The fifth Invesco Global Factor Investing Study found that 97% of factor investors were planning to either maintain or increase their factor allocations over the next 12 months, with investors in EMEA more likely to be making additional allocations to factor strategies (47%) than their counterparts in North America (31%) or Asia Pacific (44%).
Factor investing is an investment strategy whereby securities are chosen based on their characteristics and attributes (commonly termed ‘factors’) that have tended to offer favorable risk and return patterns over time. Levels of adoption and sophistication have increased rapidly in recent years, with investors recognizing the potential benefits of incorporating factor strategies within a portfolio.
The rise in factor allocations versus the 2019 studyisdriven in part by the broader adoption of factors including its incorporation into additional asset classes such as fixed income and by the gradual building up of exposures over time.
This year, 65% of institutional and 67%of wholesale investors reported that their factor allocations met or exceeded their overall performance expectations in the 12 months leading up to the study.
In global equity markets, the momentum, quality, and low volatility factors have generally outperformed over the survey period. In contrast, the value factor and the small size factor, underperformed. Indebtedness and liquidity concerns weighed particularly on the small size and value factors, especially early in the interview period when many firms rushed to raise capital due to Covid-19.
Georg Elsaesser Senior Portfolio Manager, Quantitative Strategies at Invesco said: “Factor strategies have performed as expectedand sentiment towards factor investing has remained very positive, even considering the peculiar conditions and lower returns for some factors over the past couple of years. Factor investing is here to stay and is being increasingly adopted by more investors of every size. It is important to stress that factor investors are long term, whose belief that factor premia results in excess return over the long run underpins a sense of pragmatism in the face of short-term volatility.”
Investors increasingly look to fixed income factors in their portfolios
Record numbers of institutional and wholesale investors are now using factor strategies within their fixed income allocation. Two-fifths (40%) of survey respondentssaidtheynow use factors in fixed income while more than a third are actively considering doing so.Just 17% of institutional investors said they were not considering implementation.
The 2020 study found the belief that factor investing can be applied to fixed income is now close to universal, having increased from 59% in 2018 to 95% this year. According to the research, investorsbelieve fixed income is a good fit for a factor-based approach, with 63% agreeing that factors in fixed income are equally as important as in equities.
Georg Elsaesser said: “The relatively high proportion of respondents either investing in fixed income via factors, or considering their introduction, points to the appeal of more systematic approaches to the asset class. Investors cite the potential for a factor approach to shine a spotlight on alpha generation by active fixed income managers and bring more transparency to the market overall, as has been the case with equities.”
Investors continue to switch to factor-based ETFs
Over the past 12 months, the use of factor ETFs has increased furtheramong both institutional and wholesale investors: 60% ofinstitutional investors now make use of ETFs, accounting for an average of 14% of their factor portfolios. In the wholesale segment more than two-thirds of investors make use of ETFs accounting for half of factor portfolios overall. For wealth managers ETFs are usually the primary vehicle for gaining factor exposure, making up three-quarters of the average factor allocation.
For respondents that are investing in factor strategies based around passive indexing strategies, ETFs are particularly valued for their ease of use and price. For these types of ‘enhanced’ or ‘smart beta’ applications investors reported being attracted to transparent, rules-based products that can better meet their risk-return objectives than market-weighted allocations.
The Invesco study also found that ETFs are being increasingly used to implement active factor strategies. Some investors described moving towards ETFs, having previously implemented factors through swaps or other derivatives executed via an investment bank. In comparison to these vehicles, ETFs were seen as preferable due to their increased transparency and for some, this shift was being driven by the additional transparency demands of new or enhanced ESG policy thresholds.
At the intersection of ESG and factor investing
ESG has been a principle area of focus among both institutional and wholesale investors for some time and last year’s Invesco report noted that factor adoption has often taken place in parallel with ESG adoption. This year 84% of institutions and 71% of wholesalers (all of them factor investors) had an ESG policy in place, while more than half were already incorporating, or considering incorporating, ESG into their factor portfolio.
Most investors saw ESG as aiding factor strategies. Some 64% of institutional and 47% of wholesale investors perceived a helpful symbiosis, believing that incorporating ESG in factor models should provide the means to manage short term downsidewith the potential for a greater upside over the longer term.
For institutions, these benefits were generally broad: they see them in terms of superior risk management (90%) and a potential ESG-related return boost. Meanwhile, wholesalers, while also focused on return and risk management, saw benefits from ESG including the ability to manage factor-specific risks, such as the risk of value traps.
Georg Elsaesser said: “While ESG and factor investing are becoming increasingly integrated, theconcurrent adoption of both appears to be causing challenges for some investors that used to implement them independently of each other. This is especially true as many factor products are not ESG-integrated, and most ESG products are not factor strategies.More knowledge transfer in terms of how perfectly factor strategies are suited to incorporate ESG is required as factor strategies can help to smoothly implement an ESG focus, and this may even improve a portfolio’s risk/return characteristics.”
“Looking forward, it is also likely that ETFs will play an important role in the ESG space. More recent ESG adopters often lack experience and face implementation challenges and are eager for simple, cost effective solutions. In addition, ETFs do not necessarily have to be passive only, they can also wrap truly active investment strategies and tailored solutions for instance, in order to establish customized ESG integration, including enhanced reporting.”
In the Middle East, the number of investors turning to factor investing to better manage portfolios has been slowly increasing, according toZainab Kufaishi, Head of Middle East and Africa at Invesco. Zainab said: “Investors in the region are committed to assessing risk and return of factor investing strategies over a long-term horizon, as opposed to a speculative, short-term strategy, identifying additional drivers as they gain experience. They see factor investing as a strategy with a distinct profile that can combine advantages of both active and passive investment approaches.”
