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Invesco study finds factor investors increase allocations to weather market volatility and integrate ESG

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Asset management firm Invesco has published the findings of its seventh annual Invesco Global Factor Investing Study. The study is based on interviews with 151 institutional and retail factor practitioners managing over USD25.4 trillion in assets combined.

This year’s study found respondents expect factor-based strategies to outperform in an inflationary environment with slow economic growth. The firm writes that respondents also believe the current market environment makes factor investing in fixed income more attractive as a better way to manage volatility and diversify portfolios.

Persistent inflation and rising interest rates over the past 12 months have dramatically impacted the investment environment, compelling respondents to re-evaluate their portfolios including factor exposures, Invesco says. Despite these challenges, respondents still generally believe that factors are well-suited to managing risk during market turbulence, with 67 per cent agreeing that factor investing helped them manage market volatility over the past year. A similar number, 64 per cent, indicated their faith in factors grew over the previous 12 months.

Factor allocations continue to rise, with 41 per cent of respondents increasing allocations over the past year and 39 per cent planning an increase in the next year.  Only 1 per cent of respondents decreased allocations to factor over the past year.  Respondents expect value, low volatility, and quality to be the best performing factors over the next 12 months. A majority (over 80 per cent) believes their factor allocations have met or exceeded the performance of their fundamental active strategies, while 64 per cent indicated their factor allocations met or exceeded performance versus market-weighted strategies.

Georg Elsaesser, Senior Portfolio Manager, Quantitative Strategies at Invesco says: “The confidence in factor-based investment strategies has not only persisted in volatile times but grown stronger as their performance has recovered over the past 18 months.”

Meanwhile, the frequency of respondents reviewing and changing their factor definitions is changing.  41 per cent stated they rarely (every three to five years) change their factor definitions, which is down from 66 per cent in 2021. Currently, 43 per cent of respondents are changing their factor definitions frequently (every one to three years), up from 16 per cent in 2021.

This year’s research indicated an increased demand for fixed income factors as bond markets ended a multi-decade bull run. Over 50 per cent of respondents believe the current market environment makes factor investing in fixed income more attractive. Fixed income factors also continued their steady increase in acceptance this year, with 92 per cent of respondents believing factor-investing can be successfully applied in fixed income, a significant increase from 61 per cent in 2016.

Investors generally see fixed income returns as closely tied to fundamental macroeconomic variables. Respondents applying a systematic approach to their fixed income portfolios often initially prioritise traditional macro drivers of return, such as inflation and interest rates, before later incorporating investment factors such as value. This year 54 per cent of respondents said they use both macro and investment factors, and only 14 per cent target investment factors in isolation.

Within fixed income asset classes, respondents are using factor investing the most in government bonds (76 per cent) and corporate bonds (75 per cent), reflecting both the depth and liquidity of these markets as well as the number of products available. Respondents anticipate that factor investing will spread further in fixed income, with a clear majority (71 per cent) believing they will use high yield bonds as part of their fixed income factor exposure in the next five years.

Elsaesser says: “With the changing landscape for fixed income investments, the need to analyse and risk-manage portfolios through a factor lens has risen substantially. This is especially true in EMEA, where geopolitical risks are being felt strongly.”

Respondents have shown increasing adoption of ESG in their overall portfolios, driven partially by a conviction that such adoption can enhance performance.  This conviction has come under pressure over the last year as extractive industries have broadly seen strong returns, reflected in the fall of respondents to 59 per cent from 75 per cent last year, who see enhanced performance as the main reason for ESG adoption.  Notably, while enhanced performance was previously the most commonly cited reason for ESG adoption, this year the top reason was demand from clients and beneficiaries (76 per cent of respondents).

Invesco writes that this challenging period for ESG performance is seen by many as creating an opportunity for factor investing. Improved performance is cited by 72 per cent of respondents as the advantage of using factors to help implement ESG and 66 per cent of investors now believe factors can be used to implement their ESG objectives, an increase from 2018 (42 per cent). However, the lack of consensus around methodology remains a barrier to implementation, with respondents’ keen for further research in this area.

Georg Elsaesser concludes: “Factor investing is clearly emerging as a solution to mitigate potential unintended biases from ESG integration in equities, and even more so in fixed income, where the task is more challenging. With ESG especially front of mind in EMEA, this is yet another trigger for re-intensifying demand for factor-based investment strategies.”

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