Systematic Equity: An active approach to avoiding the hidden risks of factor investing
Factor investing has emerged as a well-established investment discipline, bolstered by a wealth of academic research that substantiates its effectiveness in achieving excess returns. This approach involves selecting securities based on specific characteristics, or “factors,” such as value, size, momentum, and quality, which empirical studies have shown to be linked with superior performance over time. By systematically targeting these factors, investors can potentially enhance their portfolios and navigate the complexities of the financial markets with greater precision and confidence.
Key takeaways
- Many institutions have turned to factor-investing strategies in search of excess returns over the long run, especially in large, liquid asset classes. But factor-based portfolios also contain hidden risks that may cause results to fall short of investors’ needs and expectations.
- We developed a methodology to better identify those risks: “Time to Outperformance”. This tool allows us to gauge (based on history) how long it takes for any given factor to outperform the broad market with a high degree of confidence.
- While our findings confirm that factor risk premia are real and can benefit investors, they also indicate that single-factor performance can be erratic and inconsistent. Combining multiple factors can reduce these risks, but not enough to produce a more consistent return profile.
- The good news for investors: A holistic approach to factor combination that uses strategic portfolio construction and active management of factor exposures can mitigate inherent risks and significantly enhance information ratios and reduce time to outperformance.
