Factor ETFs continue to grow in popularity, finds Invesco

Oct 23rd, 2020 | By | Category: ETF and Index News

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Institutional and wholesale investors are increasingly turning to ETFs to implement factor strategies, according to research by Invesco.

Georg Elsaesser, Senior Portfolio Manager, Quantitative Strategies at Invesco

Georg Elsaesser, Senior Portfolio Manager, Quantitative Strategies at Invesco.

The fifth Invesco Global Factor Investing Study surveyed 238 different pension funds, insurers, sovereign investors, asset consultants, wealth managers, and private banks globally, collectively managing over $25 trillion in assets under management.

Interviews were conducted in April and May of 2020 against the backdrop of the Covid-19 pandemic and peak volatility.

The research found that two-thirds (67%) of wholesale respondents use ETFs to implement factor strategies, up from 63% in 2019. Those who use ETFs deploy half (50%) of their factor allocation through the vehicle on average.

Wealth managers showed a significant preference for ETFs which accounted for three quarters (74%) of their factor allocation, while private banks attain around a third (35%) of their factor allocation through ETFs.

Looking at institutional investors, 60% of respondents use ETFs to implement factor strategies now, compared to 53% last year. The average allocation deployed through ETFs was relatively lower, however, at 14% of the overall factor portfolio – ETFs accounted for almost a quarter (24%) of defined contribution pension funds’ average factor allocation, 17% for defined benefit schemes, 11% for insurance firms, and 9% for sovereign wealth funds.

Across both institutional and wholesale investors, factor ETFs were used by 77% of respondents from North America, 63% from Asia Pacific, and 45% from EMEA.

Liquidity (77%) was cited by institutional investors as the main advantage of using ETFs, followed by transparency (51%) and tactical factor tilting (47%).

For their wholesale peers, fees (71%) were the dominant factor, followed by ease of use (64%) and then liquidity (52%). The least important for both segments was using ETFs as a single point of access for specific or multiple factors.

Georg Elsaesser Senior Portfolio Manager, Quantitative Strategies at Invesco, said, “For respondents investing in factor strategies based on passive indexing strategies, ETFs are particularly valued for their ease of use and price. For these types of enhanced or ‘smart’ beta applications, investors reported being attracted to transparent, rules-based products.

“ETFs are seen as a good tool for building a portfolio and managing risk, particularly when viewed against the more limited option of market-cap-weighted products. The growing depth of ETF products on offer, including the supply of multi-factor products, was seen as important in helping with this advance, making factor investing more accessible to a wider range of investors and allowing factor strategies to fulfill more diverse portfolio objectives.”

Factor performance

Roughly two-thirds of both institutional (65%) and wholesale (67%) investors reported that their factor allocations met or exceeded their overall performance expectations leading up to the study. According to data from MSCI, as of March 2020, momentum, quality, and low volatility factors generally outperformed the global equity market over the previous 12 months, while value and size factors underperformed.

Despite a third of respondents being disappointed with the performance of their factor portfolios, only 3% of those surveyed indicated that they plan to reduce their allocation to factor strategies over the next 12 months.

Elsaesser said, “Factor strategies have performed as expected, even considering the peculiar conditions and lower returns for some factors over the past couple of years, and sentiment towards factor investing has remained very positive. Factor investing is here to stay and is being increasingly adopted by more investors of every size. It is important to stress that factor investors are long term, whose belief that factor premia results in excess return over the long run underpins a sense of pragmatism in the face of short-term volatility.

“For instance, while the previous decade has been difficult for investors in the value factor, this edition of the study finds that most investors remain committed to the value factor, believing its run of underperformance as a temporary phenomenon”

Factor investing and fixed income

Notably, belief in the applicability of factor investing to fixed income was found to be close to universal, having increased to 95% from around 60% in 2018. Investors cited the potential for a factor approach to bring more transparency to the market overall, as has been the case with equities.

This was also reflected in growing levels of adoption with 40% of investors already using factors in fixed income and more than a third (35%) actively considering introducing it, alluding to the opportunity for product developers.

Factor investing and ESG

Environmental, Social, and Governance (ESG) investing continues to grow in prominence with a majority of institutional (84%) and wholesale (71%) investors now having an ESG policy in place. Similarly, 83% of institutional investors and 69% of wholesale investors are already incorporating or considering incorporating ESG into their factor portfolios.

For North American investors, improving returns ranked alongside controlling risk as the main motivations for incorporating ESG, each cited by 85% of investors from that region. In contrast, stakeholder requirements, cited by just 44% of North American respondents, were top priority for 80% of EMEA investors.

Elsaesser added, “Looking forward it is likely that ETFs will play an important role in the ESG space. More recent ESG adopters often lack experience and face implementation challenges and are eager for simple, cost-effective solutions.

“In addition, ETFs do not necessarily have to be passive only, they can also wrap truly active investment strategies and tailored solutions for instance in order to establish customized ESG integration including enhanced reporting.”

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