Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Institutions find their faith in factors
According to the findings of the seventh annual Invesco Global Factor Investing Study, 67 per cent of respondents said that factor investing helped them manage market volatility over the past year, while 64 per cent said their “faith” in factors grew over the same time.
The study, based on interviews with 151 institutional and retail investors with a combined US$25.4 trillion in assets under management, also found that investors had upped their allocations to factor strategies in the past year (41 per cent of respondents), while 39 per cent of respondents were planning on increasing them in the next year.
“The fact that investors actually increased their support and exposure to factor strategies through this latest global bear market cycle speaks to how comfortable and confident they have become with a factor approach as a pillar of investing alongside active and passive,” said Stephen Quance, global director of factor investing at Invesco (photo at top). “This is a trend we have seen across geographies including Asia Pacific where factors can systematically target specific outcomes in a risk-off, rising rate environment.”
Investors are also looking to fixed income factors for new sources of return, with over 50 per cent of respondents saying the current market environment makes factor investing in fixed income more attractive. Government and corporate bonds were the favourite for the application of factor investing (76 per cent and 75 per cent respectively), while a “clear majority” of 71 per cent believe they will use high yield bonds in their fixed income factor exposure over the next five years.
“The evolution of factor strategies in fixed income illustrates the continuing evolution of the segment overall,” Quance said. “Without a tailwind of falling interest rates, the importance of factor exposures may increasingly explain deviations in results.”
Respondents also showed an increased willingness to use factors in ESG. The number of respondents who said that “enhanced performance” was their reason for adopting ESG fell from 75 per cent in 2021 to 59 per cent this year, with the top reason for ESG adoption now “demand from clients and beneficiaries” (76 per cent of respondents). Off the back of that, “improved performance” was cited by 72 per cent of respondents as the advantage of using factors to help implement ESG objectives.
“ESG adoption continues to increase in Asia Pacific to the point where it is now a discussion topic in most client conversation,” Quance said. “Many regional clients have even set their own ESG targets. Investors in the region are keen to understand the potential impact of these targets on the risk and return of their portfolios, which is where factor analysis and implementation can serve to counter any unintended biases.”
