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Demand for factor products increasingly globally, says Invesco study

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Demand and adoption of factor-based strategies are increasing on a global scale, with investors planning to nearly double allocations over the next five years, according to an Invesco study, 

According to a qualitative and quantitative study amongst global pension funds, insurers, sovereign wealth funds, asset consultants and private banks, 71 per cent of respondents expect to increase factor allocations over the next five years.
 
Over two thirds of respondents (70 per cent) already use factors in portfolio construction, with risk reduction as the primary driver, followed by increased alpha, and half of non-user respondents are considering factor products.
 
Many respondents explained that they had made small allocations to date as part of an initial trial period for factor investing, but plan to increase these allocations. Growth is expected particularly in multi-factor quantitative strategies, internal factor models and fixed income and liquid alternative products, as investors continue to seek alternative sources of returns in a sustained low yield environment of low interest rates and stock market volatility.
 
There is no lack of belief in the rationale behind factor investing, with 83 per cent of respondents believing that factors help explain outperformance. However, the research reveals that investors’ focus is less on off-the-shelf factor products and more on strategic factor models and a more holistic multi-factor approach which explains all of their factor exposures.
 
For example, while sovereign investors in Asia have been the fastest adopters of internal risk factor models, German insurers, driven by liquidity requirements and regulatory constraints, are migrating from fundamental investments to smart beta ETFs and equity factor models to improve risk adjusted returns. In the UK, post RDR, charge caps on default funds and stakeholder engagement have facilitated growth in smart beta products so that UK defined contribution pension funds are now using factor products because they offer a cheaper route to diversification.
 
Bernhard Langer, co-chair Factor Investing Council and CIO of quantitative strategies at Invesco, says: “Our research confirms that both popularity and desire for even greater adoption of factor investing is growing. But given the diverse nature of investors, the asset management industry needs to consciously address their clients’ needs for a tailored and consultative approach towards the implementation of factor-based strategies.”
 
There is also a strong preference for internal control over factor models with 61 per cent of respondents stating their organisations are best placed to assess the role of factors and 71 per cent believing they are best placed to manage factors internally.
 
The desire to manage factors internally leads directly to the key barrier to factor adoption. A lack of internal capability was cited as the greatest adoption barrier with a rating of 8.3 out of 10.
 
While institutions want to control their factor investments they explicitly requested support from the wider asset management industry, citing training support and consulting advice as the two most effective industry propositions to address their concerns.
 
Many investors explained that consultants should be well positioned to be the natural partner for an institution looking to develop a strategic factor based approach, referencing their experience supporting institutions with asset liability models as an example. Many institutions were also positive on the quality of internal factor products designed by consultants but explained that these products did not always fully support them in their objectives of truly understanding this investment approach and further supporting the development of their investment expertise.
 
Investors’ feedback on academic institutions was that, whilst well respected, the body of research available falls short on practical applicability and is too focused on equities. Whilst 40 per cent of non-users ranked academic research as the most effective tool to address their concerns, only 9 per cent of respondents cited academic institutions as best placed to assess the role of factors within their portfolio. Many investors, however, expressed an interest in hiring successful academics into an internal investment team.
 
To fill these gaps, respondents explicitly requested support from the wider asset management industry, though they felt that asset managers are often too focused on pitching their factor products and philosophies, rather than providing the holistic and client-centric consultancy that investors need.
 
Private banks specifically stated that they want asset managers to develop more tailored factor propositions for different implementations and more client friendly marketing materials. Their desire for factor strategies was driven by the ongoing advice regulation, increasing financial literacy amongst clients and online direct-to-consumer platforms which are challenging the traditional private banking model for investments. They stated that the greater use of ETFs, indexing, smart beta and active quantitative products alongside fundamental active management are bringing down investment costs.
 
Langer says: “There is clearly a call for the asset management industry to show a greater understanding of how investors want to manage and assess factors in their portfolios, and how asset managers can help with this. As investors and their investment service providers become more comfortable with factor-products, we expect greater separation between assessing and managing factors to emerge as investors realise they can retain control while outsourcing the strategy execution.”

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