PI: How are institutions using factors? Yvette Murphy: They are using them to understand their current investments, more so than they did in the past. That has prompted a general awareness of the factors inherent in active strategies, what the total exposure is across multiple equity allocations and a better understanding of risk metrics. We have been seeing, certainly in the conversations that I have had with clients, a lot more decomposing through the lens of factors. We are also starting to see big pension plans in the US incorporating factor benchmarks into their global policy. Whether there is a recognition that these are part of the opportunity set now or whether there is a dollar allocation, they are incorporating these themes into their governance framework. This helps contextualise another managers performance. David Barron: The industry has done a good job of tripping itself up in this space. Academic research said that factors can do something for your portfolio and so there was a mass rush to create product. We are finally making this objective-based by asking the client what they want to achieve. We approach factor meetings by saying: “Market cap’s not broken, it does exactly what you want it to do and it’s low cost, it’s transparent and it delivers benchmark return. It is fit for purpose if that’s your objective, but factors are another way of thinking about diversifying your portfolio.” The challenge for asset managers is that it is potentially the end of pooled funds, which is a trend we are starting to see. Clients have choice, they don’t want too much value, or they want low volatility, so no investor’s experience is the same and so we are tailoring our offering to the needs of a client. Erik van Leeuwen: Only 10% to 15% of factor investing is fixed income. There are 50 years of academic research in equities, but in fixed income the research only extends 15 to 20 years. We started doing our fixed income factor research in the late ‘90s but that’s still pretty recent compared to equities. We have seen a similar pattern in products coming to the market. There is a lot of interest. We have equity experts joining our fixed income meetings because they know which factors work on the equity side and are transferring that knowledge into fixed income. Scott: Is this in the UK?
Leeuwen: It’s worldwide. Pension funds, sovereign wealth funds and some wholesale funds have started to adopt it. Scandinavia, the Netherlands, the UK and Germany are quant oriented as are Australia, the Middle East and Singa- pore. In the US they are aware of the factor equity story, but in fixed income it is still relatively early days. Data and academic research are sparse, that’s why it takes time for people to understand that there is also an eco- nomic rationale for factor investing in fixed income. You can show empirical data, but it easily takes two or three years for people to get comfortable with it, which is understand- able and reasonable.
PI: Is factor-based investing in fixed income just about generating alpha? Leeuwen: The main goal is diversification. We wouldn’t say that factor investing is better than fundamental investing. But if you look at how fixed income assets are managed on the credit side, it’s a 99% fundamentally driven market. When we analyse global fundamental managers, there is typically quite a strong correlation between them. In fact, regardless of domicile, a 20% or 30% correlation is not unusual.
Factor investing is a different way of creating alpha. It is active management; you are trying to harvest alpha but
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