Many investors have told us recently that, in a globalised world, factors are more important than regions when it comes to investing in equities.
But with such an array of enhanced index or ‘smart beta’ funds to choose from, we wondered how popular actual factor funds have become among the model portfolio and multi-asset providers in our database.
The five main factors are value, size, momentum, volatility, and quality but, upon closer inspection, it seems that such strategies have a rather limited appeal.
Beginning with minimum volatility indices – which tend to focus on defensive stocks that are less susceptible to recessions – the uptake is low.
The UBS MSCI World Minimum Volatility Index is owned by two allocators, including Morningstar Wealth.
Portfolio manager Mark Preskett said it was useful for downside protection and added that factor investing forms a significant part of their approach to asset allocation.
“It can also be useful in fund analysis – and we use factors to try to assess whether a manager has actually delivered alpha, or was he or she simply riding a specific factor,” he said.
Elsewhere, Invesco FTSE Emerging Markets High Dividend Low Volatility, if you’ll pardon the word salad, is owned by just one allocator.
The value factor, however, has a bit of more of a fanbase.
The iShares Edge MSCI USA Value ETF is held by three allocators, including Bentley Reid.
“Value has suffered at the hands of growth, particularly in the US given the AI euphoria over recent years,” said Paul O’Neill, their chief investment officer. “Looking at the valuation gap and the potential for mean reversion plus limited absolute downside, it makes sense to skate to where the puck is going instead of where it already is, to misquote Wayne Gretzky.”
O’Neill raises a good point: value has been out of favour for so long that it’s bound to reverse at some point – right?
This is the inherent issue surrounding factor investing – one has to be comfortable standing by them for a period of potentially lengthy underperformance.
Momentum and growth have been the flavours of the decade, and perhaps a rotation is due.
Another instrument we’ve been looking into recently is the idea of the equal-weighted index: a kind of proxy value fund that has grown in size recently.
It deliberately overweights small caps and cuts down anything that gets too large – indeed, one DFM compared its return profile to the Russell 3000, not its sister index, the S&P 500.
Five allocators in total currently own this form of tracker, which are run by both Xtrackers and iShares.
We recently spoke with Charles Stanley portfolio manager Benedict Tottman about how he views that value element of the fund.
“Part of the reason why we’ve introduced this allocation is that the idiosyncratic risk within the headline index has increased a significant amount over the past two years,” said Tottman.
“And so this is just simply trying to reduce some of that single-name exposure within our portfolios.”
