Pioneers in factor investing
Joop Huij, PhD
In 2014 Robeco went live with its Factor Investing Solutions: tailored solutions based on multiple factors. “Robeco is not the founder of factor investing, but we are among the first to translate the theory into practical investment solutions,” says Robeco’s Head of Factor Investing Research Joop Huij with pride.
What is factor investing?
“Factor investing uses scientific insights that show that in addition to the reward for taking risks, there are other premiums to be earned in the market. These premiums are referred to as ‘factors’. The scientific background of factor investing dates back over sixty years. Last year the Nobel Prize in Economics was awarded to researchers who have done a lot of work in this field. Robeco has long used factor insights, but tailored solutions based on multiple factors are new.”
What is making this investment approach so popular?
“Clients appreciate factor investing’s academic basis. The demand for hard evidence that an investment style actually works has increased as a result of the crisis. Investing without clear rational reasons is a thing of the past. Asset owners have greater responsibility and therefore more to explain as well. Regulators have also become more critical. And the fact that this investment method offers higher expected returns is of course also appealing.”
What extra returns does factor investing deliver?
“Our research shows that a fund with exposure to any one factor earns a return of around 160 more basis points than an average active fund that doesn’t use factor investing. Exposure to any two factors increases this return to some 330 basis points, and the result is even better with exposure to three – an outperformance in excess of 350 basis points per annum.”
‘More than ever, it is important to base investment decisions on evidence’
In which market segments does Robeco see good opportunities?
“We have selected three ‘sweet spots’: the low-risk segment (low-volatility stocks perform better than more volatile ones), the value segment (value stocks perform better than growth stocks) and the positive momentum segment (stocks that have performed better recently will continue to do so in the coming period). We then look at what the optimal solution could be for each client, based on preferences and his or her current portfolio. There is no optimal mix of factors.”
Why do these sweet spots exist in the market?
“What sets us apart – and we see this as a shortfall in the academic literature – is that we want to explain the existence of sweet spots. The academic research does not go beyond discovering patterns. We also want to know why they exist, because this is just as important. We think that the career concerns of asset managers have an impact on the premiums. Many asset managers have an interest in taking extra risks to enhance the likelihood of higher rewards. Asset managers that operate in a different way can benefit from this.”
If everyone embraces factor investing, will the extra returns come to an end?
“More money will be put into factor investing, which may reduce the size of the premiums somewhat. But this method of investing is certainly not for everyone, so it could still be possible to earn premiums in the future.”
How is factor investing positioned in the discussion on active versus passive investing?
“We see it as a third route – between active and passive. Active investors have a very high degree of freedom in the investment process; factor investors don’t. At the same time, factor investments are more heterogeneous than passive investments, which track movements in indices.”
But isn’t factor investing just one of the many smart beta strategies?
“No, not in the slightest. Most smart beta investments are merely based on statistical patterns. Which is good, but not optimal. It’s better to use any information you have on the origin of these patterns in the investment process too, because this enables you to provide extra value. With most smart beta approaches it is assumed that the premiums are a way of compensating for risks. However, we see no evidence to support this notion.”
Lastly, who is factor investing for?
“We want to offer tailored solutions to large institutional customers. This matches Robeco’s ambition to further grow in the institutional segment. Factor Investing Solutions is an important part of this. We want to be able to use the range of factor solutions flexibly, in order to better serve multiple customers. Alongside pension funds, we are now also focusing on sovereign wealth funds and other professional investors.”
Head of Factor Investing Research
"I am sure that the financial industry will adopt an evidence-based approach to designing the investment process."