Factor investing is growing in popularity as portfolio managers strive to beat the returns of index investing, but it's an investment style the requires patience, according to three investment strategists.
The key to making factor investing work, they added, is making it mesh with an investor’s time horizon and portfolio objectives.
“Any single factor can underperform for a while, so you need to be committed to maintaining exposure to the factor in order to benefit,” David Koeing, investment strategist for research and innovation at Russell Investments, said during a panel discussion at a Morningstar ETF conference in Chicago yesterday.
“This is more a strategic investment and not tactical,” he added.
Factor investing focuses on segments of the market that drive returns rather than traditional sectors such as emerging markets. In equity investing, examples of factor segments could include hard-to-define features such as quality, momentum or low volatility.
Members of the Morningstar panel said focus investing requires patience.
Christopher Huemmer, a vice president at the Northern Trust Company responsible for equity strategy in Northern Trust Global Investments’ Exchange Traded Fund Group and investment strategy for the firm’s FlexShares ETF products, said factors can be cyclical, exemplified by periods of large-cap stock underperformce.
While factors can drive investment results, determining how they work is trickier, said Daniel Morillo, managing director, head of research and co-head of model portfolio solutions at iShares.
“We can’t observe behavior,” he said, so it’s hard to judge how much behavior influences factors like momentum, for instance.
If strategists knew exactly how factors work, the factors would be arbitraged away eventually, anyway, Koenig said. There’s a debate on why factors exist and “the fact that there’s an ongoing debate supports the long-term potential that the markets will continue to show these characteristics,” he added.