Important legal information

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 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 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.

I Disagree
Unintended factor biases

Unintended factor biases

28-02-2017 | Factor investing challenges

Allocation to factors has become increasingly popular in recent years, but practical implementation remains a puzzle for many investors. Avoiding unintended factor biases often ranks amongst their top concerns.

Speed read

  • Unintended factor biases can affect performance 
  • Determining precise exposure to factors is key
  • Robeco has developed a specific tool to help investors
Stay informed on Quant investing with monthly mail updates
Stay informed on Quant investing with monthly mail updates
Subscribe

Analyzing and attributing the origin of past portfolio returns is an essential part of the investment process. This is obvious for investors using a traditional fundamental country and business sector selection approach, but it is also the case for those allocating systematically to factor premiums.

However, while this kind of analysis appears relatively easy to perform for fundamental investors, accessing a portfolio’s exposure to factor premiums and calculating the performance of individual factors is much less straight forward, especially for newcomers to the factor investing arena.

This has far-reaching implications as undetected and unintended factor biases can seriously affect performance. A FTSE Russell survey carried out in 2016 actually suggested that avoiding unintended factor biases ranked second among investors’ concerns, when considering factor allocation.

Beware of smart beta indices

As we indicated in the first article of this series dedicated to the major challenges investors face when considering factor investing, the fact that it is virtually impossible to effectively time the different premiums makes a strong case for broad diversification. Unfortunately, this is easier said than done because factors can also clash with each other.

These potential clashes are one of the reasons why products based on common smart beta indices often prove inefficient when it comes to harvesting factor premiums. For example, most generic value strategies do not avoid stocks that are cheap for a reason, such as those of financially distressed companies. This is a typical case of the value factor clashing with quality.

‘Investors need to be able to access their exposure to different factors’

As a result, an investor using this kind generic value investment product will also often end up being negatively exposed to quality, without realizing it. In a 2015 white paper(1) David Blitz, head of Quantitative Equity Research at Robeco, and Matthias Hanauer, Quant Equity Selection Researcher, argued that the performance of a particular strategy explicitly targeting one specific factor depended heavily on the implicit exposures towards other premiums.

They also found that the return difference between ‘bad’ and ‘good’ strategies could amount to as much as 5%-7%, depending on secondary exposure to other factors. To measure this, they simulated four generic global strategies targeting value and momentum – two of which were good and two of which were bad. The good strategies specifically avoided factor clashes, while the bad strategies had strong negative exposure to other risk factors.

At Robeco, we exploit four factors that have proven their long-term performance potential: value, momentum, low volatility and quality. And while combinations of generic single factor products often result in opposing premium exposures that partly or totally neutralize each other, we make sure that all our strategies efficiently combine factors to avoid unintended biases. This is true both for equities and fixed income(2).

However, it is also important to note that existing portfolios may already be heavily factor-biased without investors realizing this. When considering a new factor-oriented strategy, investors must therefore make sure they are fully aware of their exact exposure to different premiums. For example, an existing significant value tilt in a client’s holdings may mean that their optimal factor strategy needs to target a lower explicit weight for this specific factor.

When considering allocation to factors, the first task investors face is determining which premiums they intend to exploit and defining them precisely. Then, they also need to be able to evaluate their exposure to each individual factor and the corresponding performance.

Dedicated monitoring tool

To make sure our clients know exactly which factor premiums they are exposed to and how these have performed in the past, we have developed an innovative performance attribution model, the Factor Exposure Monitor(3). This comprehensive tool fully allocates performance to the set of selected factors used in our quantitative equity strategies.

Of course, there are many other tools available in the market for quantitative factor performance attribution, and the body of academic literature on the subject is extensive. Our proprietary approach, however, stands out thanks to its relative simplicity and the fact that the applied factor definitions are consistent with those used in our own quantitative investment processes.

Many non-Robeco models that are used for a broad range of different strategies are rather complex, something that can also make the results more difficult to interpret and understand. Furthermore, the factor definitions used are not completely in line with those we apply in our own strategies.

Our Factor Exposure Monitor provides a concise overview of the contribution of each factor to the portfolio’s return. It can be used in conjunction with other tools(4) in order, for example, to evaluate allocation and selection effects resulting from sector or country positions.

(1) Read our previously published article on the pitfalls of value and momentum investing.
(2) Read our previously published articles about the way we efficiently combine factors for equities and for bonds.
(3) Read more about our Factor Exposure Monitor in our case studies book.
(4) Read more about our DSAA risk-return analysis tool.

Factor investing challenges
Factor investing challenges

This series of articles aims to answer some of the key issues faced by investors when implementing factor investing strategies.

Read all articles
Subjects related to this article are: