You would not be pleased if you thought you had the right exposures to factors that drive expected returns, but it turns out you actually have precisely the opposite tilts. This is happening quite often though. Quantitative researcher Joop Huij and head of equity research David Blitz argue that institutional investors should be careful when assessing asset managers.
There is over twenty years of academic literature on how investors can get extra returns with exposure to factor premiums such as value, low volatility and momentum. These parts of the market offer the best prospects in terms of risk and reward and investors are well advised to adjust their portfolios to these premiums.
So are investors using these insights to their advantage? Huij and Blitz helped to develop the Robeco Factor Exposure Monitor to measure exposure in portfolios versus the benchmark. They scanned several portfolios of institutional investors and found a surprising outcome. “Often these portfolios turn out to be concentrated in the wrong type of stocks: high-risk, growth stocks which have poor prospects for returns,” says Huij. But why are investors doing this?
Blitz studied the academic literature and found that the reason may be a conflict of interest between investors and asset managers.
“Often asset managers take high-risk stocks that do well in bull markets. This is the period when money is flowing to the market”, he says. The winner takes all, so a profit-maximizing asset manager has the incentive to take high risks in order to be a top performer, says Blitz.
“This strategy would allow him to attract more assets under management. But it is not in the interests of investors.”
”The problem is that asset owners often do not know that asset managers are taking large risks with their money. In some cases asset managers even change their fund name to a hot style, while their investment policy remains unchanged,” he adds.
‘Let the numbers tell the tale’
Huij argues that the way to prevent this conflict of interest is through more transparency. “Even though investors know that exposure to factor premiums enhances risk and reward, they are often not aware of their actual exposure. They should gather more information to base their decisions on, and the Robeco Factor Exposure Monitor can provide it. Let the numbers tell the tale.”
This article is written as part of a series of articles for the Robeco World Investment Forum on how long-term trends influence investments.