Demands growing for multi-asset multi-factor solutions – Survey
The latest annual Invesco Global Factor Investing Study has been published, and the findings suggest that institutional investors, such as insurers, pension funds and sovereign wealth funds are pushing for development of multi-asset multi-factor solutions, according to co-author Georg Elsaesser, senior portfolio manager Invesco Quantitative Strategies.
For the industry, the challenge lies in the fact that there is relatively little academic research backing a shift to such solutions, as compared to some three decades of academic and industry application of single factor or multi-factor solutions based on the single asset class of equities, Elsaesser notes.
The conclusion is based on the Study results, which were based on interviews with 108 different investors and intermediaries – up from 66 in 2016 – in 19 countries accounting for over $7trn in AUM.
The Study found that there are three reasons generally cited by investors for using factor investing: risk management – the first thing mentioned across the board by respondents, and cited as the most important reason why they would use such an approach; performance; cost; and a fourth reason that Elsaesser says is based on his analysis of the everyday situation facing investors, which is the customisation opportunities, to use factors to develop bespoke solutions to match particular risk/return expectations.
Growth in use of factor investing continues, he added; while some 12% of those institutions surveyed a year ago reported adoption of and allocation to factor products, including so-called smart beta and active quantitative strategies, that had grown to 14% by this year’s research, but an additional question in the Study elicited responses suggesting that the proportion could grow to 18-20% in the next five years.
Insurers continue to lead the way in adopting factor based strategies, Elsaesser says. In last year’s Study, some 90% reported using factor investing in some way.
Use among sovereign wealth funds has increased since Norway’s Pension Fund Global produced its own research into the issue previously.
Now there is growing evidence of adoption by DB (final salary) and DC (money purchase) pension schemes.
As Elsaesser understands it: insurers are first movers because of strong pressure for additional yield. Especially larger insurers are pressured thus and need to move out of their ‘comfort zone’, particularly into equities he adds, “plus insurers are quite technical anyway, so the mindset is there to move to factor investing anyway”.
For the DB and DC schemes, it is cost that arises as an important consideration. Regulation forces them to adhere to maximum costs they can charge for certain structures, meaning factor investing is attractive for the ability to offer reasonable potential for stable returns at an attractive cost relative to traditional active fund management, Elsaesser says.
A new pillar
One of the reasons factor investing is growing, Elsaesser argues, is that it is taking the place of a third pillar alongside active and passive investing in equities, but with the ability to offer a broad range of strategies, using either highly active single factor strategies or multi-factor ones, in areas such as beta 1, long/short, and many others.
For investors this implies a need to ensure they have the necessary resource themselves to take a proprietary informed decision on finding their way in the “factor investing jungle”, he says.
“If they are able to do this, then they are able to decide to award to factor investing specialists.”
Thus far, factor investing has relied on a handful including momentum, value, quality, size, low volatility. But despite the number of factors being relatively limited, there are many types of strategies that flow from their use. For example, argues Elsaesser, smart beta, which will always be active because it deviates from benchmarks, will use standard definitions of, say value, but an active quantitative manager such as Invesco may put the question whether a better outcome can be achieved than relying on a standard definition of a factor.
“The devil is in the detail,” he notes.
“Clearly, part of the Study is about going to factors in other assert classes. Up to now it’s only been about equities, and there the discussion is pretty advanced – since the 1980s, lots of research and work has been done in this area.”
“But what people are saying is that there is strong demand to go beyond, eg, to develop fixed income factors, as a bridge to considering asset allocation from a factor perspective. So, people want to look at overall allocation through a factor lens.”
“This makes a lot of sense. For example, if you think that equities/bonds is a diversified portfolio; but what happens if equities crash, but interest rates can’t go down? There is a need for better diversification.”
The point, Elsaesser stresses, is that if it is possible to develop factors not only in fixed income, but also areas such as commodities and currency, then they will facilitate improved understanding of return from diversified portfolios.
And the pressure is on for the industry to do just that, Elsaesser adds. Anecdotally, he says discussions with end investors makes him believe that they would like to see such factors available as soon as possible. The challenge is that there is lack of availability of such factors currently. While there may be over three decades of research into equity related factors, there has been relatively little research into fixed income – partly because the 30-year bull run in fixed income has diminished any need to do such research, he says, but also because it is more difficult. Questions include how to determine which are the ‘right’ bonds to look at, and what factors to look at, and how a fixed income factor might compare with an equity factor. An immediate question also is whether there is a carry factor in fixed income as there may be for equity. Going further, the industry still has to come up with definitions of factors that are then comparable across asset classes, and then to implement these.
“Research is one thing, but applying this is another,” Elsaesser says.
Invesco itself is engaged in research on this topic ongoing, seeking to find out how to bring a multi-asset multi-factor solution to meet the growing demand. Tellingly, Elsaesser adds, about a third of the Study respondents also said they cannot implement their preferred factor strategy.
“So, expect lots more news on this front,” he says.
Meanwhile, growth in factor investing overall will continue, he adds, with possibly strong growth even beyond the 5-year time horizon Study respondents were asked about (see above). The behaviour of market participants has also changed; less looking for a ‘product’ and increasingly about taking a consultative/solutions approach, as institutional investors start to analyse existing portfolios to understand if there are factor biases affecting them.
To download a copy of the Study click here: IGFIS2017_Text_EMEA_Low-res_2