Barriers to Increasing Factor Allocations Have Fallen Away as Confidence in Third Pillar Continues to Rise – Invesco Study

Nov 5, 2018

• Half of institutional and a third of wholesale investors are increasing factor expertise within investment teams
• 60% of investors intend on increasing factor allocations in the next three years
• APAC institutional investors report the highest number of factor strategies deployed, while North America leads in the wholesale space
• APAC investors deploying factor strategies beyond equities, with 50% either “considering adding”, “currently using”, or “extending use of” factors in fixed income, versus global overage of 39%.
• Segregated mandates are preferred vehicle for APAC investors, with 62% of respondents executing through such mandates.

Hong Kong, Melbourne, Mumbai, Singapore, Tokyo, 6 November 2018: Barriers to factor investing are falling rapidly as investor capability continues to improve, according to the third annual Invesco Global Factor Investing Study. As confidence in factor investing grows, the asset management industry is accelerating changes to how it captures the benefits of factor - the third pillar of investment strategies - with half (50%) of institutional and a third of retail investors (33%) hiring talent to manage factor investing more effectively.

The qualitative and quantitative study – the most comprehensive of its kind – interviewed over 300 wholesale and institutional investors across 21 countries who have over US$19 trillion in AUM. The findings reveal that the most significant barrier, internal capability, has fallen significantly over the past two years, dropping 1.8 points when rated on a scale of one to 10. In addition, barriers such as belief in the factor theory, executive support from internal stakeholders and crowding have all declined over this period. For seasoned factor investors introducing additional strategies, barriers are 10-15% lower.

Stephen Quance, Director of Factor-Based Investing at Invesco, said: “Factor investing’s progress reflects a structural change within the industry, creating a true third pillar in the investment world, distinct from traditional active and market cap weighted passive options. Investors – both wholesale and institutional – increasingly see factor investing as a distinct competency requiring specific rather than generalist expertise from elsewhere in the internal team.”

A factor approach could be appealing for investors who want to increase returns, but do not want the specific risk that comes from traditional alpha managers. It may also be suitable for those who want to manage downside risk but are still aiming to pursue excess return over market-weighted strategies. The “best” strategy depends on what the investor would like to accomplish and the risks that concern them.

The prediction that factor allocations will continue to rise over the coming years, a conclusion of the 2017 report, continues to hold true. According to the study, investors intend to increase factor allocations over the next three years. Three fifths of investors overall (64% of institutional and 56% of wholesale investors) plan on increasing factor allocations by 2021. 

While the sentiment of global investors is to increase their factor allocations over the coming three years, this is even more the case for Asia Pacific factor investors. Over three quarters (77%) of respondents intend to increase factor allocations, in comparison to 57% in Europe and 54% in North America. The key driver for further increases in allocations by investors is, by some distance, better net performance, followed by cost-effectiveness and two dimensions of risk reduction.

A relatively new theme emerging from this year’s study is the use of factor allocations to address portfolio ESG requirements. Almost half (47%) of institutional investors believe factor strategies can address ESG objectives, and over a third (38%) of wholesale investors echo this belief. The use of factor strategies to address ESG requirements is even more common amongst sophisticated institutional investors, as 60% see potential ESG applications for factor strategies.

Asia Pacific in Focus
This year’s factor investing study revealed Asia Pacific investors to be energic adopters of factor investing strategies. The leading adopters of factor investing in the region are the larger and more experienced institutions such as Asian sovereign funds and insurers, as well as Australian pension funds. Private banks and other wholesale investors are typically still gaining experience.

A revealing indicator is the take-up of factor strategies among institutional investors in Asia Pacific; among those institutional investors that have adopted factor investing, the average reported allocation is 23% of portfolios to factor strategies. This is the highest allocation among institutional investors of any region surveyed (19% allocation among North American institutions and 11% among European), and Asia Pacific institutions are the segment where factor allocations are closest to overtaking passive strategies.

Further underscoring the high level of take-up, institutional investors in the APAC region revealed that they have implemented more strategies than the global average, at 3.5 strategies versus 2.9 globally.

An additional area where take-up of factor strategies in Asia Pacific is outpacing the global average is in extending the use of factors outside of equities; 50% of Asia Pacific investors are either “considering adding”, “currently using”, or “extending use of” factors in fixed income, versus a global overage of 39%. In multi-asset, 56% of Asia Pacific Investors are currently or considering using factors, versus 44% globally.

In terms of vehicles for accessing factor strategies, Asia Pacific factor investors utilize segregated mandates to a significantly greater extent than their peers in other markets, with 62% of the region’s respondents executing their smart beta factor strategies through a segregated mandate (compared with 16% in North America and 13% in Europe). This partly reflects the importance of very large institutional factor investors in APAC, along with the relative scarcity of locally-listed ETF or ETN products.  

Positive experience
Despite many global factor investors being relatively recent adopters, the great majority report a positive experience. For a significant proportion, the factor approach has exceeded expectations. For example, over half (53%) of wholesale investors found smart beta allocations have exceeded expectations versus passive products, with a further 40% noting performance has been in-line with expectations. 

When comparing performance relative to their active products, a quarter (25%) of institutional investors stated smart beta allocations have outperformed expectations. The Study has found similar or better results when comparing the performance of active quant. A third (33%) of institutional investors have found this form of factor investing has surpassed expectations compared to traditional active.

The factor experience has been even more positive for those who consider themselves more sophisticated investors. For experienced institutions, it exceeded expectations for 41% of respondents and for over 20% of experienced wholesale investors.

Stephen Quance added: “Factor strategies can provide flexibility to investors to pursue their specific investment goals while enhancing scalability by covering a broad set of securities. The approach could also be suitable for those investors who want specific risk control measures in place but are still aiming to pursue excess return over passive strategies. We believe rigorous research and technology advances will continue to enhance the capabilities of factor investing, and eventually this pillar will become an even more meaningful proportion of Asia Pacific portfolios.”

About Invesco Ltd.
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Sample and methodology

The fieldwork for this study was conducted by NMG Consulting (“NMG”)’s strategy consulting practice. Invesco chose to engage a specialist independent firm to ensure high quality objective results. Key components of the methodology include: 

• A focus on the key decision makers within institutional investors, asset consultants, and private banks, conducting interviews using experienced consultants and offering market insights 
• In-depth (typically one hour) face-to-face interviews using a structured questionnaire to ensure quantitative as well as qualitative analytics were collected 
• Analysis capturing investment preferences as well as actual investment allocations with a bias toward actual allocations over stated preferences 
• Results interpreted by NMG’s strategy team with relevant consulting experience in the global asset management sector

In 2018, the third year of the study, we conducted interviews with 300 different asset consultants, insurers, pension funds, sovereign investors and private banks globally (up from 108 in 2017). In this year’s study, all respondents were ‘factor users’, defined as any respondent investing in a factor product across their entire portfolio. We deliberately targeted a mix of investor profiles across multiple markets. The breakdown of the 2018 interview sample by investor segment and geographic region is displayed in figures 58 and 59. Invesco is not affiliated with NMG Consulting.