The Drivers and Inhibitors of Factor Investing

68 Pages Posted: 10 Dec 2019

See all articles by Dunhong Jin

Dunhong Jin

The University of Hong Kong - Faculty of Business and Economics; University of Oxford - Said Business School; University of Oxford - Oxford-Man Institute of Quantitative Finance

Date Written: November 22, 2019

Abstract

I model the equilibrium asset allocations when households can invest directly, search for factor (smart-beta and ETFs) investments or fundamental (stock-picking) investments. Managers endogenously choose to specialize in factor or fundamental information given the equilibrium fee structure. Fundamental managers can opt to be opportunistic “closet indexers.” I show that wealth inequality increases demand for factor investing: fundamental investing attracts the wealthiest households, who are more willing to detect closet indexing. Fundamental managers have to compete more aggressively through information acquisition, which lowers their excess returns and thus delegation fees. The reduced fees earned by fundamental managers force factor managers to lower their fees, making factor investing more attractive. However, the equilibrium fraction of capital allocated to factor investing can never reach 100 percent: the ceiling is determined by the endogenous level of opportunism in the fundamental investment industry.

Keywords: Asset Management, Indexing, Wealth Inequality, Capital Allocation, Information

Suggested Citation

Jin, Dunhong, The Drivers and Inhibitors of Factor Investing (November 22, 2019). Available at SSRN: https://ssrn.com/abstract=3492142 or http://dx.doi.org/10.2139/ssrn.3492142

Dunhong Jin (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

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