt traditional multi-asset approaches (see What is Risk-Factor Investing sidebar).That’s been one of the drivers for our teams, focusing on our long-adopted risk-factor approach across a number of strategies.

WHAT IS ‘RISK FACTOR-BASED INVESTING’?

Multi-asset portfolios have attracted interest around the world in recent years as investors seek new ways to capture equity-like returns with less volatility. Many of these approaches have focused on traditional asset allocation methods of shifting between stocks, bonds and cash. However, Franklin Templeton Solutions is using a different strategy, one that makes use of a larger toolkit to seek value based on diversifying the risk factors, and not the asset class.

The experience of the financial crisis suggests to us that when there is a big market shock, correlation between asset classes tends to increase, causing them to move more in sync. We think this limits investors’ ability to reap the full benefit of diversification, and suggests that a successful investment strategy requires a combination of skills and ability to make a number of independent trades or investments in a specific time period, typically a year.

A cursory glance across the investment landscape gives an indication of the extent of the challenge for traditional portfolio managers and investors.

We, as a team, are optimistic on global growth, which we see as a positive sign for risky assets such as equities. However, we recognise that very few risk assets—even those considered to be “safe assets”—are not without their challenges. Most face some kind of headwind.

That means an investor or portfolio manager has to look across the field in more depth. For example, fixed income is in a challenging environment now, with near record-low interest rates in many of the world’s developed economies. It is difficult for an investor to generate a return from this asset class. As an alternative, some investors may look to emerging markets for potential opportunities.

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