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Institutions increase investment in factor-based strategies


A new study from The Economist Intelligence Unit, sponsored by BlackRock, finds that institutional investors are increasingly employing factor-based strategies across their investment process.

 Respondents to the study believe factors can help them deliver long-term outperformance, decrease overall portfolio risk, increase transparency in portfolio construction, and better understand past and future drivers of return.
The global survey of 200 organisations representing USD5.5 trillion in assets found factor use is widespread and on the rise.
The study says: “Supported by years of academic research, factor investing holds that the risks and returns of all investments, no matter how nominally diverse, can be mapped to a common set of underlying factors. The idea of factors is to distill investments into something very simple: macro-economic factors such as economic growth, inflation and interest rates, and style factors like value, quality, momentum and volatility.”
 More than 85 per cent of respondents utilise factors in some part of the investment process. Close to two-thirds of the institutions surveyed stated that they had increased their usage of factors over the past three years. The trend is expected to continue, with 60 per cent of respondents indicating they plan to increase their use of factors over the next three years. The desire to improve returns is the most important motivation for increasing factor use.
“As is often the case, adversity has given rise to innovation. The unexpected correlations of asset performance during the financial crisis spurred investors to better understand underlying risks.  This has resulted in a growing interest in factor strategies,” says Andy Tunningley, Head of Strategic Clients in BlackRock’s UK Institutional Business.
“Following an initial focus on risk management, investors increasingly believe that factor strategies can drive enhanced performance.”
For new factor users, a better understanding of risk exposures is the top motivation: more than three-quarters (76 per cent) of factor users cited the desire for a better understanding of risk and return as a motivation, and the same percentage said they had achieved this goal. More than half (59 per cent) have achieved greater diversification (the second most-cited motivation), and similar proportions have lowered risk (56 per cent) and increased returns (55 per cent).
Macro and style factors are employed in both risk management and investment strategies. More than half (53 per cent) of the institutions surveyed use investment strategies targeting one or more factors with value being the most commonly targeted style factor and inflation being the most commonly used macro factor. Equity factor strategies (e.g. smart beta) are most widespread, used by 68 per cent of investors, but more advanced long/short multi-asset strategies are also widely used, cited by 57 per cent of those who invest in factors.
The study also found institutions are taking a number of steps to support future factor use. More than two thirds of those increasing over the next three years will ensure they have appropriate risk management systems. More than half expect to seek advice from asset managers, while 37 per cent expect to hire additional staff. Half of those increasing say they will make an initial allocation to an investment strategy to monitor performance.
“Having worked with several of the early adopters, seeing the increasing acceptance of factors by institutional investors is particularly gratifying,” says Andrew Ang, Head of Factor-Based Investing Strategies at BlackRock. “The research echoes my experiences with clients. The broad and growing number of institutional investors adopting factor-based investing reflects the benefits and versatility of the approach. Those reasons are why we are so confident in the outlook for factor investing.”

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