Although Factor Investing is rapidly gaining popularity, there are still ongoing debates about this concept. In our view, the key feature of Factor Investing is that asset owners select factors and their weights themselves, rather than leaving this up to their asset managers.
Factor Investing is a relatively new concept which is rapidly becoming mainstream. However, we sometimes encounter confusion and notice a lack of consensus on what Factor Investing really is and what sets it apart from traditional quantitative investment approaches.
Factor Investing is founded on the existence of various factor premiums. Well-known examples of factor premiums in the equity market include the value, momentum, quality and low-volatility premiums. The existence of these factor premiums has been extensively documented in the literature, and they have been shown to be robust over time and across different markets. Similar premiums have been documented in the corporate bond market and also in the multi-asset space, so Factor Investing is not necessarily limited to the equity part of a portfolio.
The initial evidence for the existence of factor premiums goes back multiple decades, so in that sense they are not new. Quantitative asset managers have developed various investment approaches to harvest these factor premiums. They have traditionally done so by creating proprietary multi-factor models, in which quantitative factors are combined in such a way that the resulting portfolio consistently generates outperformance over the market index. Crucial in this regard is that asset owners allocate to conventional asset classes, such as global equities, and leave it up to asset managers how to get the most out of factor premiums. Asset owners focus their efforts on selecting the offering with the best performance characteristics.
More recently, other investment approaches have come to the market. This includes index providers who entered the business by offering all kinds of indices designed to benefit from factor premiums. For instance, the MSCI Minimum Volatility index series specifically targets the low-volatility effect, while fundamentally weighted indices provide exposure to the value effect. In this way, factor premiums became alternative betas, or, more popularly, smart betas.
Although investors can passively track smart beta indices, it is important to realize that they are essentially active strategies, because they systematically deviate from the market index and require someone else to be on the other side of the trade. The difference with traditional quantitative strategies is that smart beta indices use a relatively simple and transparent investment approach.
The availability of smart beta indices made it relatively easy for asset owners to consider factor premiums next to traditional classes in their Asset Liability Management (ALM) or strategic asset allocation process. This is what we call Factor Investing: asset owners allocating strategically to factor premiums next to traditional asset class risk premiums, and essentially treating both as equal.
‘There is no single optimal factor allocation’
We strongly believe that there is no single optimal factor allocation as the optimal Factor Investing portfolio depends on investor-specific beliefs and preferences. For example, the low-volatility factor is very attractive for investors looking for downside protection without sacrificing return potential, such as pension funds aiming for funding ratio stability. However, it can be less attractive for clients who care more about maximizing return than about reducing risk and for clients who dislike the high tracking error involved with low-volatility strategies.
After choosing a strategic allocation to factors, asset owners have various ways in which to implement their Factor Investing strategy. A key decision is whether to follow public factor indices, such as a fundamentally weighted index or a Minimum Variance index, or make use of proprietary approaches. For an index-based approach one could follow an appropriate smart beta index for each factor. These compete with proprietary approaches, which either target various factors individually or multiple factors simultaneously using an integrated model.
We believe that although smart beta indices are a good way to obtain exposure to factor premiums, it is possible to do better by avoiding the pitfalls encountered with these indices:
Robeco’s factor solutions are designed to offer more efficient factor exposures by specifically addressing these issues.
In our experience there can be confusion about the concept of Factor Investing. For instance, when we engage in a dialogue with institutional investors who indicate that they are interested in Factor Investing, it is not unusual for us to find out that they have no desire to select factors and weights for these factors themselves, but instead see this as the asset manager’s responsibility. In this case a traditional quantitative product might actually be a better fit. One might of course say that this is all just a matter of semantics, but it can be confusing when the same concept means different things to different people.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.