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Revolutionise the way you invest in equities

The rise of factor investing

Multi-factor strategies aim to maximise return exposures, while diversifying risk. These strategies tend to favour rules-based or systematic strategies that aim to invest in groups of stocks which exhibit characteristics that have been empirically proven to deliver better risk-adjusted returns e.g. Value.

Alternative weighted methods have seen significant growth over the last decade. Investors are now recognising that risk and return characteristics can be mapped to a common set of underlying factors, providing them with a better understanding of the risks in their equity portfolio.

Why factor-based investing?

Factors aim to capture patterns, or more correctly premia, which explain long-term performance and give investors the potential to seek a better risk-adjusted profile than simply investing in the market.

For instance, evidence supports that small stocks tend to be riskier than larger ones and as such small-stock investors should be rewarded for the additional risk. That premium – for the added risk – is what explains the long-term outperformance of small stocks over larger ones (and also their underperformance in certain market cycles) and should be unique to the size factor.

Allocating to factors can enable investors to better understand and manage the underlying portfolio risks while offering a more transparent and cost effective way to access these sources of returns.

A portfolio which takes advantage of factor premia has been shown to offer the opportunity to outperform the market-capitalization index over the medium to long term. However, by maximising exposure to a desired factor and minimising incidental factors, this return can be far better targeted towards the intended drivers of risk and return.

The five key factors, which are often employed within an effective multi factor equity portfolio are: value, quality, momentum, volatility and size. We are able to use both technical and fundamental analysis to break down these factors. In examining these sub components we can identify which equities best define each factor. By having a high, medium or possibly low exposure to each of these factors we can customise the optimal portfolio to achieve investor's investment objectives and constraints.

However, there are a number of elements which need to be addressed in order to ensure these exposures are correctly correlated through asset selection. These include:

  • Factor methodology and the advantageous use of proprietary factor definitions,
  • Ensuring that factors remain statistically independent to avoid correlation contamination,
  • Avoiding high stock specific risk, by focusing on portfolio construction and constraining areas, for example Sectors or countries, which are not explained by the strategies stock level insights.

Typically pro-cyclical

Excess returns from stocks priced below their fundamental value. Typical indicators include:

  • Historic value
  • Current value
  • Risk adjusted value
  • Forward value

Typically defensive

Excess returns from high-quality stocks characterised by low debt, stable earnings growth etc. Key indicators include:

  • Profitability
  • Leverage
  • Earnings quality

Dynamic

Excess returns from stocks with strong past performance. Key indicators include:

  • Group momentum
  • Multiple specification periods

Typical defensive

Excess returns from stocks with below-average volatility or beta. Key indicators include:

  • Predicted beta
  • Uses estimated volatilities and correlations

Typically pro-cyclical

Excess returns from small cap. Key indicators include:

  • Market capitalization
  • Sales
  • Total assets

Accessing factor strategies

Our multi factor capability is defined by:

  • An investment approach that is highly adaptable to implement customised portfolios based on client requirements eg. ESG
  • A 'pure' factor framework, which focuses on maximising return whilst ensuring minimal unintended risks and maintaining independence among factors
  • Our robust implementation capabilities and proprietary technology and risk modelling infrastructure
  • 14 years’ experience in hands-on factor investing, designing and managing multi factor solutions
Risk Warning
The value of investments and any income from them can go down as well as up and investors may not get back the amount originally invested. The value of the underlying assets is strongly affected by interest rate fluctuations and by changes in the credit ratings of the underlying issuer of the assets.