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New Factor Allocator Tool Shows the Value of Factor Investing

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Optimal Asset Management launched a free online tool for advisors called Factor Allocator, which among its many features, helps advisors build factor-based replicas of any mutual fund using ETFs.

“Factor investing is based on the idea that a small number of factors dominate the returns of the portfolio,” Vijay Vaidyanathan, CEO of Optimal Asset Management, told ThinkAdvisor. “What Factor Allocator lets you see is how true that really is, and what the implications of that seemingly simple statement really are to your portfolio.”

Optimal is an asset manager that offers institutional-class factor strategies to RIAs through ETF-based implementations. According to Vaidyanathan, the firm has about $2.5 billion in various factor-based strategies it has built for large pension funds and institutional investors.

In the process of creating these factor-based portfolios, Vaidyanathan said he realized that there was a knowledge gap in factor investing.

“I came to the realization that even the most sophisticated of these users have a hard time wrapping their head around factors, and how you build factor portfolios, and what happens if you have more of this factor or that factor?” he told ThinkAdvisor. “Or even very simple questions like, ‘how much of this factor do I already have? And what would happen if I had less of it?’”

According to Vaidyanathan, the “intuitive, visceral understanding” of what factors do to one’s portfolio is something that Optimal thought people should get their heads around.

“But there wasn’t a tool to help with that,” he said.

So, the firm built Factor Allocator as a way to help investment professionals educate themselves about how to implement factors in their core portfolios. The free software tool also allows them to play around and get comfortable with factor-based building blocks.

“We’re not a software company; we’re an asset manager, but we felt it was really important for people to understand how these factors work and to actually run them against [a large data set],” Vaidyanathan told ThinkAdvisor.

Factor Allocator features more than 20 years of historical factor-based index data from S&P Dow Jones Indices. Advisors can upload their portfolio, or name a mutual fund, and Factor Allocator will deconstruct the S&P factors and identify exactly what factors make up the portfolio.

Factor Allocator includes two special features – “Factor Playground” and “Factor Fit.”

The “Factor Playground” feature provides visual feedback on the impact of various factor choices.

The “Factor Fit” tool helps financial professionals by estimating the underlying mix of factors that drive the returns of a mutual fund, ETF or active manager.

The Factor Fit tool can be used to evaluate whether it might be appropriate to substitute an investor’s mutual fund or active manager holdings with a combination of low-cost ETFs that target similar returns drivers as the mutual fund or other core holding, with the added benefits of scientific diversification and low fees.

Right now approximately 500 advisors have played around with the Factor Allocator tool, and Vaidyanathan has plans to roll the tool out more prominently.

—Check out Smart Beta Strategies More Popular Than Ever and Growing Rapidly: Survey on ThinkAdvisor.