Stephen Quance
Invesco has released the findings of its seventh annual Invesco Global Factor Investing Study. The Study is based on interviews with 151 institutional and retail factor practitioners managing over US$25.4 trillion in assets combined.
This year’s study found respondents expect factor-based strategies to outperform in an inflationary environment with slow economic growth. Respondents also believe the current market environment makes factor investing in fixed income more attractive as a better way to manage volatility and diversify portfolios.
Market turmoil highlights value of factors in managing risk
Persistent inflation and rising interest rates over the past 12 months have dramatically impacted the investment environment, compelling respondents to re-evaluate their portfolios including factor exposures. Despite these challenges, respondents still generally believe that factors are well-suited to managing risk during market turbulence, with 67% agreeing that factor investing helped them manage market volatility over the past year. A similar number, 64%, indicated their faith in factors grew over the previous 12 months.
Meanwhile, factor allocations continue to rise, with 41% of respondents increasing allocations over the past year and 39% planning an increase in the next year. Only 1% of respondents decreased allocations to factor over the past year. Respondents expect value, low volatility, and quality to be the best performing factors over the next 12 months. A majority (over 80%) believe their factor allocations have met or exceeded the performance of their fundamental active strategies, while 64% indicated their factor allocations met or exceeded performance versus market-weighted strategies.
Stephen Quance, Global Director, Factor Investing at Invesco, commented, “The fact that investors actually increased their support and exposure to factor strategies through this latest global bear market cycle speaks to how comfortable and confident they have become with a factor approach as a pillar of investing alongside active and passive. This is a trend we have seen across geographies including Asia Pacific where factors can systematically target specific outcomes in a risk-off, rising rate environment.”
Meanwhile, the frequency at which respondents review and change their factor definitions is evolving. 41% stated they rarely (every 3-5 years) change their factor definitions, which is down from 66% in 2021. Currently, 43% of respondents are changing their factor definitions frequently (every 1-3 years), up from 16% in 2021.
Respondents looking to fixed income factors for new sources of return
This year’s research indicated an increased demand for fixed income factors as bond markets ended a multi-decade bull run. Over 50% of respondents believe the current market environment makes factor investing in fixed income more attractive. Fixed income factors also continued their steady increase in acceptance this year, with 92% of respondents believing factor-investing can be successfully applied in fixed income, a significant increase from 61% in 2016.
Investors generally see fixed income returns as closely tied to fundamental macroeconomic variables. Respondents applying a systematic approach to their fixed income portfolios often initially prioritise traditional macro drivers of return, such as inflation and interest rates, before later incorporating investment factors such as value. This year 54% of respondents said they use both macro and investment factors, and only 14% target investment factors in isolation.
Within fixed income asset classes, respondents are using factor investing the most in government bonds (76%) and corporate bonds (75%), reflecting both the depth and liquidity of these markets as well as the number of products available. Respondents anticipate that factor investing will spread further in fixed income, with a clear majority (71%) believing they will use high yield bonds as part of their fixed income factor exposure in the next five years.
Stephen Quance commented: “The evolution of factor strategies in fixed income illustrates the continuing evolution of the segment overall. Without a tailwind of falling interest rates, the importance of factor exposures may increasingly explain deviations in results.”
Increased application of factors to ESG
Respondents have shown increasing adoption of ESG in their overall portfolios, driven partially by a conviction that such adoption can enhance performance. This conviction has come under pressure over the last year as extractive industries have broadly seen strong returns, reflected in the fall of respondents to 59% (from 75% last year) who see enhanced performance as the main reason for ESG adoption. Notably, while enhanced performance was previously the most commonly cited reason for ESG adoption in factor investing, this year the top reason was demand from clients and beneficiaries (76% of respondents).
This challenging period for ESG performance is seen by many as creating an opportunity for factor investing. Improved performance is cited by 72% of respondents as the advantage of using factors to help implement ESG and 66% of investors now believe factors can be used to implement their ESG objectives, an increase from 2018 (42%). However, the lack of consensus around methodology remains a barrier to implementation, with respondents’ keen for further research in this area.
Stephen Quance concluded: “ESG adoption continues to increase in Asia Pacific to the point where it is now a discussion topic in most client conversations. Many regional clients have even set their own ESG targets. Investors in the region are keen to understand the potential impact of these targets on the risk and return of their portfolios, which is where factor analysis and implementation can serve to counter any unintended biases.”