Factor investing gives investors new scope for diversification and returns, says AllianceBernstein

The key for investors to improve their potential risk-adjusted returns doesn’t always lie simply in taking a rounded view of the companies whose stocks comprise their portfolios, global asset manager AllianceBernstein said today.

“Fundamental considerations such as the nature of a company’s business, the quality of its management and its ability to perform well in a given business environment are always important,” said Vadim Zlotnikov, the firm’s New York-based Chief Market Strategist.

“But quantitative factors or themes are important too, and our research suggests that it’s possible to increase portfolio diversification and potential investment returns by focusing on particular factors when they appear likely to work for or against a company and managing exposure to the stock on that basis.

“This approach cuts across conventional ideas of stock selection and we believe it could be very helpful for investors concerned about the risk of crowding, or concentrated exposures, in multi-manager portfolios—as we know to be the case among the growing number of Australians investing offshore.”

Zlotnikov’s role includes leading AllianceBernstein’s Factor Portfolios service which offers a range of portfolios, each designed to deliver high exposure to a particular factor. Zlotnikov and his team have identified nine factors they regard as useful in generating excess returns and managing risk exposures.

“Six of them have outperformed the market over various time frames while the other three serve as useful control tools. The out performers include what we call Deep Value, where a stock’s price-to-book ratio indicates its attractiveness relative to the potential for mean-reversion in the stock’s fundamentals.”

Other out performers or “alpha factors” include Current Value (earnings before interest and tax-to-enterprise value, which measures the attractiveness of a stock on current earnings) and Momentum (price momentum, which measures investor reaction, fund flows and sentiment feedback).

Factors that have outperformed only periodically include Beta (a measure of the sensitivity of a stock’s share price to movements in a relevant index), Size (market capitalisation, a measure of “size bias”) and Risk (an attempt to measure residual or embedded risks in a business, which the business cannot control).

“By rotating these factors we can enhance risk-adjusted returns, and the lack of correlation between these portfolios and fundamental research-based strategies gives a very high degree of diversification,” said Zlotnikov. “The ability to use factor portfolios as overlays can also make them very cost-effective.”