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Mark Carver, MSCI

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How factor investing is reinventing asset allocation

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For long-term investors, an unpredictable year in financial markets has underlined why it is more important than ever to understand the factors at work in their portfolios – Mark Carver (pictured), Global Head of Equity Factor Products at MSCI

For long-term investors, an unpredictable year in financial markets has underlined why it is more important than ever to understand the factors at work in their portfolios.

Factor rotation was rapid in 2020: national lockdowns put pressure on value stocks, while returns on ‘momentum’ stocks soared thanks to the new era of working from home leaving technology companies largely unscathed. 

“Factors often provide answers, and what we found last year is that more and more investors were looking at factors in real time to try to understand the behaviour of markets and make decisions about how they might rebalance portfolios,” says Mark Carver (pictured), Global Head of Equity Factor Products at MSCI.

This is part of a profound shift that is taking place in asset management towards ‘Asset Allocation 3.0’, says Carver.

Investors are no longer “setting it and forgetting it” by buying generic equity and fixed income portfolios that blindly rebalance to neutral weights.

“At one time, asset allocation was about stocks, bonds, and cash. Then, we moved to an allocation model that was geographic centric, ‘Do I want to take an overweight position in certain regions?’. Today, it’s ‘How do I want to take my exposure in that region?’ which is where factors play a greater role,” says Carver. 

Precise allocations may now be needed as long-term investors negotiate the pandemic, as economic recovery has occurred at different rates across the globe, with countries like China leading the restart. 

“There are certain market periods that are episodic due to the market dynamics, such as the market concentration we saw last year. While this is not necessarily an original idea, we observe heavy concentration in terms of what drove the returns in the US market last year, specifically the MSCI USA Index return in 2020 was around 21 per cent*, and in the broad index of 620+ names only a narrow number, the top ten contributors accounted for 63 per cent of the return while the other 610+ accounted for the rest.” Carver explains.

“When the market broadens, we may see transition in factor leadership, shown by strengthening stronger performance among the factors that benefit from improved market breadth.” 

Over the last fifteen years, factor investing has grown from being a niche strategy employed by a few quant investors and academics to a mainstay of modern asset allocation – one that most organisations use to meet their objectives such as reducing risk, generating returns, expressing investment views and increasing diversification. 

The democratisation of access to factor strategies is taking place through MSCI’s leading indexes, which are leveraged in index ETFs, Mutual Funds, and UCITS Funds. 

“Today, it’s more evident that factors serve as the foundation for portfolio management, investment analysis and for asset allocators as key part of investment due diligence,” says Carver.

In November, the approval of a Pfizer and BioNTech vaccination caused stock markets everywhere to surge, with cyclical value stocks outstripping momentum stocks for the first time in the year. 

MSCI’s tools enabled investors to track and assess these movements on a daily basis.

“Among the most common questions we heard from clients last year was around the performance of the value factor and it’s notable that we observed strong flows to value at the end of the year. That was a big change from what we saw over the last few years.” says Carver. 

MSCI has heard many clients wondering whether factors such as value and size, the so-called pro-cyclical factors which rebounded strongly in the fourth quarter will continue to perform well in 2021 as the economic recovery continues. 

Looking ahead, another vital theme will be investors examining how Environmental, Social, and Governance (ESG) factors can be combined with existing factor strategies, to quantify and communicate the impact of ESG on portfolio risk and return.

Carver believes that ESG and more specifically climate is “in the first inning of a nine-inning game” and will cement itself as one of the biggest trends in 2021.

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