Invesco Study: Increase In Factor Investing Driven By Performance Recovery, Consistency, And Conviction

The sixth annual Invesco Global Factor Investing Study found that factor allocations are continuing to rise, with 43% of respondents citing increased allocations over the past year and 35% having plans to increase in the next year.  The increase in adoption is driven by the ability to better control sources of risk and the possibility of increased returns.  This year’s study, released today, is based on interviews with 241 global factor investors responsible for managing over $USD31 trillion in assets.¹

Factor investing is an investment strategy whereby securities are chosen based on quantifiable characteristics and attributes (commonly termed ‘factors’) that help explain risk and return patterns of a portfolio over time.  Levels of adoption and sophistication have increased rapidly in recent years in the Middle East, with regional investors recognizing the potential benefits of incorporating factor strategies within a portfolio using a systematic, quantitative approach to investing. Factor investing offers investors a complementary approach to traditional active and pure passive investing.

“The number of investors in the Middle East who are utilizing factors to build and manage their portfolios has grown substantially over recent years,” said Josette Rizk, Director of Institutional Clients, Invesco. “Middle East sovereigns, for example, are looking at factor-based strategies to achieve a specific investment outcome in an attempt to improve long term risk-adjusted returns, or tactically to express a market view.”

The potential benefits for ESG incorporation have led investors toward a factor-based approach

In recent years, there has been a focus on increasing sustainable investing and the study highlights the rapid increase in appetite for incorporating ESG in a factor methodology. In 2021, 78% of global respondents, all of which are factor investors, indicated they incorporated ESG in their portfolios.Historically, demand from stakeholders and beneficiaries had been the key driver of implementing ESG, whereas the current study finds that the most important driver is the belief that ESG potentially enhances long-run investment performance.

The study found that, while a fundamental active approach to ESG investment is favored due to its greater flexibility in implementation, factor investing is seen as more compatible with ESG when compared to a passive market-weighted approach.. Despite this, respondents were more likely to say that ESG was pushing them towards a factor approach, partly due to the ability to replicate a quantitative methodology across different parts of a portfolio. Josette Rizk said: “Incorporating ESG parameters in a portfolio using factors has taken hold in the Middle East. Some investors are taking a more quantitative approach analyzing ESG exposure and carbon footprint of their portfolios through a factor lens.”

A minority of respondents from the study believed ESG is an investment factor, replicating the characteristics of factors such as value and quality but the more commonly held view is that ESG is completely independent of investment factors (41%).

Georg Elsaesser, Senior Portfolio Manager, Quantitative Strategies at Invesco said: “Factors can help in decomposing the impact of ESG on a portfolio. We have to consider both the risks of not including ESG and the risks of including ESG. Both ways, factors can help.”

Further analysis showed that there is an unmet demand for ETFs that combine ESG and factors. Nearly half of global investors (46%) responded they would be more likely to invest in a factor ETF if it incorporated ESG. Generally, the intersection of ESG and factor investing was seen to not yet yield a wide enough supply of ETF products, and 49% of asset owners agreed they sometimes struggle to find the right factor ETF to suit their needs.

Low yields drive factor uptake in fixed income

Nearly half (45%) of global survey respondents said the low yield environment has made the use of factors within fixed income portfolios more attractive, offering an opportunity for additional sources of return and diversification. A significantly higher number of investors are now using factors in fixed income (55%), up from 40% in last year’s study. For the majority (52%), factor investing in fixed income includes the use of both investment factors (such as value/quality) and macro factors (such as duration/inflation), whilst 23% are only using investment factors and a quarter look at factors solely through a macro lens.

Findings showed factor investors are incorporating multiple investment factors within their portfolios, with value and quality preferred. When looking at macro factor use, duration, liquidity, inflation, and credit risk were the most cited. Duration was widely acknowledged as the most important driver of fixed income returns overall, whilst liquidity has become more prominent throughout the pandemic. The current economic environment has made factor investing more attractive, providing the opportunity to uncover return potential and additional diversification.

Dynamic multi-factor investing shows evolution and adaption

Over the last six years, Invesco’s Global Factor Investing study has noted factor investing rapidly advance in sophistication, particularly through the use of multi-factor strategies, as investors seek exposure to a greater range of factors.

The rapid uptake of a multi-factor approach has also seen factor investing become more dynamic. Only 22% of global factor investors look to keep factor exposures completely fixed, while around half (48%) use an approach allowing for variation in exposures over the long run and a third change their exposures regularly. The dynamic approach is set to accelerate, as 29% of investors say their approach has become more dynamic over the past 2 years, while 41% expect to be more dynamic over the next 2 years.

The study found that, despite sophisticated implementation of analytics among a segment of factor users, for many there was still an appetite for better tools. Particularly with regards to monitoring exposures and attributing performance.  Investors want clearer visibility of factor exposures and to use this information to better predict changes to the portfolio across different scenarios.

Research indicated a continued momentum around factor ETFs as an important tool for implementing factor strategies among both wholesale and institutional investors. ETFs can act as the cornerstone of a strategy, as a tactic or portfolio completion tool, which explains why institutional use of factor ETFs is accelerating particularly rapidly. 46% of respondents plan an increase in ETF use over the next three years.

Georg Elsaesser, commented, “The post-pandemic period tested some of the assumptions around the benefits of factor investing. However, most investors report that adopting a factor approach has been successful and there has evidently been a strong uptake towards factor investing strategies. The growing allocation reflects a broader adoption as investors consider factors in the context of the whole portfolio and in asset classes beyond equities.”