www.institutionalassetmanager.co.uk | 2FACTOR INVESTING REPORT | October 2019
MSCI MARKET INSIGHT
I
nstitutional investors face a number of pressures driven by regulation, the market
environment, the global economy and their own internal policies. The rise of
factor investing can help ease some of these burdens by introducing new levels
of transparency and systematic portfolio construction which then allow for a better
deployment of the available risk budget.
Factor investing is not new and has not been discovered recently, however changes
in the way the returns generated are accessed can offer additional value and innovative
benefits to investors. This has been driven by significant advances in technology, data
gathering and analysis witnessed in the industry. In particular, the proliferation of big data
has allowed for the increased capture of the premia from factor investing which are now
being made available to a broader base of investors.
“Factors are common characteristics that affect the risk and performance of individual
stocks and portfolios,” explains Dimitris Melas, Managing Director and Global Head of
Core Equity Research at MSCI. “Factor investing, in essence, reflects the way equity fund
managers select stocks and construct portfolios. If you go down the list of how equity
fund managers pick stocks and what they look for, you will find a lot of commonality
between the characteristics they consider and the main factors.”
The creation of factor indices has allowed investors to identify the returns associated
with factors through index tracking products. Whenever making an investment allocation,
within any market or any asset class, investors are exposed to factors. By identifying the
factors and understanding what drives their performance, investors can seek to have
a better grasp of the factors their investments are exposed to and find ways of taking
advantage of them in a cost-efficient manner. This is what has changed – the factors
themselves have always existed.
Head of Equity Applied Research for Americas and EMEA at MSCI, Raman Aylur
Subramanian says: “Investors now have better tools to deploy their asset allocation in a
more refined manner. They now have a set of index solutions at their disposal to help
them create a rules-based investment process to harvest risk premia from factors. The
factors in the market remained the same, so value remains value but the way the premia
is captured is what has changed.”
Factor investing
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MSCI MARKET INSIGHT
Factor investing is a growing part of investment
management with strategies drawing sizeable inflows in
the past few years. For example, low volatility strategies
attracted $12 billion over the first six months of 2019.
Further, large institutional investors in the Nordics and
the US, like AP3, ATP, PKA and PSERS, are leading the
charge and allocating to alternative risk premia, in some
cases to replace direct hedge fund investments.
A bigger toolkit
In the past, investors would employ active managers to
access these risk premia but they were dependent on that
manager and had no way of confirming they were being
given the exposure they were promised. Subramanian
says: “Now investors can get exposure to factors in a
much more consistent fashion. The creation of rules-
based indices means you can more easily construct
a portfolio with greater levels of transparency in the
performance of those portfolios. Then you can easily
deploy them in your overall asset allocation.”
Mark Carver, Executive Director and Global Head of Factor
Index Products at MSCI talks about the role MSCI has played
in making this a reality, “by making factors accessible through
indexing, MSCI’s work has allowed clients to understand
that these exposures can be captured in a systemic way
with transparency in a rules-based fashion. It has allowed
investors to change the way they select active managers and
has freed up active managers to pursue alpha beyond the
common factors which can be delivered in indexes.”
Melas elaborates on this, saying investors now have
a toolkit at their disposal which gives them more choice
and flexibility in how they manage their portfolios. He
says: “When institutional investors make an allocation
to equities, they also need to decide how to split that
allocation. Selecting one or more factor mandates allows
them to allocate the rest of the money to high conviction
active managers who build concentrated portfolios.
“So now when institutional investors hire an active
manager, they really look for high tracking error, high
conviction concentrated portfolios because they can get
the market returns through ETFs, indexes and they can get
factor premia through factor mandates. So, this all allows
them to allocate their risk budget more effectively and more
efficiently to high conviction concentrated mandates.”
Another key development has been the rise of multi-factor
indices. “Previously investors had to hire different managers
to get exposure to the individual factors – value, quality, etc
– but now with multi-factor portfolios investors are able to
harvest multiple risk premia in the one single construct,”
Subramanian, explains, “This has allowed them to not only
capture the premia in a single construct but also bring down
the cost of implementing the entire portfolio.”
Melas says this approach is of particular benefit to
investors who may not have a strong view on which factors
they believe will perform. “In this case the best solution
would often be to diversify their portfolio across three or four
factors and make an allocation to a multifactor mandate.
The thinking there is that they don’t necessarily have a
view on which factor will perform better or worse over the
coming period, but they expect that over a full market cycle,
a diversified portfolio which has high exposure to multiple
factors will deliver risk adjusted returns,” he says.
Beyond active and passive
Historically investment management has been considered
either active or passive and some industry commentators
have hailed factor investing as an approach with blends
the two philosophies. Melas however believes this debate
is misplaced. “There is only one type of investing and that’s
active investing. Indexes and ETFs offer tools to investors
to construct portfolios and implement their asset allocation.
Individuals who use these tools have already made an
active decision, for example to invest in equities and not
fixed income or to increase allocation to equities. Then they
Factors are common characteristics
that affect the risk and performance
of individual stocks and portfolios.”
Dimitris Melas, MSCI
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MSCI MARKET INSIGHT
may select to use an ETF or an index fund to implement
that decision – they are part of the toolkit investors have at
their disposal when making active investment decisions,”
he says, “I think many of us are guilty of confusing security
selection with active investing – when really active investing
is a lot more than security selection.”
Subramanian believes factor investing complements
both investment approaches – those focused on the
beta end and also those who make greater use of stock
picking managers at the other. He says: “Factors are a
good way of integrating the two approaches. You may
still have a bias on whether you want a view on pure
market beta or a bias on active management but since
it complements both ends of the spectrum, it is easier
for investors to create a portfolio which will have them
achieving their long term objectives.”
One of the steps investors can take in their factor
journey is to analyse their existing portfolio to understand
what factors are actually driving their returns and what
factor exposure they may have but are not aware of.
Carver explains: “The truth is all investors are already
factor investors. They may not have deliberately taken
or chosen that exposure but fact of the matter is when
they’re allocating to a certain set of ideas, whether they
do that through indexes or active managers, there will be
factor exposures embedded in those portfolios and as a
consequence all investors are factor investors.”
To help investors have a better view into what factors
they are exposed to, MSCI created FaCS a factor
classification standard, which was rolled out a year ago.
“This tool allows clients to see the factor exposures they
have inside their portfolio in aggregate. Then if they want
to look at a particular manager or group of managers,
they can see what factor bias they might have within that
subset of managers,” Carver says.
This level of transparency has provided clients better
insight into their allocations and into whether they have
the diversification they intended in their portfolios. This
information has provided a whole new lens that was
lacking prior to MSCI introducing it.
Launched in 2018, MSCI FaCS is a classification standard
and framework for analysing and reporting style factors
in equity portfolios. The standard is based on the factor
structure in the latest global Barra equity factor risk model,
the Barra Global Total Market Equity Model for Long-Term
Investors (GEMLT). The standard organises the 16 style
factors of GEMLT into eight factor groups – Value, Size,
Momentum, Volatility, Quality, Yield, Growth and Liquidity.
The goal is for this tool to create a common language
and definitions around style factors to be used by asset
owners, managers, advisors, consultants and investors.
Managers can use the framework to analyse and report
factor characteristics, while investors and consultants can
use the data to compare funds and monitor exposures
over time using common definitions.
By deploying the FaCS, investors can have a better
understanding of what they are paying for. “By using this
tool, you will know that you’re paying active fees for truly
active portfolios and lower, beta fees for more systematic
type exposures,” Carver says, “You need to have real
transparency in those exposures and the FaCS enables
investors to have this. They can then use that information
to control the cost of their allocations. This is highly
appealing to most investors.”
He explains that investors are more comfortable today
with systematic approaches to all things in life and are
utilising data and information to make decisions a lot
more nowadays. “That plays well into factor investing
where 10 years ago you didn’t have that same level of
comfort or that same demand for transparency. These
trends are not likely to slow down; they’re likely to
accelerate and as a consequence the appetite for factors
not only as investments but also as broader tools, will
increase,” Carver adds.
These trends are not likely to slow
down; they’re likely to accelerate and
as a consequence the appetite for
factors not only as investments but
also as broader tools, will increase.”
Mark Carver, MSCI
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MSCI MARKET INSIGHT
Factor investing adds a certain level of predictability
to an investor’s portfolio performance. Each factor is
impacted by market events in different ways, but that
impact is always the same. Subramanian says: “If you
have a view on what is going to happen in the market,
then you will know what will happen to the performance
of the factor. This is not the case with an active manager
– you can’t know whether an active manager will perform
well or not depending on the state of the economy
because you don’t have the full view of what is in that
portfolio.”
According to Melas, investors are driven to factor
investing by a number of motivations. He says: “There
are a number of incentives investors have when they
consider making factor allocations. Performance is one
but also transparency and simplicity. They appreciate the
fact that through separate factor mandates they have a
better understanding of how their portfolio is constructed.
“There are cost considerations as well. A number of
investors face cost pressures and they want to use their
resources as efficiently as possible. They recognise there
are talented active fund managers and perhaps it’s worth
paying high fees for their stock selection skills, but to be
able to do that, they need to be more efficient in how they
spend their risk budget and the total pool of fees they
have at their disposal.”
So, the attraction of factor investing is a combination of
performance, risk, transparency and cost considerations.
Knowledge is key
But this does not come without difficulties. One of the most
significant challenges factor investing poses is related to
investor understanding of their cyclicality. Subramanian
explains how important it is for internal committees and
trustees to fully understand the reasons why factors
behave the way they do. “If they don’t fully grasp how
it all works, they risk getting into a factor investment
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MSCI MARKET INSIGHT
programme and questioning the whole thing,” he says.
“Value is a good example. For the last six/seven years
value was not seen as the factor to invest in but if you
look at the last 30 to 40 years, it was the best performing
factor in the world. So, understanding why factors perform
and what causes their cyclicity is something investors
are always challenged with. Therefore, reporting and
governance are crucial for a factor investing programme
to succeed,” Subramanian continues.
Although factor investing can be integrated into a portfolio
of any size and for any type of investor, this knowledge
curve makes retail uptake slightly more difficult. Subramanian
says, “Some of the more advanced advisers understand, but
the average retail portfolio, even the model portfolios built
by wealth managers are not fully exposed to factors. So
penetration of factor investing has not fully happened in the
retail space and we think there are considerable benefits to
considering factors for retail investors.”
After deciding to allocate in factors, investors are faced
with the dilemma of choice. Melas elaborates: “They need
to decide which factors to allocate to. Some investors
already have a view about a particular factor and they
may decide to concentrate the allocation on one or
two factors. Other investors have objectives related to
lowering the risk of the portfolio in which case, low vol
strategies are appropriate or perhaps even increasing the
yield/the income of the portfolio in which case they would
allocate to high dividend yield strategies.”
According to Carver ahead of these specifics, investors
struggle to decide how to fund their factor investment. He
says: “One of the biggest challenges our clients face is
where to allocate the money from. Most investors have
a portfolio allocated to a group of strategies already. So,
when they’re going to add a factor portfolio as a new
exposure, they have to decide – do they take it from an
active mandate, a passive mandate the equity side, take
down their fixed income position?”
Deep heritage in factor investing
MSCI is a unique player in the factor investing space.
The investment professionals at MSCI, including Carver,
Melas and Subramanian have been key influencers to
the discussion and penetration of factor investing in the
market today.
Carver says: “MSCI has been a part of the factor
investing journey from the very beginning. You can argue
that as an organisation, MSCI really lies at the centre of
the factor conversation. We created the first factor risk
model 45 years ago – an equity risk model based on
the US market which looked at four factors – value, size,
momentum and yield. Since then factors have moved from
being a way to think about and attribute risk in a portfolio,
to becoming an investable strategy in many different
forms. And MSCI was there every step of the way.”
For over 40 years MSCI, starting with Barra, has
researched and developed financial support tools, data
models and factors to determine their effects on long term
equity performance.
Barra was the original pioneer in researching and
providing solutions to analyse the relationship and
drivers of risk and return. The Barra Risk Factor Analysis
was created by Barr Rosenberg, founder of Barra Inc.
They pioneered the relationship between factors and
security returns through models that could be used to
predict and control risk and return. Barra transformed
theory from academia into practical application, tools
and solutions.
MSCI acquired Barra in 2004 and has paved the way
for factor investing as we know it today, through factor
risk models and factor indices.
“We are an independent research entity in the market,”
adds Subramanian, “we have spent decades focusing
on providing cutting edge factor investing solutions. Our
mission is not complete as we continue to lead the future
applications and research in this area.” n
Understanding why factors perform
and what causes their cyclicity is
something investors are always
challenged with.”
Raman Aylur Subramanian, MSCI
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MSCI MARKET INSIGHT
Dimitris Melas is Managing Director and Global
Head of Core Equity Research at MSCI. Dimitris
leads a team of researchers located in several
cities around the world. The team develops all
MSCI equity indexes and equity models and works
with investors to help them integrate these tools
into their investment process.
Prior to joining MSCI in 2006, Dimitris worked
at HSBC Asset Management as Head of Research
and Head of Quantitative Strategies. At HSBC,
Dimitris was also a member of the Global
Investment Strategy Group, the senior committee
responsible for setting investment strategy and
asset allocation policy.
Dimitris is a Chartered Financial Analyst (CFA)
and holds an MSc in Electrical Engineering, an MBA
in Finance, and a PhD in Financial Mathematics
from the London School of Economics.
He currently serves as Editorial Board Member
of the Journal of Portfolio Management and
has published several research papers in aca
-
demic and industry journals. His paper “Efficient
Replication of Factor Returns” was voted “Best
Index-Related Research Paper” at the 6th Annual
William F. Sharpe Indexing Achievement Awards.
As Head of Equity Applied Research for the
Americas and EMEA, Raman Aylur Subramanian
conducts research on MSCI product applications,
and presents the results in interactive sessions
with clients. Raman joined MSCI in 1999, and has
been working in a variety of research roles and is
a member of MSCI Equity Index Committee. Raman
has established close relationships with clients and
gained an in-depth understanding of their needs
with respect to the MSCI indexes.
Prior to joining MSCI, Raman worked in the
Indian petroleum industry where he worked on
sales and product management.
Raman received a Bachelor of Technology in
Petroleum Engineering from Indian Institute of
Technology (Indian School of Mines), India, and
a Masters in International Management from
Thunderbird School of Global Management, USA.
Additionally, he is a CFA charter holder from the
CFA Institute in Virginia.
Mark is an Executive Director and Global Head of
Factor Index Products. In this role Mark is respon-
sible for commercial strategy, client support &
education and partners with Applied Research and
New Product Development teams to develop strat-
egies to enhance the industry leading MSCI factor
index products. Mark led the 2018 launch of MSCI
FaCSTM, the Factor Classification Standard, creating
a common language and definitions for equity factors.
Prior to MSCI, Mark was a member of the
Global Alternative Premia group at AQR Capital
Management. Mark joined AQR from BlackRock
where he spent ten years, most recently as a regional
executive and Head of Smart Beta for iShares. In
this role Mark was responsible for the commercial
strategy, client support, product development and
marketing for both active and index-based factor
strategies. Before BlackRock Mark served as Vice
President and Senior Client Portfolio Manager for fun-
damental growth at Columbia Management Group,
now ColumbiaThreadneedle. Mark began his career
at Fidelity Investments in Boston.
Mark earned an MBA from University of New
Hampshire and an ALM with a concentration in
Finance from Harvard. Mark lives in Westport, CT
with his wife and two daughters.
Dimitris Melas
London
MANAGING DIRECTOR
AND GLOBAL HEAD
OF CORE EQUITY
RESEARCH
E dimitris.melas@msci.com
Raman Aylur
Subramanian
New York
MANAGING DIRECTOR
AND HEAD OF EQUITY
APPLIED RESEARCH
FOR THE AMERICAS
and EMEA
E raman.aylursubramanian@
msci.com
Mark Carver
New York
EXECUTIVE DIRECTOR
& GLOBAL HEAD
OF FACTOR INDEX
PRODUCTS
E mark.carver@msci.com
YIELD
Yd
QUALITY
Qy
VOLATILITY
Vo
MOMENTUM
Mt
SIZE
Sz
VALUE
Vl
A common language for Factor Investing
MSCI FaCS™
Put factors to work for your portfolio with MSCI FaCS.
To know more MSCI FaCS, mail us at factorinvesting@msci.com
Learn more about Factor Investing at msci.com/factor-investing
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