PA ANALYSIS: The innovation to usurp active management

Multi-factor investing is being billed as the next big thing by asset managers eager to continue to weaponise passive management.

PA ANALYSIS: The innovation to usurp active management

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The investing style offers the simplicity and low cost of traditional passive investing, but advocates say it also offers higher return potential and diversification benefits.

With the recent cutting-edge innovation of ‘bottom-up’ multi-factor investing starting to create sophisticated portfolios without the need of an active manager, it seems like a good time to ask if multi-factor investing is the future of mainstream investing.

The biggest innovation to shake up traditional capitalisation-weighted passive investing in recent years has been smart beta, which allows passive investors to up their holdings in shares that are rich in certain market factors they favour.

There is today a panoply of factor-based indices tracking markets around the world to choose from, with common themes including low volatility, value, quality, momentum and others.

A quick look at the iShares website shows it has $3.7bn in its Edge MSCI USA Quality Factor ETF, for example, and $2.7bn in a similar tracker targeting Value shares in the US market.

The beauty of these products is that they are based on simple calculations from widely-available information and so can be managed cheaply – in fact, almost as cheaply as their traditional passive-fund cousins.

Passive investing’s appeal has therefore broadened considerably.

While smart beta gives investors a greater variety of factor choices, it falls short of active because ultimately the investor bears the responsibility of choosing which factor to follow – and that is something most everyday investors would be unlikely to do.

More worryingly, experts warn there is a significant cyclicality in the performance of single-factor smart beta funds. In fact, they can be prone to deep and long-term periods in the doldrums relative to standard indices.

But there may be a solution.

 

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