A new study released Monday by Invesco finds that demand for and adoption of factor-based strategies will continue to climb.

Seventy-one percent of institutional investors surveyed said they expected to increase factor allocations in the next five years.

In addition, 70% of respondents reported that they already used factors in portfolio construction, with risk reduction being the primary motivation, followed by increased alpha and improved diversification.

Half of non-user respondents said they were considering factor capabilities.

NMG, a consultant, conducted in-depth, face-to-face interviews with 66 key decision makers within asset consultants, insurers, pension funds, sovereign wealth funds and private banks globally.

According to Invesco, many respondents said they had made small allocations as part of an initial trial period for factor investing, and expected to increase these allocations as they continue to look for alternative sources of returns in the low-yield environment.

Their responses suggested growth was likely particularly in multi-factor quantitative strategies, internal factor models and fixed income and liquid alternative products.

Tailored Approach Key

The research showed that investors buy into the rationale behind factor investing, which involves selecting securities based on attributes associated with higher returns, such as style, size and risk.

Eighty-three percent of respondents agreed that factors helped explain outperformance.

At the same time, their focus was less on off-the-shelf factor capabilities and more on strategic factor models and a more holistic multi-factor approach that explains all of their factor exposures.

Bernhard Langer, Invesco’s chief investment officer for quantitative strategies, noted in a statement that because of investors’ diverse nature, “the asset management industry needs to consciously address their clients’ needs for a tailored and consultative approach towards the implementation of factor-based strategies.” 

Consider these differences among investors, according to the research:

  • Asian sovereign investors have been the fastest adopters of internal risk factor models
  • German insurers, driven by liquidity requirements and regulatory constraints, are moving away from fundamental investments to smart beta ETFs and equity factor models to improve risk-adjusted returns
  • In the U.K., post retail distribution review, charge caps on default funds and stakeholder engagement have led to growth in smart beta products, and defined contribution pension funds are now using factor products as a more cost-efficient route to diversification.

“Global trends in factor investing are resonating across the U.S. as well, with investors seeking efficient vehicles for yield and risk protection, driving flows into smart beta fixed income strategies and low volatility ETFs,” Dan Draper, Invesco’s global head of PowerShares, said in the statement.

Asset Manager Opportunity

Despite a strong preference for internal control over factor models, investors in the study said a lack of internal capabilities was the greatest adoption barrier.

At the same time institutions said they wanted to control their factor investments, they explicitly requested support from the wider asset management industry, citing training support and consulting advice as the two most effective industry propositions to address their concerns.

There is clearly a call for the asset management industry to show a greater understanding of how investors want to manage and assess factors in their portfolios, and how asset managers can help with this,” said Langer.

“As investors and their investment service providers become more comfortable with factor capabilities, we expect greater separation between assessing and managing factors to emerge as investors realize they can retain control while outsourcing the strategy execution.”

Many investors explained that consultants should be well positioned to be the natural partner — with practical application expertise — for an institution looking to develop a strategic factor-based approach.

According to the study, only 9% of respondents said academic institutions were best placed to assess the role of factors within their portfolio.

Invesco said this was where asset managers could engage in an extended partnership role with institutional investors, offering hands-on support and bringing in global capital markets teams to help with trade execution and liquidity services when needed.

Private banks in the survey said greater use of ETFs, indexing, smart beta and active quantitative products alongside fundamental active management were driving greater cost efficiencies.

“Factor strategies are opening new doors to portfolio diversification,” Draper said, “and we’ve found that — along with growing investor adoption — there is increasing demand for fund providers to demonstrate their holistic understanding of clients’ needs beyond product selection to also recommend practical insights for portfolio implementation.”

— Check out Factor Investing and Risk: The Anomaly of Low Volatility on ThinkAdvisor.