Why fixed income factor investing has seen low adoption
Institutional investors generally believe that factor-investing strategies are applicable in fixed income portfolios, but most have yet to implement them on a large scale, according to this year’s Invesco factor-investing study to be released later today (October 19).
This study incorporates the views of 138 *institutional investors and 100 **wholesale investors that manage a combined $25.4 trillion in assets as of March 31. Among them, 65 were from Asia Pacific (Apac). All of them were ‘factor users’, and interviews for the study were conducted in April and May this year.
Challenges remain for fixed-income factor investing even though it continues to gain traction, according to the study. Factor investing is a type of investment strategy whereby securities are chosen based on their characteristics and attributes, or factors, that have tended to offer favourable risk and return patterns over time.
"It's well over 90% [of the respondents] that believe in the concept of factor investing in the fixed income space, [but] the adoption is significantly lower than that," Stephen Quance, director of factor-based investing at Invesco, told AsianInvestor.
There are not many strategies that have established track records. It is relatively new compared to equity factor investing which has been around for decades, posing difficulties for investor adoption, Quance said.
"In the earlier days, there is greater deviations of design and even philosophies - why are there potential factor premia in fixed income, what is the nature of them, how do you scale them? How do you calculate them cost-effectively?" he said.
In the study, price modelling and a lack of consensus around definitions and terminology were quoted by respondents as the most pressing challenges in Asia Pacific. They commented on the difficulties of working with different external managers across fixed income factor mandates and the lack of unified definitions when discussing fixed income factors internally.
This challenge was further exacerbated by the limited availability of fixed income products with respondents pointing to frequent gaps in coverage across both regions and asset classes.
The respondents’ belief in the applicability of factor investing to fixed income was found to be close to universal at 95%, while it was just around 60% two years ago. Regional investors were most likely to apply factors in government bonds (71%) than in investment grade corporates (63%) or high yield (54%), the study shows.
Quance argued that the ultra-low interest rate environment as a result of Covid-19 will encourage the development of fixed income factor investing.
Historically, high-quality bonds have been good defensive buffers to equity declines, but they may not be as reliable counter balances now that yields are at zero or even negative, he said.
Fixed-income factor investing is a relatively straightforward way to create a well-diversified, cost-effective portfolio that includes bonds with desired factors without having to load up on a portfolio of bonds all of which may have zero yield, he said.
The Bureau of Labor Funds in Taiwan invited bids in June for a five-year $2.3 billion global US dollar corporate bond mandate, which applied factor investing.
It tends to be the more progressive and the larger institutional investors that have staff that can analyse new approaches, take on new concepts and understand them when adopting the more complex fixed income factor investing, Quance said.
So asset managers are moving quickly to seize the opportunities. A number of Invesco’s rivals are moving towards this quickly as they see the benefits and demand, he added.
It is worth noting that Invesco's belief on this is subjective; the fund manager offers several factor-based products, so it potentially stands to benefit from a rise in institutional investor engagement.
*Institutional investors are defined as pension funds (both defined benefit and defined contribution), sovereign wealth funds, insurers, endowments and foundations.
**Wholesale investors are defined as discretionary managers or model portfolio constructors for pools of aggregated retail investor assets, including discretionary investment teams and fund selectors at private banks and financial advice providers, as well as discretionary fund managers serving those intermediaries.