Factor investing isn’t new, but it sort of feels that way because of all the new factor-based investment products—particularly exchange-traded funds—that have been hitting the market of late. Factors are portfolio building blocks that explain the risk and return attributes of the underlying securities. Portfolios can be built that isolate—or combine—various factors including size, value, low-volatility, yield, quality and momentum.


Optimal Asset Management, a registered investment advisor in Los Altos, Calif., earlier this year rolled out the Factor Allocator, a free online tool that helps financial professionals understand their existing factor exposures and the impact they have on investment returns. “We’re targeting financial advisors who are willing to look at more state-of-the-art approaches such as smart beta and factor investing,” says Vijay Vaidyanathan, CEO of Optimal, whose calling card is applying factor investing and technology to the asset management process.  

He notes the underlying theory of factor investing is that any portfolio is driven by a small number of factors, so the investing process can be improved by isolating and harnessing these factors in various ways.

“If you invest in equities, it behooves you to understand where the results are coming from and the factors that are driving it,” Vaidyanathan says. “You can look at hundreds of factors, but we try to simplify things by sticking with the major factors—value, momentum, quality and low volatility.”

Vaidyanathan acknowledges that building software for factor-based portfolios was the easy part. The hard part is explaining to people how to use these portfolios and why they can make a difference.

While factor investing has become a buzz phrase, many investors and their financial advisors still aren’t sure what it means or how it works. “The factor allocator is meant to be a tool to help you visualize and to educate you on investing in terms of factors,” says Charles Stallings, product manager at Optimal Asset Management. “The software will allow you to see how these factors have looked and acted together in the past and how they may going forward.”

The Factor Allocator dashboard contains a comprehensive array of features that enable users to type in the name of any mutual fund in Morningstar’s style boxes. The site performs the analytics on the chosen fund to provide a factor-based composition that lays out what those factors are in the exact ratios.

“We can decompose the fund into factors so you can understand what you bought,” Vaidyanathan says. “So if you bought, say Fidelity Magellan, for example, and you find that the fund includes no low-vol, then don’t be surprised if Magellan underperforms in a down market. Next, if you can see that a fund is nothing more than these four factors in these proportions, do I need to buy that fund? Why don’t I just buy those factors that are available more cheaply?”

Optimal aims to help investors replace pricey, underperforming mutual funds by getting into factor positions via ETFs. But it’s not trying to undercut the mutual fund industry entirely.

“There are many [mutual] funds out there you can repackage as a group of factors and often do it in a better, more cost-effective way,” Stallings says. “But it [Factor Allocator] also is a way to educate investors about [mutual fund] managers who are doing something special.”

Optimal manages about $500 million in institutional money with a factor and smart beta bent. It’s offering Factor Allocator for free so that users can get comfortable with factor-based investing and, the company hopes, ultimately turn to Optimal to handle their investment management needs.
 

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