Factor investing is growing rapidly — not only are more investors adopting factor strategies, but as investors gain experience, they increase their use of them. This is one of the key findings from our recent Global Factor Investing Study, which is based on face-to-face interviews and discussions with more than 300 institutional and wholesale factor investors around the world — including financial advisors, pension funds, private banks and insurance companies.
Investors are adopting more factor strategies, but still in small doses
Factors are measurable characteristics of a security that help explain its performance. Our study found that once asset owners have developed internal capabilities and knowledge about factor investing, they tend to adopt multiple strategies. The institutional and wholesale investors surveyed in the study have gone on to implement from two to four factor strategies on average.
However, factor allocations generally represent a small proportion of the asset classes they are being applied to, especially in relation to fixed income, which only about 10% to 15% of factor investors currently use.
How much do factor investors allocate to this category? According to survey, the allocation represents between 8% and 20%, depending on the types of investors. This remains smaller than market-cap passive approaches, which represent 24% to 28%, or than traditional active strategies, which account for 52% to 68%.
For those institutional investors who described themselves as “sophisticated” factor users, this segment reported nearly double the average allocation to factor strategies than the less sophisticated segment, at nearly 20%. This trend also applies to wholesale investors, where the more sophisticated users reported average factor allocations of 15%.
Which factor is the most used?
Our study found that Value continues to be the most commonly utilized style factor in portfolios and is particularly ubiquitous in institutional portfolios — which is notable given the extended underperformance of equity value strategies in recent years. Other key style factors include Low Volatility, Momentum, Size and Quality.
Respondents noted that they tend to start their factor journey with equities, and look to extend into fixed income and multi-asset applications.
Single or multi-factor?
When it comes to applying a single or multi-factor approach, our study found that equity single factors are the most common approach, closely followed by equity multi-factor. Some distance behind are multi-asset approaches, followed by single- and multi-factor fixed income.
The reasons behind these choices are relatively clear.
- For institutions, single factor approaches are driven by the desire to reduce or minimize complexity and to keep costs low. This is particularly relevant for newer factor investors and smaller institutions with limited internal resources.
- Institutions favoring multi-factor approaches have different motivations — control of risk, factor tilting and enhancement of performance were cited by respondents as much more important than costs. Multi-factor strategies tend to be deployed by larger investors that have significant scale and lower cost ratios.
- For wholesale investors, the drivers are very similar, with lower costs cited as an even stronger driver for single factor usage.
Learn more about how institutions and wholesale investors are using factor strategies.
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Factor investing is an investment strategy in which securities are chosen based on certain characteristics and attributes that may explain differences in returns. There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics (“factors”). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. Factor investing may underperform cap-weighted benchmarks and increase portfolio risk.
Low volatility describes investments that consistently demonstrated lower volatility than securities in the same asset class.
Momentum identifies investments with positive momentum (recent strong returns) or negative momentum (recent weak returns) to calibrate portfolio exposure to either.
Size represents the potential higher-than-benchmark returns associated with relatively smaller stocks within the universe being considered.
Quality characterizes companies with strong measures of financial health, including a strong balance sheet and stable earnings growth.