*This article is produced in partnership with iShares by BlackRock and MSCI.
According to our 2023 research, major investors across the globe consider style factor exposure foremost in their ability to generate alpha, ahead of stock, sector or country allocations. Prior to the pandemic, global equity markets experienced a prolonged period of strong performance. This was partly driven by sub-industries within the technology sector due to the sector’s many long-term growth drivers, which led some to question the continued relevance of broad characteristics, or equity style factors, in generating returns.
However, the change in macro environment in the post-pandemic period, as reflected in persistent global inflation, waning economic growth, and the hawkish actions of global central banks, has driven strong performance in equity factors, like value in 2022 or quality in 2023, and reignited investor interest in these historic drivers of return.
This increasing uptake was evident in MSCI’s 2023 survey of global wealth managers and institutional investors, representing firms with a combined assets under management of more than $3.5 trillion. The survey was designed to gain insights on how investors both view and currently use equity factors in their allocation and portfolio construction decisions given the increasingly complex investment landscape.
In addition to the previously mentioned importance of factors in generating returns, investors also mentioned the use of factors opportunistically by over/underweighting specific factors within their asset allocation and rebalancing activity. During the volatile pandemic period many of the key style factors often used by investors to capture outperformance, including low volatility, size and value, underperformed significantly, leading some to question whether factors were still relevant given changing market dynamics.
However, in a world of high interest rates and uncertain growth, investor sentiment shifted and nearly half (49 per cent) stated an expectation to increase exposure to quality stocks and another 35 per cent to value stocks.
The great factor rotation
A longer-term strategic allocation to factors was also popular among respondents, with 43 per cent saying they would characterise their approach to factors as long-term with a 10-year plus time horizon. More than half of investors also consider that factors will outperform over the next 5-10 years. In that spirit, one industry colleague, Tamara Stats, iShares ETF specialist, likens factor investing to driving, suggesting factor investing requires understanding the various components that influence your journey, “Instead of being a passenger at the mercy of market waves, factor investing allows you to take control and navigate your portfolio towards your investment goals”, Stats says.
In line with this, the ability to rotate in or out of certain factors has recently been top of mind for investors. The vast majority – 78 per cent – of respondents to our survey indicated that they planned to keep their proportion of assets allocated to factors the same over the next year. This corresponded with the approximately 81 per cent of investors who already used factors in their portfolio construction, indicating very few were planning to move out of factors.
However, other investors, as stated earlier, take a more active approach to allocating to factors, illustrating the cyclical nature of factors is well understood by investors, and that choices to tilt toward or away from specific factors may often be done as part of regular portfolio rebalancing activity, depending on where they see markets going from here. Rotation between factor strategies can also help to enhance other regional allocations within an investor’s portfolio. We have had several clients remark about the dispersion in returns to value portfolios across various regions and countries for example.
Factors and the future of investing
So how are factors likely to evolve in future? Investors indicate that themes such as environmental, social and governance (ESG) and machine learning are increasingly being considered as part of their allocation decisions and are therefore likely to be integrated into the way we look at factor investing going forward, rather than simply allocating to the more traditional factors.
Around 70 per cent of investors surveyed have an active ESG policy and almost 40 per cent are looking to improve the ESG characteristics of their factor allocations. Adding ESG allocations alongside or on top of existing factor strategies can present challenges as it may dilute an investor’s exposure to factors, and potentially impact performance, so investors may want to consider how to integrate the two more closely.
In addition, 56 per cent of investors feel that information extracted from alternative datasets, or the application of advanced machine-learning techniques can have a role to play in their factor allocations. We believe machine learning will be a valuable addition to a factor investor’s toolkit by helping to further explain and confirm the power of factors, and potentially unearth new factors over time and enhance the understanding of the interaction among factors.
While the way they are incorporated with other strategies may change over time as the investment landscape gets more complex, we believe factors will continue helping investors understand risk and return in equity markets. Despite varying market conditions, whether the volatility of the pandemic and the current high inflation environment, professional investors continue to turn to factors to help them generate positive returns for clients.
Mark Carver is global head of equity factor products for MSCI.
