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Factor Investing Essay

872 words - 4 pages

Factor Indexes and Investing

Steven Kowal, CFA

Moderator Executive Director Index Business Head of Wealth Advisory Channel Management EMA & India MSCI

What is Factor Investing

A large body of academic research highlights that long-term equity portfolio performance can be explained by systematic factors Some factors represent exposure to systematic risk and have historically earned a long-term risk premium Factor investing is the investment process that harvests risk premia through exposure to factors MSCI currently identifies six risk premia factors - each of which have solid explanations as to why they have provided a premium

6 KEY FACTORS
Low Size Value

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Investment Beliefs 2. Strategic vs. Tactical Allocations 3. Selection of Individual Factors 4. Global vs. Domestic 5. Optimal Allocation 6. Funding of the Factor Allocation 7. Active vs. Passive Implementation 8. Index and Manager Selection (methodology, turnover, transparency, fees, … ) 9. Governance and Operational Risk

Combining Factor Indexes
Factor
Value Momentum Low Size Quality Low Volatility Yield

Risk
Comparable to market Comparable to market Higher than market Lower than market Lower than market Lower than market

Correlation
Low with Momentum and Quality Low with Value, Yield, and Quality Low with Min Volatility, Yield, and Quality Low with Value, Size, Yield and Momentum Low with Value and Momentum Low with Size, Quality and Momentum

Business Cycle
Pro-cyclical Pro-cyclical Pro-cyclical Defensive Defensive Defensive

Factor Allocation

Multi-Factor Investing: Strategic Asset Allocation
   


Smoothing Performance Improved investability Still benefiting from factor outperformance Passive management

European Pension Fund
Objective: Increase risk-adjusted and total return over the cycle 3 regions: North America, Europe ex-Domestic, and Emerging Markets Move 50% of the Equity portfolio over time to 50% Value Weighted/50% Minimum Volatility Implementation is passive through multi-factor indexes

Timing Factors: Tactical
   

Using models to signal entrance and exit Eliminating the need for stock selection Focusing on timing Active management


US Retirement Fund
Objective: To efficiently adjust,...

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