As investors gain experience with factor investing, usage of these strategies through exchange traded funds and other financial instruments has increased. Yet, many of these factor adopters still have over 80 percent of their equity and fixed income allocations in traditional active and/or market cap-weighted passive strategies, leaving lots of room for potential growth. Particularly so, as these investors are less worried about overcrowding than in the past.
Invesco recently published the results of its 2018 Global Factor Investing Study, based on interviews with key decision makers of more than 300 institutional and wholesale factor investors. Interviews conducted independently by NMG Group included hourly meetings with financial advisors, insurance companies, private banks and pension funds around the world.
Factor investing, based on academic research highlighting the benefits of using low volatility, momentum, quality, size, value and yield selection criteria, has gained in acceptance and demand has followed suit. BlackRock and Invesco are among the biggest proponents of factor investing in the U.S. asset management industry.
However, the Invesco study highlighted that nearly half of the investors adopted factor investing for the first time in 2015 or more recently. The study further found that the factor journey started with a single strategy, but it was uncommon for investors to stop there. The institutional and wholesale investors surveyed went to implement between two to four factor strategies on average. Particularly appealing was that North American wholesale investors had the highest usage across geographies and channels.
For clients who are closer to retirement but want to maintain a high level of equity exposure, an unnamed North American private bank responded that it would consider low volatility strategies. U.S.-listed ETF examples include Invesco S&P 500 Low Volatility ETF (SPLV) and iShares Edge MSCI USA Minimum Volatility (USMV). The same respondent said 25 percent of U.S. equities is an appropriate amount for clients to have within factor strategies.
Despite being out of favor until recently, value was easily the most commonly utilized style factor in portfolios, according to the study, and was only one of two (yield is the other) to not experience a notable year-to-year drop from the 2017 study. Invesco S&P Pure Value (RPV), iShares Edge MSCI USA Value Factor ETF (VLUE) and Vanguard US Value Factor ETF (VFVA) are among the value-oriented ETFs that investors can consider from larger asset managers.
Particularly compelling from the study was the most popular barrier to further factor investing implementation was lack of internal capabilities. To the authors, this demonstrated that investors see factor investing as a distinct competency requiring specific rather than general expertise from elsewhere internally. This was considerably higher than timing risk, which suggests that once resources are provided, further implementation was to be expected.
In addition, the second most popular choice by wholesale investors was lack of products. We would think this is more the result of lack of products with enough assets and perceived liquidity since nearly a dozen firms offer a U.S.-listed low or minimum volatility ETF. Still, many of these remain small.
In contrast, crowding was tied for the ninth most popular barrier cited among the 12 choices and the concern was ranked lower than it was a year earlier. In the past, some investors and media outlets have expressed fear that the growing popularity of factor-investing approaches, including low volatility, was negatively impacting the returns. While CFRA doesn’t think factor ETF investing is large enough to notably impact stock prices, a falling level of concern could spur greater ETF usage.
When it comes to applying a single or multi-factor approach, the study found that equity single factors were the most common approach (used by 67 percent of respondents), but this is closely followed by equity multi-factor (59 percent). Some distance behind were single- and multi-factor fixed income (14 percent and 16 percent, respectively).
Single factor approach usage was driven by the desire to reduce complexity and to keep costs low. This is particularly relevant for newer factor investors with limited internal resources. Meanwhile, those favoring multi-factor approaches had different motivations than cost. Indeed, control of risk, factor tilting and enhancement of performance were cited by respondents.
While value and low volatility strategies lagged in recent periods, including the first half of 2018, investors would have been better off having exposure also to momentum and quality. Yet, in recent months, value and low volatility investing returned to favor.
For example, JPMorgan Diversified Return US Equity ETF (JPUS) selects stocks from the Russell 1000 Index relative value, momentum and quality factors, and weighted inversely by volatility. Another ETF, John Hancock MultiFactor Large Cap ETF (JHML) emphasizes small-cap, lower relative price and high profitability, offering a different multi-cap experience for investors.
Many of CFRA’s advisory and retail clients likely consider factor investing differently than the institutional investors that were part of the Invesco study. However, they should take comfort that as ease and usage of factor ETF grows, the liquidity of and the trading costs for these products will improve.
This article was originally published on MarketScope Advisor on Nov. 27, 2018. Visit https://newpublic.cfraresearch.com/etf/ to gain access.
Todd Rosenbluth is the director of ETF and mutual fund research at CFRA. Learn more about CFRA’s ETF research here.