The concept of factor investing has been around for decades, but it’s only in recent years that it’s gained widespread adoption among institutional and wholesale investors.
In a global survey of more than 300 institutional and wholesale factor investors, Invesco has found that factor allocations and factor applications among North American investors are expanding. “Since Invesco first polled investors about factors in 2016, North American respondents have increased their adoption of factor strategies at an average rate of 5% per year,” the firm said.
Asset owners often start with just one factor-based strategy, the firm found. But as time passes, they tend to incorporate other factor strategies. They also consider extending their factor strategies across asset classes, starting with equities and moving on to fixed income and multi-asset.
invesco stressed that factor investing is still in the early stages of the adoption cycle: it estimates that approximately half of institutional investors have taken up a factor strategy, with the retail side lagged at only 20%. Among the survey respondents, it found that over 80% of cases saw less than 20% of equity and fixed-income allocations going to factor strategies.
“Only a third of factor investors have 4-8 years of experience, and half are relatively new,” the firm reported. Because investors will find it difficult to gauge the true effectiveness of a strategy until it’s gone through a full market cycle — i.e., including volatile and declining markets — the potential for factor strategies to break into the mainstream is still unclear.
But even among respondents who haven’t been using factor strategies for long, the benefits that are being sought are reasonably clear. The most cited drivers of adoption, unsurprisingly, were return and risk benefits. Two dimensions of risk were noted: broad risk reduction (reducing volatility and asset correlations) and portfolio-exposure control improvements.
“Investors using factor strategies are generally motivated by more sophisticated risk management and/or achieving potentially more favorable net returns for an existing level of risk,” the firm said.
Respondents also cited cost reductions as a factor, but not to the expected extent. That highlights the fact that not all investors go from active management to factor management; a considerable proportion of cases involve an investor moving from market-cap-weighted management to factor management.
“Other benefits of note include improvements to benchmarking and transparency, and the ability to replace or outperform either passive or active portfolios,” the report said.
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