‘Factor investing beats the market and inflation’

By Supplied Time of article published Sep 21, 2019

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“The future is factor investing” was the theme for the inaugural Satrix conference, hosted in Cape Town and Johannesburg last week. This event focused on factor investing as a solution to optimising outcomes in an increasingly challenging investment environment.

According to Investopedia, factor investing is a strategy that chooses securities on attributes that are associated with higher returns.

There are two main types of factors that have driven returns of stocks, bonds, and other factors: macroeconomic factors and style factors. The former captures broad risks across asset classes, while the latter aims to explain returns and risks within asset classes. Some common macroeconomic factors are credit, inflation, and liquidity, whereas style factors embrace style, value, and momentum, to name a few.

Helena Conradie, the chief executive of Satrix, opened the occasion with a US Open tennis analogy. “Even if you have all the luck in the world, if you face a Federer, Djokovic or Nadal, luck won’t help you; only skill will. Our world is a different ball game. There are only a few factors you can control. It’s a combination of skill and luck We need to scrutinise our portfolios’ exposure to factors and increase the portion that can be explained by skill and not luck.”

Dominant trends in fintech

Fintech entrepreneur Simon Dingle opened with a story of rivalry-turned-respect.

In 2003, Microsoft launched its “Get the fact” campaign to spread misinformation about Linux - an open-source operating system creating a collaborative community of coders. First, Linux was “laughed at” and not perceived as a threat. Then its software proliferated into different niches, gaining credibility, and Microsoft woke up and became worried.

Microsoft’s campaign didn’t work. But Linux also didn’t win the way it thought it would.

Windows has remained the dominant desktop software, while Linux has become the base of today’s Android and iOS operating systems. And it’s also the kernel off which Windows 10 runs.

Windows went from being Linux’s biggest competitor to being one of the biggest global spenders on open-source on the planet. And that, said Dingle, is how innovation goes. “They ignore you. They laugh at you. They fight you. You win. Sometimes.”

Dingle said that today’s tech trends that interest him the most are the ones being laughed at, fought or ignored. He touched on Bitcoin and cryptocurrency, and the evolution of machine learning and Google.

He emphasised that a key difference is the switch in the flow of information. Whereas before we went out looking for information, information now “looks for us”, he said. And we need to find a way of embracing this turn of events.

The next generation of factor investing

Money is in motion, said Peter Weidner, the head of factor solutions at Wells Fargo. Referencing a FTSE Russell smart beta survey, he said factor investing’s adoption has nearly doubled in three years, and the benefits of smart beta are being perceived as multi-dimensional.

Additionally, research shows that over the past 50 years, those who invested in factors would have experienced better performance.

How do we know this success will continue in the future? Weidner said three things drive returns, and successful investors will take advantage of these:

* Behavioural biases. The momentum factor can exploit biases such as herding behaviour (for example, our propensity to buy in the highs and sell in the lows).

* Structural constraints. For example, the low volatility factor. People often buy high-beta, high-risk stocks, which means that lower volatility stocks are less loved, which provides investors with the opportunity to harness the potential offered by these stocks and generate better returns in their portfolios.

* Risk compensation. A factor approach lends itself to investing in a broadly diversified portfolio of smaller and riskier stocks to efficiently exploit this foundational principle of finance.

Does factor investing really work?

Kingsley Williams, the chief investment officer of Satrix, showed that factor investing has added value over time, outperforming the market and inflation. Performing a live demonstration of the newly launched Satrix Factor Tool, Williams showed how portfolio construction can be revolutionised and made extremely transparent.

He showed the magic of blending - combining funds that should intrinsically behave differently - and demonstrated how the tool can reveal what’s driving the strategies of different unit trusts and whether these are being managed according to “what they say on the box”.

Williams delved into the Satrix SmartCore Index Fund, which was launched earlier this year as a South African equity general fund based on a factor investing methodology. The proprietary SmartCore index drives returns through enhanced exposure to the factors of momentum, quality and value. 


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