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How style factor investing works

  • Describe how style factors work multi-asset investing
  • Describe how style factors apply to certain asset classes
  • Describe the performance of funds using these strategies
CPD
Approx.30min
How style factor investing works

As with so much of the language used in financial markets, jargon frequently serves to confuse rather than to illuminate.

The cause of the problem is that practitioners sometimes use two different phrases to mean the same thing, or the same phrase to mean different things.

So, to help alleviate this problem, here are some definitions.

Factors are an identifiable source of return and there are two types

Macro: the risk related to an economic environment which persistently explains the return of an asset class, such as growth and equities or inflation and bonds.

Macro factors can be implemented via a long exposure to traditional assets classes and markets.

Style: a characteristic that persistently explains the relative returns within an asset class (carry and currencies or value and equities).

Style factors require long and short exposures to be implemented in their purest form and therefore will almost always use derivatives when it comes to implementation. This is also known as Alternative Risk Premia.

Our experience is that clients frequently initially find this Style Factor approach hard to understand but, when these definitions are used, they realise they know quite a bit about it already.

For example, value investing in equities has been a part of portfolios for over 25 years (Fama and French published research in 1992) and there has been a plethora of articles since.

They will also have been investing in markets using value as a core investment approach for many years, although the precise methodology behind these investments will vary from manager to manager.

Having established a reasonable degree of familiarity, our investors are happy to expand the conversation to include other factors, with the best known being carry, momentum and volatility, while size and quality are also widely used.

Again, our experience shows they are already very familiar with many of these.

What asset classes use this investment technique?

As the original research was focussed on equities, the investment history has its roots in this asset class.

However, it has since expanded into other asset classes such as bonds, currencies or commodities, across broad investment universes, including EM markets.

As a result, investors can now enjoy the benefit of multi-style and multi-asset portfolios, which has opened up a new use for these portfolios.

Is there evidence of demand for this investment technique?

The first investors were large pension funds in the US, Scandinavia and Holland and, as they use segregated mandates to invest in this technique, monitoring flows is problematic.  But we have two sources of data.

The first is a market review by Allenbridge, published in 2017, that estimated total asset of around US$200m, and this survey covered both asset managers and investment banks.

The second source is the AUM of the main managers offering mutual funds in Europe only, it can be seen that assets have grown from under $3.0bn in 2015 to around $15bn today.

CPD
Approx.30min

Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. Why do style factors use derivatives?

  2. What is a style factor?

  3. Which of the following is this style of investing NOT used for?

  4. Absolute return funds have had absolutely no impact on style investing, true or false?

  5. Until 2017, what kind of uncorrelated returns was style factor investing producing against cash?

  6. Most ARP strategies made a negative return in 2018, true or false?

Nearly There…

You have successfully answered all the questions correctly, well done!

You should now know…

  • Describe how style factors work multi-asset investing
  • Describe how style factors apply to certain asset classes
  • Describe the performance of funds using these strategies

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