Factor allocations to increase globally backed by demand for fixed income and multi-asset factor str
Insurers and sovereign wealth funds driving the increase in factor allocations across Europe.
Factor allocations are expected to rise significantly over the next five years according to the second annual Invesco Global Factor Investing Study, with an increasing demand amongst investors for fixed income and multi-asset multi-factor strategies.
The qualitative and quantitative study, which was conducted with 108 different global pension funds, insurers, sovereign wealth funds, financial advisers, asset consultants, private banks and intermediaries across 19 countries who in total account for well in excess of $7 trillion in AUM, reveals an increase in both adoption of and allocations to factor products. It is expected to rise over a five year horizon with investors’ adoption intentions accelerating. Retail investors are expecting to significantly increase factor allocations to 17 per cent by 2022, putting portfolio allocations on an almost level playing field with institutional investors expecting to increase allocations to 18 per cent in the next five years.
Georg Elsaesser, Senior Portfolio Manager, Quantitative Strategies at Invesco said, “The growth in factor investing over the past 12 months demonstrates the value it can play in an investor’s portfolio. It is still relatively early in the adoption process for many, but our respondents make it clear that it will become more prominent over time.
As central bank policies have driven interest rates down to around record-low levels, investors are increasingly aware that the quality of diversification in their portfolios is much weaker than it used to be. This may drive demand for fixed income factor strategies to reduce risk and improve diversification and performance. In addition to fixed income strategies, investors are showing an appetite for the expansion of factor investing into multi-asset as well, highlighting the opportunity for product development.
With only a third of investors able to allocate to their preferred factor strategies, we see these products as the next evolution post-equities, providing investors with more choice and resulting in the further strengthening of factor investing as a third pillar alongside fundamental active and passive strategies.”
Over the past year overall allocations have increased from 12 per cent to 14 per cent, amongst repeat participants. Respondents in both institutional and retail segments globally continue to adopt factor-based strategies, allocating 17 per cent and 6 per cent of their portfolios to factor investing in 2017, respectively. This compares to allocations of 15 per cent and 4 per cent in the previous year.
Global adoption and the drivers
Whilst global demand for factor investing has increased, North America leads the adoption of factor investing in both institutional and retail segments. North American institutions have increased their allocations in factor strategies to 19 per cent, compared to 16 per cent in 2016, and this is predominately driven by insurers and state pension funds.
Institutional respondents cited risk benefits as the primary reason for larger allocations, slightly ahead of potential alpha improvements, and cost also remains an important driver. Within established factor strategies, the preferred product remains smart beta according to two thirds of respondents (66 per cent), with funding coming from fundamental active strategies.
In Europe, institutional investors are also the greatest adopter of factor investing, with 19 per cent allocating their portfolios to this strategy, compared to 17 per cent in 2016. Insurers and sovereign wealth funds are the biggest drivers in this region, and respondents have reported a similar combination of risk-return benefits to North Americans, but with less emphasis on cost reductions. In contrast to North America, 62 per cent of those surveyed in Europe invest in quantitative products over smart beta products (38 per cent).
Although Asian institutional and retail investors have the lowest allocation to factor investing, this year’s study reveals the highest rate of annual increases globally. With the uptake in adoption of factor investing in the Asian market increasing, respondents cited the potential to improve returns as the most important driver over risk reduction.
Across investor segments, factor investing is being driven by its growing role as a third pillar of portfolios, alongside fundamental active and passive strategies, to help mitigate challenges such as pricing and macro and geopolitical risk exposure in public asset markets, and pricing, accessibility and liquidity in alternative and real asset categories.
For those investors who have adopted factor-based strategies, nearly half (49 per cent) of respondents identified value as one of the easiest factors to implement out of the current mainstream factor set, followed by low size and low volatility.
However, according to 42 per cent of investors, momentum is the most difficult factor within their portfolio, with respondents highlighting trading costs, volatility and frequency of rebalancing as particular problems. Investors also highlighted low volatility and quality as difficult to implement.
Demand and expansion
As global adoption of factor investing increases, the study reveals a growing interest in expansion to fixed income and multi-asset strategies. To date, inflows have mostly been into single factor equity and equity multi-factor strategies, but the study indicates a demand for new factor products. With the majority of investors (68 per cent) not invested in their preferred types of strategy, there is an increasing importance on finding new directions for factor investing.
Respondents also revealed demand for fixed income factor strategies, with two thirds (68 per cent) believing that the theory can be applied to fixed income, but just one third (32 per cent) using factor strategies within their fixed income portfolios. Interest has also expanded into multi-asset products, particularly in North America and Europe, with 52 per cent and 47 per cent of respondents, respectively, stating multi-asset multi factor as the preferred structure for factor products.