Index funds – Feature


within an individual portfolio or across plan assets. And a sig- nificant number of pension plans have invested in technology that can help them analyze risk exposures within their portfo- lios,” Murphy adds.


This is a point that resonates with Kjær. “Getting the infra- structure – setting everything up electronically – up and run- ning was hard work, but it has been worth it,” he adds. “If you want to do this in-house, you need to have a strong infrastructure.” However, data in this segment of the market is hard to come by. The managers and investors concerned use their own pro- prietary definitions of the factors used, so it is hard to find information that is directly comparable or consistent. But without doubt, it is an expanding universe. “Investors now have an infinite universe of investment strategies availa- ble to them to match their own unique goals and objectives,” Murphy says.


Test delayed


There are two other interesting points. One is that before the pandemic, when factor investing was becoming all the rage, it was believed that it would be best judged not by inflows while markets are artificially inflated by central banks, but by their resilience when the next big market correction came. “However, that test has been delayed by the unprecedented intervention by central banks in March 2020 following a mar- ket rout,” Rajan says. “It has driven valuations to nose-bleed levels and severely distorted the markets.” Secondly, and equally import, there is no guarantee that a fac- tor’s historical returns will persist. “Factors can become over-


valued as they attract new money,” Rajan says. “Individual fac- tors can be cyclical and underperform over extended periods. For this, look no further than the plight of the value factor over the past decade. Much depends upon investors’ ability to stay the course.”


Need to know


While factor investing can provide a good blend of index and active investing, it should come with disclaimers, Murphy says. “I would argue that there are pros and cons to factor investing and understanding the trade-offs is key before implementing,” he adds. “Plan sponsors and asset owners should be aware as to how factors are being defined, how they interact with other factors within the portfolio and how they may perform in dif- ferent market environments.” The index management business has experienced significant change during the past 20 years which is likely to continue – possibly at a more rapid pace. Index managers are, therefore, at an interesting crossroad, where they will need to adapt and evolve their capabilities to remain competitive. “With so many assets, and so much revenue at stake, [index managers] may well need to find ways to position themselves on multiple parts of the value chain,” Murphy says. “The increased demand for flexibility and scale will force managers to invest in areas such as data extraction, risk modelling and analytics, which need to be provided at a reasonable fee level for the investor.”


Index managers will need to become part asset manager and part software developer if they want to be successful


in the new world order. Shaun Murphy, Polaris Global Advisors


Instant access Technology will inevitably play a huge part in how this can be achieved. Tools that portfolio managers use may also need to sit on a client’s desktop, Murphy says, so they can instantly access their assets as well as helping them to feel more inte- grated into the investment process. “Index managers will need to become part asset manager and part software developer if they want to be successful in the new world order,” Murphy says. This in turn is likely to mean more developments in the index funds space. So how should investors approach this evolving landscape? “I would advise an investor to try to understand the design of the index funds they are looking to invest in,” Murphy says. “This will mean looking for index funds that are transparent in their methodology, which will help predict what outcomes could look like in different economic environments. “And make sure the asset owners investment staff and espe- cially trustees are comfortable with the linkage between their goals and objectives and the index funds utilised,” he adds. If done, then the commitment can be worth it, Kjær says. “We wouldn’t be where we are today if we hadn’t taken this journey.”


Issue 111 | March 2022 | portfolio institutional | 47


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