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Investing in equity factors for the long run

 

 

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Factor investing: a long-horizon investing building block

Many asset owners construct their investment portfolios with the aim of meeting long-term liabilities or objectives. No institution can be sure of achieving its savings goals unless it adopts a full liability-matching strategy, which is typically expensive. Instead, most investors rely on a portfolio of assets to generate sufficient returns over time and thus face the uncertainties inherent in exposure to the financial markets.

However, an institution can increase its chances of success in long-horizon investing by following a number of steps. These include a thorough planning process, ensuring the ability to tolerate inconsistent returns, a diversified approach to portfolio construction and discipline when conducting portfolio rebalancing.

Equities are an asset class of choice for long-horizon investors and equity factors offer an attractive means of sourcing returns from equities. Factors arguably offer a more efficient way of constructing portfolios than the traditional approach of alpha/beta separation.

Under the traditional alpha/beta approach, an asset owner tracks market capitalisationweighted indices for the beta core of the portfolio and engages active managers to generate alpha. The owner can expect benchmark performance in the core (before fees, which are typically minimal), but relies on the ability of the asset manager to generate alpha in the active part of the portfolio. As multiple studies have demonstrated, persistence in producing alpha is very hard to achieve.

Instead, a factor approach could be used across the whole equity portfolio.

By using factors, an investor “looks through” the equity asset class and benefits from the systematic sources of return associated with particular stock characteristics. This provides an opportunity for a longhorizon investor to tailor their equity exposure more closely to their liability profile or long-term objectives. A 2017 Thinking Ahead Institute study identified factor investing as one of the building blocks of a substantial longterm premium for genuine long-horizon investors.

However, given the fact that factors work well at different points in the economic and market cycles, diversification across factors can help mitigate downside as well as tail risks and provide superior long-term risk-adjusted returns.

TAILLARDAT Bruno , Smart Beta & Factor Investing, Amundi
BERNARD Michel , Amundi Asset Management
HODGSON Tim , Thinking Ahead Group
YIN Liang , Thinking Ahead Group

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Investing in equity factors for the long run
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