Factor Investing in Practice: A Trustees' Guide to Implementation
Forthcoming in Journal of Portfolio Management
Posted: 7 Feb 2014 Last revised: 2 Feb 2016
Date Written: February 6, 2014
Factors represent certain parts in the market, which are more attractive in the long term than other parts. In the case of equities for example, leading academic studies demonstrate that momentum, small cap and low-volatility stocks systematically generate higher risk-adjusted returns. Factors can also be applied in other asset classes such as bonds. Strategically allocating toward factors is called factor investing.
The prospect of higher risk-adjusted returns is obviously appealing to institutional investors. Many are investigating the opportunities provided by factor investing. This leads to a new question: how can factor investing be embedded in the investment management process?
In this study, our focus is therefore on the practical aspects. We analyze how pension funds and other institutional investors: - can implement new insights concerning factor investing; - work with the factors that drive asset returns as a portfolio construction tool; - change the investment models they use; - learn from peers that have already taken the steps towards implementation.
We also review hurdles of the implementation process and analyze the reasons behind them. Our findings are translated into a checklist for implementing factor investing. We find that three approaches to factor investing are emerging and we discuss case studies to examine how these approaches are implemented and correspond to our checklist.
A point about our relationship with Robeco. Robeco considers factor investing as essential for its institutional and other professional clients. It does extensive research on this matter and supports external research. This external research is not limited to the theory, but includes the challenges investors face when implementing research findings. Therefore, we were given the assignment to write this research report.
Keywords: Factor Investing, Regulatory Perspectives, Checklist, Case Studies
JEL Classification: G11, G12, G15, G23
Suggested Citation: Suggested Citation