Factors can include broad macroeconomic influences, which can be based on risks such as inflation and economic growth; and style-based factors, which may be based on specific returns and risks such as momentum and value. Strategies based on these factors have become more popular in recent years.
Factor Allocation is Increasing Globally
Factor allocations are expected to rise over the next five years, according to Invesco’s Second Annual Global Factor Investing Study, published in May of this year. Over the past year, allocations have increased from 12 percent to 14 percent among repeat survey participants.
The survey covered responses from 108 investors and intermediaries across 19 countries, accounting for assets totaling more than $7 trillion. The study showed that allocations made to smart beta and active-factor strategies comprised 17 percent of institutional portfolios for 2017. This is up from 15 percent back in 2016.
In Europe and North America, the main reason for allocating to factor products was to reduce portfolio risk. In Asia, the strongest reason was to increase alpha.
“The industry has to make the effort to develop some frameworks for evaluating these strategies,” said Felix Goltz, head of applied research at EDHEC-Risk Institute. “You have the traditional business consultants to help with manager selection, but who is helping with factor selection?”
Factor allocations were found to be the largest among European sovereign wealth funds and insurers. Data shows that investors were looking beyond geographic and sector diversification due to concerns over increased volatility of equities, as well as fixed income. Thus, diversifying and managing macro or cyclical risks are some of the main reasons why investors appear to be increasing factor allocations.
Of the investors who were surveyed that choose not to invest by factors, the main reason appeared to be a lack of belief in the theory of factor-based investing. This was followed closely by a lack of in-house expertise.
In-House Factor Allocation
Invesco’s study quizzed 108 investors and intermediaries across 19 countries, with more than $7 trillion in assets under management. It appears that there is a growing desire to manage factor allocations in-house. Invesco’s study also found:
- Nearly a quarter (23 percent) of investors already managed some factor assets in-house
- Nearly one-third (31 percent) stated an intention to develop capabilities to handle factor assets internally
The decision to build internal factor capability is rooted in a desire to receive risk-return outcomes that are similar to those offered by external managers, except at relatively lower costs. Demand for factor allocations is expected to rise significantly over the next five years.
Factor allocations were found to be the largest among European sovereign wealth funds and insurers. Data shows that investors were looking beyond geographic and sector diversification due to concerns over increased volatility of equities, as well as fixed income. Thus, diversifying and managing macro or cyclical risks are some of the main reasons why investors appear to be increasing factor allocations.
Factor Investing for Fixed Income
While the concept of factor investing for equities has been popular for many years, the application of such concepts to traditional fixed-income is yielding different results.
Barriers to entry in exchange-traded funds for fixed-income are high when compared with equities. The challenges in implementing systematic strategies in fixed income are data and liquidity. This type of research is easier to obtain in the equities sector, as data is more available, easier to source, and easier to analyze.
By comparison, security-level data is expensive to source for fixed income — adjustments are needed for bond duration, and there is a greater need to build in transaction costs. While the factors used in equities such as quality, value, momentum, size, etc., may apply to fixed income, they will likely need to be defined differently when applied to equity.
Exchange-Traded Fund (ETF) Activity Also on the Rise
A survey by Risk Magazine of 210 institutions from around the world found that in Europe, 30 percent of institutions executed ETF’s more than 50 times per month. By comparison, just over half of Asian fund managers stated that they trade ETF’s 10 times per month or fewer. Lastly, U.S. investors are increasingly using ETF’s as a way to shift asset allocations. Some managers consider ETF strategies as subsets of factor investing, while others say it is related to smart beta.
In other news, NASDAQ recently filed suit in U.S. District Court against a New Jersey fund management company, alleging that the firm is attempting to steal a number of multimillion dollar ETF’s that are in its care. This lawsuit, along with the growing trends in ETF activity, highlights the importance of regulating this industry.
Strategies and approaches for institutional investors can be complex. If you have any questions or concerns regarding the regulation of institutional investor activity, contact us today at Kessler Topaz. Our team is committed to assisting investors prosecute corporate fraud claims and recover assets on a global scale.