Factor-based strategies can help investors get exposure to a particular factor. Fifth article of a series on how factors can help investors achieve specific goals.
Well before factor investing became popular in the late 2000s, many investors were already exploiting individual factor premiums. Value strategies are a good example. The value effect is the empirically-documented tendency of inexpensive securities to achieve above-market returns relative to their intrinsic value as measured for example by the book-to-price ratio of a company.
For decades, prominent investors have advocated buying securities trading below their intrinsic value and many traditional active managers have been offering so-called value strategies. As early as the 1930s,1 Benjamin Graham and David Dodd of Columbia Business School advocated investing in undervalued stocks. Later on, Warren Buffett became famous for his very successful investment philosophy largely based on this same principle.
In this context, many investors have recently turned to factor investing as a systematic and cost-efficient way to achieve exposure to a particular factor premium, such as value or momentum, or to a specific set of factors. In fact, a recent FTSE Russell survey of asset owners found that getting specific factor exposure ranked fifth among the top investment goals that led them to consider factor-based strategies.
As discussed in a previous article in this series, decades of academic research have shown that strategies focusing on a handful of well-vetted factor premiums deliver statistically and economically significant abnormal returns. These factor premiums are distinct phenomena, which exist beside one another, and have been identified across markets and asset classes.2
Targeting different factor premiums will therefore normally lead to different investment outcomes. Figure 1 provides an illustration of this. It shows the Sharpe and information ratios generated with four generic single-factor strategies – based on popular equity indices like the MSCI World Value Weighted index, the MSCI World Momentum index, the MSCI World Minimum Volatility index or the MSCI World Quality index – investing global equity markets, over the period from June 1988 to December 2015.
The differences between different single-factor strategies are not only visible over long periods of time. In the shorter term, for instance, factor premiums can experience periods of underperformance or outperformance, relative to the market as well as other factor premiums. Such periods can continue uninterrupted for several years.
All these findings illustrate how different factors perform independently over time. It therefore makes sense to consider exposures individually and to allocate to each individual factor, depending on the needs and priorities of each investor, using single-factor strategies. For example, investors that have a clear preference for income, can allocate more to value or low volatility strategies, which typically deliver high dividends. Other investors may prefer to limit turnover, and therefore choose not to allocate to momentum which tends to lead to higher portfolio rotation.
But while monitoring and adjusting individual factor exposures depending on the strategic interests of each investor may look like a simple task on paper, there is much more to it in practice. The body of academic literature on the subject is extensive and there are many products available in the market for quantitative factor exposure measurement and performance attribution, including Robeco’s own tool.
Nevertheless, accurately measuring exposures to these factors often remains a challenge, in particular for the less sophisticated investors, who typically lack the necessary resources. Many academics and practitioners have warned about the dangers of poorly designed or inappropriate models.3
Without the relevant measurement tools, investors may, for example, confuse systematic exposure to one particular factor with alpha generated by an active portfolio manager. This explains why asset managers increasingly offer (multi-factor) solutions that provide exposure to a preset blend of factors.
Another important pitfall for those looking for specific factor exposures has to do with the way factors interact and in some cases clash with each other. Generic single-factor strategies usually ignore these interactions and therefore provide suboptimal factor exposures, resulting in, e.g. a value strategy that has very negative momentum exposures.4 This underscores the need for efficient factor strategies that use enhanced factor definitions that prevent negative exposures to other proven factors.
1Benjamin Graham and David Dodd, ‘Security analysis’, 1934
2See for example our recently published book of collected research articles: G. Baltussen, M. Martens, P. van Vliet, ‘Quant Allocation - Collected Robeco Articles’, 2018.
3See for example: Israel R. and Ross A., ‘Measuring Factor Exposures: Uses and Abuses’, The Journal of Alternative Investments”, 2017.
4For more information, see for example: Blitz D. and Vidojevic M., ‘The Characteristics of Factor Investing’, Robeco working paper, 2018.
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
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.