While factor investing isn’t new, the way investors are accessing and using factors is changing, says Mark Carver, global head of factor index products at MSCI Inc.
“The most common [mis]perception is that factors are new,” he says. “Factors are not new. Some of the strategies that today we bucket as factors have in fact been strategies that active managers have employed, not for years, but literally for decades.”
In the last five or six years, factor indexes are becoming more common, he adds.
Technology is allowing investors to recognize that factors are driving much of returns and this isn’t necessary alpha, says Carver. “The way we can analyze and assess portfolios today is so much greater than it’s ever been that we’re able to see that some things we used to believe were alpha are in fact systematic factors. And so that insight, that power, has transformed the way investors think about their portfolios, both from an understanding [of] their allocation to then ultimately capturing themes that they think can drive their returns.”
Today, investors want to allocate more to factors, but they sometimes want to do this quite differently than in the past, he notes. “The big shift that we’re seeing among mostly institutional clients is the divide between the tactical and the strategic. Historically, factor investors have been more strategic in nature; where they would have a conviction on a factor, they would invest in that factor and hold that for the long period. Today, partly because in some ways factors are replacing active managers, at least on the fringes of portfolios, people are more interested in . . . can you dynamically allocate or adapt your factor exposures based on the market environment itself?”
Carver says he’s seeing some clients aiming to be more active, rotating between value or quality or momentum based on macro-dynamics.
Another trend is including factors and environmental, social and governance principles, he says. “They’re going to start with a framework of incorporating ESG principles and then potentially build factors on it, or maybe they’ll start with factors and then they’ll want to have ESG improvement.”
While factors are currently most prevalent in equities, this is starting to spread beyond the asset class, with studies of factors in currencies, fixed income and commodities. Some would say seeing these dynamics play out in other assets gives investors confidence factor premia are real versus being luck or data mining, says Carver. “We are seeing that there are managers who run factor strategies against other asset classes.”
MSCI has a multi-asset class factor model in its analytics framework and has launched currency factor indexes. “There were a small number of clients who wanted a better way to evaluate active managers who were using currency strategies, so we did that,” he says. “We’re hoping later this year to introduce fixed income indexes that will be trading factors.”
Equity factors have been studied for 40 years because there’s been great data available, which hasn’t been the case for fixed income, says Carver, noting more data is now available and is being improved in fixed income.
Today, factors are still looked at asset class by asset class, and the evolution will be looking at the full portfolio and moving down, he says. “As the industry understands these concepts and gets more comfortable with them, you’ll start to drill down versus drill up.”