Q&A with Jonathan White, Head of Client Portfolio Management, Rosenberg Equities, AXA Investment Managers
Factor investing has attracted a lot of funds. How will the inflows develop in the future?
I think that investors will continue to allocate to factors and the market segment will grow. The empirical idea that there are risk and return patterns associated with specific company characteristics is timeless, as is the notion that there is a more efficient way to allocate capital than using the market capitalisation weighted index. Investors want an efficient way to access the equity risk premia and factor investing is the way to achieve this.
Is factor investing active or passive?
We wholeheartedly believe that factor investing is active investing. It’s an active decision to move away from market capitalisation as a start point for asset allocation, and then choosing the right mix of factors to meet your investment objectives is also an active decision. It’s an active approach, it needs active oversight and it needs an active mind-set.
Customers can purchase factor premiums conveniently and efficiently via ETFs. Why should they go through an active asset manager?
We welcome some of the attributes that ETF providers bring to the investment ecosystem. However, factor ETFs based on popular indices have some important limitations that customers should consider. For example, it’s typical for the factor design and investment implementation to done by separate organisations. This creates a fiduciary grey area for oversight and accountability. Another problem with many factor ETFs is they typically use commoditised data and simplified metrics to build factors from and suffer from a ‘set and forget’ approach when it comes to product development.
Active asset managers such as Rosenberg Equities, on the other hand, own the whole value chain when it comes to factor investing. Investors can benefit from on-going research and development, implementation considerations that are built-in to the product design, and there is no doubt about who is on the hook with respect to the investment outcome.
Asset managers also use their experience to build better factors by incorporating proprietary data and additional controls to manage things like tail risk. A good example of this is that we are now using non-financial data such as board-room diversity of to build a better view on quality. We are also starting to use information from natural language processing models to improve our measure of momentum.
Finally, and a surprisingly under-discussed point, is that as an active manager we build portfolios that are responsible; we engage and vote on our clients’ behalf.[1] This is an area where the passive industry, perhaps because it has to be by definition ‘passive’, is deficient.
Which factor premiums result in particularly attractive combinations?
It really depends on your return expectation and risk budget. Blending value, quality and momentum is a more return-seeking approach but comes with more volatility, while blending the low volatility and quality factors may offer a return premium but with much less volatility than the market. Recently the low-volatility/quality has proven very attractive given the widespread market volatility, and we believe it may well be suitable for an environment of slowing growth and geopolitical jitters.
The 3-factor model identified value and size as factor premiums. Do they still have a future today?
Yes. I think concerns that factors such as value and size are broken are made because of recency bias: I acknowledge that its odd to use the term ‘recent’ given value has been weak for a protracted period, over 10-years on some measures of value, so I understand it’s pretty tempting to say ‘value no longer works’. However, all individual factors suffer from some cyclicality in their patterns of performance. While 10 years is a long time, there are economically rational reasons for this underperformance, such as the ultra low interest rate environment, which has fuelled a bull market for growth-oriented investors.
It’s worth remembering that there have been longer periods when the equity risk premium itself has been negative or not worked: over last 100 years there have been 3 periods that lasted over 10 years.[2]
No one would credibly abandon the idea of market risk premium because it’s so fundamental and linked to the real economy. Similarly, you should not lose faith in fundamentally grounded factors such as value. Rather, investors should recognise that all factors such as value and size will have cyclical performance, which is why it may be suitable to blend factors in order to reduce the risk of cyclical weakness.
That said, it’s important that factors evolve so they can more effectively capture the fundamental outcomes that drive their return premia. It’s conceivable that changes in market structure, such as the rise of asset light companies, will mean how we measure value needs to be more nuanced and forward looking.
How can investors better differentiate providers of factor investing approaches: on the basis of the selected premiums or in the implementation?
I think it’s in both. You have to not only build a better factor, but you have to implement it efficiently. Factor investing by its nature requires diverse exposure to many companies, so an efficient trading style, considerate rebalancing and low fees are all important considerations when considering a factor-based approach. If you have a manager that’s turning over the portfolio frequently then you have to consider the depth of their factor insight and how much alpha is being eroded through costs.
[1] Engagement activities not conducted by Rosenberg Equities directly. No representation is made as to the outcome of engagement activities.
[2] 15 years from 1929 through 1943, the 16 years from 1966 through 1981 and the 13 years from 2000 through 2012.
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