Yet investors should be careful when investing in factors, said Piré, because passive, smart beta approaches to factors like low volatility and momentum are unlikely to rebalance often enough to capture all of the benefits of holding an allocation to momentum or low volatility.
Though CLS uses some smart beta products in its ETF strategies, Smith agreed.
“We’re always trying to measure the degree of purity of a factor exposure,” said Smith. “What are the other consequences that you’re getting from exposure to a factor? The timing to a rebalance versus the purity of an exposure at a point-in-time, for something like momentum especially, can be a little worrisome. For factors more driven by fundamentals, the information is already there and isn’t really moved by price.”
Other factors operate over such long-term cycles that investors may not have the patience to hold an exposure long enough to achieve its performance benefits.
For example, the value premium has all but disappeared in U.S. equities since the 2008 financial crisis, said Smith, but when investors look across a longer time span, or globally, the benefits of value as a factor still exist.
“When you look at data over a much longer term, you see that the value premium has been persistent and pervasive across markets,” said Smith. “People tend to forget that the value premium takes a while to pay off. If you’re looking at a window of a year, or three years, there’s a lot of research to show that you’re not going to see value magically working over shorter periods of time.”
Smith also described ESG methodologies as risk mitigation for international investing. CLS tends to avoid countries with weak governments.
Seeyond uses a similar method to remove countries with high levels of government intervention or poor corporate governance, said Piré, before appyling a more formal negative ESG screen to weed out specific companies with low ESG scores
“We think about performance in an ESG framework,” said Piré. “Our studies on our own strategies show that if we have this layer excluding ESG worst offenders embedded in the strategy, we end up taking on less risk. There is no drag on performance, and even if ESG doesn’t enhance performance it can potentially be an additional risk management layer in our process that isn’t picked up by the quantitative model.”