Advertorial: Factor investing: Adding investment skill to index returns

However, index funds will only ever perform in line with their index, and we believe that by adding investment skill to index investing, there is an opportunity to grow returns. 

What is factor investing?



In its most basic form, factor investing is just investing in a group of stocks with similar characteristics, such as low volatility or high dividend yields.

However, these single, bottom-up criteria are often combined to build aggregate factors such as Value, Momentum, Quality and Growth.

An interesting implication of factor investing approaches is that they do not usually build on fund managers’ discretionary stock picking skills, but on the evidence that exposures to certain factors can result in outperformance in the long run.

Using multiple factors



At Invesco Perpetual, our factor investing goes far beyond this single factor approach. We implement strategies with well-diversified exposures to multiple factors with different cyclical characteristics, thereby offering the opportunity for a more stable return profile.

We constantly see new ideas bubbling up and an incessant stream of new datasets becoming available  Michael Fraikin

More importantly, our factor investing approaches focus on bottom-up stock selection we incorporate explicit alpha (and risk) expectations to construct multi-factor portfolios within the scope of extensive risk management. 

Balancing index-like performance and index outperformance



To many, the beauty of being passive is the idea to generate index-like performance without bearing any excessive drawdown risks relative to a benchmark.

However, the caveat of being passive is that after costs, the index return is never fully captured, which can lead to meaningful compounded underperformance over time.

At the same time, investors’ search for yield is becoming ever more difficult, so each additional basis point of extra return generated from equity exposures is important.

This is why multi-factor equity strategies are gaining interest from investors: they offer access to moderate extra return potential without them having to go too far from their comfort zone.

These strategies maintain some characteristics very similar to passive strategies, but also offer an explicit outperformance expectation over the benchmark.

Careful implementation of moderate active positions versus the benchmark (i.e. building up active money) in a risk-controlled framework, in order to generate positive alpha expectations, is the added value the Invesco Perpetual enhanced index fund range managed by Invesco Quantitative Strategies (IQS) team can offer. 

Factor evolution



With over 30 years’ experience in this field, we know that nothing is as constant as change. Factor development responds to opportunity and threat. It deals with weaknesses and strengths.

When we look at the opportunities, we constantly see new ideas bubbling up and an incessant stream of new datasets becoming available. 

However, life and markets are not only about opportunities. There are threats too. Other market participants pursuing similar ideas in a number of ways make markets more efficient, so our factors need to subtly evolve to stay ahead of the market.

Data sources and insights that were originally available to only a few have become widespread. Regulatory changes make factors questionable. When companies began to off-set goodwill from acquisitions with their book value, a number of value factors became increasingly unreliable.

At IQS we believe our strengths are not only in the broad global scope of the team, but in our attention to detail. For example, when we evaluate the changing expectations of analysts, we make sure we cannot only identify the firm that is responsible for an estimate, but the individual analyst.

Thus we can identify the changes that may be caused by a change of analyst rather than a change of mind. Similarly, a confident change in mind is much more important than one that lacks conviction – and the two can be told apart.

Ongoing evolution of factors is, we believe, a necessary requirement for any ability to sustain an edge in investment markets today.

We can demonstrate that enhancements to factors add value and that some of the simplest factors that were useful in the past are much less useful today. But this is not limited to factors – all other elements of the investment process need to be regularly evaluated and honed, resulting in steady evolution and progress.

Michael Fraikin is global head of research for Invesco Quantitative Strategies

Find out more

To find out more about the Invesco Perpetual enhanced index funds, which focus on UK, European, US and Global equities, visit www.invescoperpetual.co.uk

Important information

This article is for Professional Clients only and is not for consumer use.

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Where Michael Fraikin has expressed opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco/Invesco Perpetual investment professionals.

Issued in the UK by Invesco Asset Management Limited, Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire RG9 1HH, UK.

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