Investors give a cautious welcome to factor investing
Investors in Asia and the US have welcomed strong performance of factor investing strategies this year, led by value, but are not generally increasing allocations.
Led by a turnaround in the performance of value – which, for many years, has underperformed market cap – factor strategies have showed strong returns so far in 2022.
Factor approaches select stocks according to attributes, or factors, that have tended historically to offer favourable risk and return patterns. Besides value, factors include minimum volatility, momentum, quality and size, and are often combined in multi-factor strategies by investors.
Stephen Gilmore, CIO of New Zealand Superannuation Fund’s (NZ Super) told AsianInvestor the turnaround in value had been a valuable source of returns for the fund, with recent increases in interest rates fuelling more recent performance.
“At the beginning of [our factor investing] value didn’t do very well, with interest rates staying low and long-duration growth assets outperforming, but that has turned around as interest rates have risen. [this year],” he said.
At the end of December 2021, the fund had NZ$3.9 billion, 6.4% of its total AUM, in a multi-factor mandate managed by Northern Trust, an allocation which dates from 2018, and NZ$1.6 billion, 2.6% of total AUM in multi-factor mandate with UBS, which dates from 2021.
Gilmore said what he looked for in a factor manager was the same as what he looked for in any manager employed by the fund. “It’s about capability and alignment, and people and process – including the culture of the company - risk mentality and business model, and how they think about ESG,” he said.
However, given the likely variation in equity factors over time, he said the fund had no plans to increase allocations or to shift allocations within equity factors to those that have outperformed recently.
“You don’t want to put all your eggs in one basket. And your time horizon is important: ours is a very long-term one and factors have a very long track record of doing well over a long time,” he said.
AUSTRALIAN FACTORS
In Australia value and momentum strategies have outperformed all other factors over the past year. Andrew Cassar, head of Australasian equities at Jana in Melbourne, said superannuation funds and other investors have maintained a constant exposure to systematic factor strategies
“Investors typically remain patient without timing the turning point in the style performance. Value style strategies have historically featured short periods of significant outperformance followed by long periods of gradual decline,” he said.
Cassar said that allocations to factor strategies were likely to increase as the superannuation industry consolidates and the size of individual super funds increases.
Fund requirements to deploy large amounts of capital in local equities markets steers them towards factor strategies and away from active managers, where their allocations would make up too large a share of manager capacity, he said. “The large and mega funds continue to allocate towards quantitative factor styles, so that trend will continue.”
The Your Future Your Super (YFYS) regulation, which imposes stiff penalties on poor performing super funds and which has intensified consolidation in the superannuation industry, is further driving this trend.
“An additional outcome of YFYS has been a tilt away from active managers and towards factor investment strategies, which tend to track performance of market cap indices more closely,” said Cassar, adding the strategies have tighter risk constraints that minimise tracking error.
Besides the benefits in terms of capacity and portfolio construction, factor-based systematic strategies also appeal for their low fees, an increasingly important driver in Australia’s super market. The strategies can typically be executed by computer programs and require smaller manager teams than traditional fundamental or "stock-picking" strategies.
US INVESTORS
Investors in the US reported a similar approach to maintaining factor allocations.
“All the performance has come back in a hurry,” Kyle Schmidt, director of quantitative equity at the Teacher Retirement System of Texas (TRST), told AsianInvestor, referring to the sharp turnaround in many factor strategies, notably value, so far this year.
“It’s not just been value, all strategies in the single name space have been working really well for the last year and a half,” he said, noting that most quantitative strategies enjoy some exposure to value especially when part of alternative risk premia.
ARP, TRST’s favoured factor-based approach, seeks market-neutral exposure, by using long and short exposure to traditional risk factors, such as value, momentum or low volatility. ARP strategies typically invest across asset classes such as equities, commodities, fixed income and currencies. With fees typically ranging between 0.5% and 1% such strategies have proved attractive alternatives to active managers, including hedge funds.
“But we’re not looking to expand our allocations to risk premia,” said Matt Talbert, director of multi-asset strategies at TRST. “Overall, other areas of active management have done well too and we don’t need to be [too] concentrated.”