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In the current market environment hit by inflation and slowing economic growth, factor investing in fixed income has become a better way to manage volatility and diversify a portfolio, according to a study.
The seventh annual Invesco Global Factor Investing Study found that 67% of respondents agree that factor investing has helped them manage market volatility over the past year, and 64% say their confidence in factors has increased over the past 12 months enhanced. (Factor investing is an investment approach that involves specific return drivers for different asset classes. There are two main types of factors: macroeconomic and style. Investing in factors helps improve portfolio outcomes, reduce volatility and enhance diversification ).
Some 41% of respondents have increased their grants in the past year, and 39% plan to increase their grants in the next year.
Interviews with 151 practitioners
The research is based on interviews with 151 institutional and retail factor practitioners around the world who manage more than $25.4 trillion in assets.
According to Zainab Faisal Kufaishi, Head and Senior Executive Officer, Middle East and Africa at Invesco, factor investing is a form of investing in which securities are selected based on attributes (“factors”) that tend to provide favorable risk and return patterns over time— — has developed into a growing part of the Middle East investment environment.
“The use of factor strategies continues to increase as regional investors become more experienced and recognize the advantages of alternative approaches in understanding the relative performance of their portfolios. Investors see factor investing as a flexible strategy that can both Short-term tactical implementation during market volatility, or enhanced or exponential addition of long-term strategic allocations to benchmark performance.”
Market volatility highlights the value of factors
Continued inflation and rising interest rates over the past 12 months have had a dramatic impact on the investment climate, forcing respondents to reassess their portfolios, including factor exposure. Despite these challenges, respondents generally agree that factors are well suited for managing risk during market volatility, with 67% agreeing that factor investing has helped them manage market volatility over the past year. A similar figure, 64%, said their confidence in the factor had grown over the past 12 months.
Feature allocations continue to increase, with 41% of respondents adding allocations in the past year and 39% planning to increase allocations in the next year. Only 1% of respondents have reduced their factor allocations over the past year. Respondents expect value, low volatility and quality to be the top performers over the next 12 months. The majority (more than 80%) believe their factor allocations have met or exceeded the performance of their underlying active strategies, while 64% said their factor allocations have met or exceeded the performance of market-weighted strategies.
Georg Elsaesser, senior portfolio manager for quantitative strategies at Invesco, said: “Confidence in factor-based investment strategies has not only persisted through turbulent times, but has grown stronger as performance has recovered over the past 18 months.”
At the same time, the frequency with which respondents reviewed and changed their factor definitions also changed. 41% of respondents said they rarely (every 3-5 years) change their factor definitions, down from 66% in 2021. Currently, 43% of respondents change their factor definitions frequently (every 1-3 years), up from 16% in 2021.
Respondents focus on fixed income factors
This year’s research shows that demand for fixed income factors increased as the bond market ended a multi-decade bull run. Over 50% of respondents believe that the current market environment makes factor investing in fixed income more attractive. Acceptance of fixed income factors has also continued to rise steadily this year, with 92% of respondents believing factor investing can be successfully applied to fixed income, a significant increase from 61% in 2016.
Investors generally believe that fixed income returns are closely related to fundamental macroeconomic variables. Respondents who apply a systems approach to their fixed income portfolio typically prioritize traditional macro return drivers, such as inflation and interest rates, before incorporating investment factors such as value. This year, 54% of respondents said they use both macro and investment factors, with only 14% targeting investment factors alone.
Within the fixed income asset class, respondents using factor investing the most were government bonds (76%) and corporate bonds (75%), reflecting the depth and liquidity of these markets and the number of products available. Respondents expect factor investing to expand further in fixed income, with an overwhelming majority (71%) believing they will use high-yield bonds as part of their fixed income factor exposure over the next five years.
Elsaesser continued: “As the fixed income investment landscape has changed, the need to analyze and manage portfolios through a factor perspective has risen significantly. This is especially true in the EMEA region, where geopolitical risks are strongly felt.”
The use of increasing factors in ESG
Respondents indicated an increasing adoption of ESG across their overall portfolio, in part because of their strong belief that such adoption can improve performance. This belief came under pressure last year, as the extractive industry generally saw strong returns, reflected in a drop from 75% of respondents to 59% who cited improved performance as the main reason for ESG adoption.
Notably, while improving performance was previously the most common reason for ESG adoption, the top reason this year was client and beneficiary needs (76% of respondents).
Many believe that this challenging time for ESG performance has created an opportunity for factor investing. 72% of respondents see improved performance as an advantage of using factors to help implement ESG, and 66% of investors now believe factors can be used to implement their ESG goals, an increase from 2018 (42%). However, the lack of consensus around the methodology remains a barrier to implementation and respondents are keen to conduct further research in this area.
Elsaesser concludes: “Factor investing is clearly emerging as a solution to mitigate the potential unintended bias of ESG integration in equities, especially in fixed income where the task is more challenging. ESG is particularly strong in the EMEA region. Getting attention is another trigger for renewed demand for factor-based investment strategies.”- arab trade news agency
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