Factor investing in fixed income has turned to be a better way to manage volatility and diversify portfolios in the current market environment hit by inflation and slow economic growth, says a study.
The seventh annual Invesco Global Factor Investing Study found that 67% of respondents agree that factor investing helped them manage market volatility over the past year, and 64% said their faith in factors grew over the previous 12 months. (Factor investing is an investment approach that involves targeting specific drivers of return across asset classes. There are two main types of factors: macroeconomic and style. Investing in factors can help improve portfolio outcomes, reduce volatility and enhance diversification).
Some 41% of respondents increased allocations over the past year and 39% plan to increase allocations in the next year.
Interviews with 151 practitioners
The study is based on interviews with 151 institutional and retail factor practitioners around the globe managing over $25.4 trillion in assets combined.
According to Zainab Faisal Kufaishi, Head of the Middle East and Africa, and Senior Executive at Invesco, factor investing – a form of investing in which securities are chosen based on attributes (‘factors’) that have tended to offer favourable risk and return patterns over time – has evolved to increasingly become a part of the investing landscape in the Middle East.
“The use of factor strategies continues to rise as regional investors become more experienced and recognise the strength of an alternative approach in understanding the relative performance of their portfolios. Investors see factor investing as a flexible strategy that allows for both short-term tactical implementation during periods of market volatility as well as an enhanced or index-plus approach for long-term strategic allocation against benchmark performance.”
Market turmoil highlights value of factors
Persistent inflation and rising interest rates over the past 12 months have dramatically impacted the investment environment, compelling respondents to re-evaluate their portfolios including factor exposures. Despite these challenges, respondents still generally believe that factors are well-suited to managing risk during market turbulence, with 67% agreeing that factor investing helped them manage market volatility over the past year. A similar number, 64%, indicated their faith in factors grew over the previous 12 months.
Factor allocations continue to rise, with 41% of respondents increasing allocations over the past year and 39% planning an increase in the next year. Only 1% of respondents decreased allocations to factor over the past year. Respondents expect value, low volatility, and quality to be the best performing factors over the next 12 months. A majority (over 80%) believe their factor allocations have met or exceeded the performance of their fundamental active strategies, while 64% indicated their factor allocations met or exceeded performance versus market-weighted strategies.
Georg Elsaesser, Senior Portfolio Manager, Quantitative Strategies at Invesco said: “The confidence in factor-based investment strategies has not only persisted in volatile times but grown stronger as their performance has recovered over the past 18 months.”
Meanwhile, the frequency of respondents reviewing and changing their factor definitions is changing. 41% stated they rarely (every 3-5 years) change their factor definitions, which is down from 66% in 2021. Currently, 43% of respondents are changing their factor definitions frequently (every 1-3 years), up from 16% in 2021.
Respondents look to fixed income factors
This year’s research indicated an increased demand for fixed income factors as bond markets ended a multi-decade bull run. Over 50% of respondents believe the current market environment makes factor investing in fixed income more attractive. Fixed income factors also continued their steady increase in acceptance this year, with 92% of respondents believing factor-investing can be successfully applied in fixed income, a significant increase from 61% in 2016.
Investors generally see fixed income returns as closely tied to fundamental macroeconomic variables. Respondents applying a systematic approach to their fixed income portfolios often initially prioritize traditional macro drivers of return, such as inflation and interest rates, before later incorporating investment factors such as value. This year 54% of respondents said they use both macro and investment factors, and only 14% target investment factors in isolation.
Within fixed income asset classes, respondents are using factor investing the most in government bonds (76%) and corporate bonds (75%), reflecting both the depth and liquidity of these markets as well as the number of products available. Respondents anticipate that factor investing will spread further in fixed income, with a clear majority (71%) believing they will use high yield bonds as part of their fixed income factor exposure in the next five years.
Elsaesser continued: “With the changing landscape for fixed income investments, the need to analyze and risk-manage portfolios through a factor lens has risen substantially. This is especially true in EMEA, where geopolitical risks are being felt strongly.”
Increased application of factors to ESG
Respondents have shown increasing adoption of ESG in their overall portfolios, driven partially by a conviction that such adoption can enhance performance. This conviction has come under pressure over the last year as extractive industries have broadly seen strong returns, reflected in the fall of respondents to 59% from 75% last year, who see enhanced performance as the main reason for ESG adoption.
Notably, while enhanced performance was previously the most commonly cited reason for ESG adoption, this year the top reason was demand from clients and beneficiaries (76% of respondents).
This challenging period for ESG performance is seen by many as creating an opportunity for factor investing. Improved performance is cited by 72% of respondents as the advantage of using factors to help implement ESG and 66% of investors now believe factors can be used to implement their ESG objectives, an increase from 2018 (42%). However, the lack of consensus around methodology remains a barrier to implementation, with respondents’ keen for further research in this area.
Elsaesser concluded: “Factor investing is clearly emerging as a solution to mitigate potential unintended biases from ESG integration in equities, and even more so in fixed income, where the task is more challenging. With ESG especially front of mind in EMEA, this is yet another trigger for re-intensifying demand for factor-based investment strategies.”-- TradeArabia News Service