Factor-based strategies can enhance returns over the longer term. Second article of a series on how factors can help investors achieve specific goals.
One of the most important transformations experienced in recent years by the financial industry has been the massive shift from active to passive investment strategies. Decades of frequently disappointing active manager performance and increasing cost awareness have pushed many investors towards low-cost indexed strategies, often through the use of ETFs.
But this shift raises a number of concerns. For instance, going passive may be cheap and prevent unpleasant surprises from wrong active calls, but it also leads to chronic underperformance, once costs are taken into account. Moreover, passive strategies expose to significant arbitrage risk.
In this context, many investors have turned to factor investing in a bid to achieve superior risk-adjusted returns while keeping costs relatively low. In fact, a 2017 FTSE Russell survey of asset owners found that return enhancement ranked second among the top investment goals that lead them to consider factor-based strategies.
Factor investing has its roots in the vast body of empirical evidence that has been accumulated over more than four decades and documents the existence of various factor premiums in financial markets. These premiums can be systematically harvested to enhance the risk-return profile of a portfolio.
Factors can be associated with different characteristics of a financial security – such as its valuation, or its price momentum and volatility – that are important determinants of its long-term risk and return. Securities featuring certain factor characteristics have shown to have higher risk-adjusted returns than the market portfolio over the longer term (see Figure 1).
Despite its deep academic rooting, the real breakthrough in factor investing did not come until 2009 and the publication of a research report1 by professors Andrew Ang, William Goetzmann, and Stephen Schaefer. Analyzing the performance of one of the world’s largest sovereign wealth funds, which invests Norwegian oil revenues, the three academics showed that rather than reflecting true skill, the added value of the fund’s active management could in fact be explained by implicit exposures to systematic factors.
The authors also advocated the adoption of factor investing because of the long investment horizons of factor premiums. From that moment, the concept rapidly gained popularity among professional investors around the world who were faced with similar issues and sought an efficient and prudent way to systematically capture factor premiums.
Implementing factor investing is not a binary “yes” or “no” decision. Once they decide to go for factor investing, investors have to make a number of important decisions that are crucial to the success of their strategy. The first concerns which factors to allocate to. Although this may seem very basic, it is far from a trivial consideration. Most product providers focus on a handful of well-vetted factors, but academics are still debating whether looking at the more exotic, recently reported factors adds value.
The second major element investors need to decide on is the weight they wish to give to each factor in their strategic allocation mix. This issue is also hotly debated among academics and practitioners. While some argue factor exposures can be timed tactically and factors showing the best short-term potential should be given priority, others – including Robeco – acknowledge that timing is difficult and advocate a balanced exposure, unless a specific factor is of strategic interest.
The third crucial step is to make sure the chosen solution efficiently harvests factor premiums. This means being able to identify the risks to which you will be exposed when you engage in factor investing and to understand which risks are necessary and which are not. This is why it is also very important to be able to develop tools that help identify and eliminate unrewarded risks.
1 A. Ang, W. Goetzmann and S. Schaefer, ‘Evaluation of Active Management of the Norwegian Government Pension Fund – Global, prepared at the request of the Norwegian Ministry of Finance, 2009.
This series of articles aims to illustrate the wide variety of investment goals that can be achieved through factor-based strategies.
Read all of the articles:
The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.
Please read this information carefully.
This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.
2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:
3. Local legal and sales restrictions
The information contained in the Website is being provided for information purposes.
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. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.
4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.
5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.
6. Third party websites
Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage.
7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.
8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.
10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong.