Using factor exposures to in pursuit of better returns in a multi-asset portfolio

April 13, 2017 Categories: Investment, Investment Strategy

Russell Investments Wire Blog Factor Exposure

The low interest rate environment of recent years has created a challenging return outlook for institutional investors. In response, one area that many investors have turned to in their pursuit of incremental returns is factor exposure management (widely referred to as smart beta).

Factor exposures in a multi-asset context
The management of factor exposures is especially interesting in multi-asset portfolios, because there are so many moving parts and so many interdependencies.

My colleague Rob Balkema (Senior Portfolio Manager, Multi-Asset Solutions) emphasises that the starting point is a coherent set of beliefs to underpin the exposures: “Russell Investments has strategic beliefs that we think should be included in multi-asset portfolios. We have beliefs about how equity factors tend to behave, beliefs about how fixed income factors tend to behave, beliefs about how currency factors tend to behave, and so on. In a multi-asset context, it’s critical, too, to have beliefs about how those behaviours interact. Together, those beliefs are the starting point.”

The list of factors on which an investor may have an opinion is long. For example, in equities, there are grounds for strategic exposure to factors such as value, momentum and quality1. In fixed income potential factor exposures include credit, illiquidity and term2. Currency has carry, value and trend. Looking wider afield, multi-asset investors may have beliefs about commodities, about real assets, about implied volatility, ESG factors and an almost endless list of other exposures.

According to Rob, “Because of the interaction between these factors across the asset classes, putting them into multi-asset portfolios needs to be a top down exercise, just like asset allocation or manager selection. For instance, value overweights in equity are highly correlated to credit overweights in fixed income, so we need a cross asset class construction in order to manage exposures appropriately.”

More to come
Factor exposure management/smart beta has been a field of enormous growth in recent years. To a small extent that is perhaps due to the work that’s gone into understanding how various factors may offer incremental return potential. But what’s really driven the growth is that instruments and trading strategies making the implementation of factor beliefs easier and more cost-effective have become widely available. Continued growth appears likely.

One of the earliest widespread applications of factor exposure management was the neutralising of systematic exposures to the volatility factor in equity portfolios3: risk management rather than return enhancement. Today, it has become an important part of the search within multi-asset portfolios for ways to supplement the traditional sources of return such as asset allocation and active management.

1See “Value, momentum, quality: a discussion of three equity return drivers” by James Barber and Evgenia Gvozdeva, Russell Investments Communiqué (4th quarter, 2014)
2See “Credit, illiquidity, term: a discussion of three fixed income return drivers” by Gerard Fitzpatrick and Leola Ross, Russell Investments Communiqué (1st quarter, 2015)
3See “Defensive equity: is the market mispricing risk?” by Bob Collie and John Osborn. Russell Investments Viewpoint (2011).

Bob Collie, Chief Research Strategist, Americas Institutional

Bob-Collie

  1. No comments yet.

This blog is not intended for retail investors. The opinions expressed herein are that of Russell Investments, are not a statement of fact, are subject to change and, unless they relates to a specified investment, do not constitute the regulated activity of “advising on investments” for the purposes of the Financial Services and Markets Act 2000.

This material does not constitute an offer or invitation to anyone in any jurisdiction to invest in any Russell product or use any Russell services where such offer or invitation is not lawful, or in which the person making such offer or invitation is not qualified to do so, nor has it been prepared in connection with any such offer or invitation.

Unless otherwise specified, Russell Investments is the source of all data. All information contained in this material is current at the time of issue and, to the best of our knowledge, accurate.

The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

Copyright © Russell Investments 2017. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

The Russell logo is a trademark and service mark of Russell Investments.

Issued by Russell Investments Limited. Company No. 02086230. Registered in England and Wales with registered office at: Rex House, 10 Regent Street, London SW1Y 4PE. Telephone 020 7024 6000. Authorised and regulated by the Financial Conduct Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS.