Do Institutional Investors Manage Factor Exposures Strategically?
66 Pages Posted: 6 Sep 2019
Date Written: September 1, 2019
Do institutional investors manage factor exposures at the asset class level strategically? This is a key asset and risk management question because factor exposures significantly contribute to return and risk. We answer the question by an empirical assessment of (un)conditional factor exposures of large institutional investors using proprietary data on occupational pension plans. The answer depends on the asset class. Based on two key findings we claim that pension funds manage equity factor exposures strategically. First, value, momentum, carry, and low beta factors contribute significantly to cross-sectional heterogeneity in unconditional equity returns. Second, time variation in conditional factor exposures for equities is limited. By contrast, support for strategic decision-making in fixed income factor exposures cannot be found. Market exposures drive the heterogeneity in unconditional fixed income returns, and the time variation in conditional factor exposures is much larger than strategic decision-making suggests. The average fixed income factor exposures can get as low as -0.6 and as high as 0.8. We also find that exogenous events and pension fund characteristics influence factor exposures through regulations. A high funding ratio and a high fraction of retirees to total participants lowers market exposures and increases exposures to credit risk, carry, and low beta. Furthermore, size does not influence factor exposures while delegated asset managers do.
Keywords: factor exposures, institutional investors, portfolio risk, regulations, returns
JEL Classification: G11, G23
Suggested Citation: Suggested Citation