you were going to do but trustees look at results and say: “Here’s the market cap result and here’s your result and we are paying you more money.” Is that a risk that you analyse? Murphy: We look at any performance deviation, positive or negative, to make sure that it is consistent with our expectations. We keep a pulse check on several strategies that are similar by name and objec- tive, but not necessarily by outcome. Particularly with underperformance, we want to understand these drivers, and whether it’s driven by the factor exposures targeted as opposed to unintended outcomes influencing performance. Peach: When building a factor or a multi-factor portfolio you want to make sure that you are getting the exposures you expect and not unhelpful ones that are working against each other. There are a number of ways of achieving that with appropriate index construction. Murphy: We have been doing more research on the implementation properties of factor strategies, mov- ing from academic factor definitions or portfolio construction techniques to looking at the relationship between exposure, risk and cost. If you have a portfolio that includes emerging markets, how do you calibrate allowable positions in less liquid countries such as Malaysia? Even if that Malaysian stock has great factor characteristics, is will likely cost a significant amount to trade. These trading costs may erode any premia that was harvested. Things like turnover and other capacity issues are starting to be built into portfolio design research. Leeuwen: On implementation in fixed income, there are a lot of similarities when it comes to risk. In credit you don’t have the upside; you only get downside, so diversification is key. Risk here is two dimensional. It’s not only versus the index but also absolute risk. We would rather have equally rated portfolios independent of how big the issuers are in the index as, from a trustee perspec- tive, it is a better composition of a portfolio. Where you see the biggest difference versus equities, is liquidity and the availability of bonds. Life is easy for equity investors because once you have the modelling and a wish list, you know you can trade all equities. You can undertake different types of program trades and see how to achieve a lower transac- tion cost, but at least you know you can buy everything. However, liquidity in credit is sparse. This must be built in from the research in the beginning. If you assume that you want to buy the top 20 names and you assume that you can buy all of them, then you are overstating the available factor exposure. In practice you are happy if you find half of the bonds and at a reasonable transaction cost. Implementation is key. Because liquidity is sparse you should be aware that once you start implementing you need keep turnover low. You need to be mindful of where you can find broker access and implement these names. We are often asked if we can create factor indices in fixed income. Our stance so far is that you can’t. If you want to create these indices in fixed income you risk creating indices which have a lot of turnover, high transaction costs and names that look good, but you can’t be tracked, or you must build complex indices, which are less transpar- ent.


For us, if you want to harvest factor investing in fixed income or credit you need to apply an active strategy where you buy attractive names and hold them for a long time. The translation from research into how to realise good results in prac- tice is still something where there’s a lot of skill needed. Trow: That has fundamentally changed the way we look at a credit portfolio. We used to aim to turn it over regularly, but the secondary liquidity’s just not there to manage a crisis. If you put something into any strategy you have to love it because you are going to have a prob- lem getting out of it.


September 2019 portfolio institutional roundtable: Factor investing 17


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