Alessandro RUSSO, Head of Factor Investing at Amundi
Leslie TEO, Director of the Economics and Investment Strategy Department and Chief Economist at GIC Private Limited, Singapore
Moderated by: Adrian DEARNELL, Financial Journalist, Founding Partner of EuroBusiness Media
At the top of the discussion the panel established a clear definition of factor investing. Alessandro Russo explained: “A factor may be a fundamental characteristic of an asset. Think of a stock being a higher than average dividend or a small-cap, or experiencing very strong recent performance. This kind of characteristic explains over the long run some component of the total performance, and over the short- run, some deviation, some fluctuation around the market return. The factor could also be a macro-economic variable, like increasing growth with a beneficial effect on equities, or decreasing growth with a beneficial effect on bonds, or increasing inflation with some positive impact on commodities, inflation-linked bonds.”
A factor is, in short, a performance driver, meaning that the investor investigates, detects those performance drivers, establishes a relationship between factors and assets, and then builds a portfolio using an asset.
Leslie Teo agreed, but gave a more granular definition: “Factors drive performance. But just in physics when we talk about matter, there are many levels to factors. With matter, we talk about molecules, atoms, protons and neutrons. We can even go further, going down to the level of quarks and string theory. It is the same with factors. At the very broad level, we might have the equity risk premium and the equity factor and then less traditional, maybe less emphasized levels, like carry, size and momentum. Therefore, my interpretation of factor investing is an investment process to harvest these more non-traditional, non-conventional premiums, like carry, momentum, quality, and size, for example.”
Factors Versus Smart Beta
There has generally been some confusion about the difference between factors and smart beta. Mr. Russo said that the two concepts are very strictly linked, but do not perfectly overlap. “We believe that smart beta somehow is a broader concept. Factor investing is part of the story. It is mainly a beta story, because it recognizes that you have additional beta compared to traditional equity bonds and commodity data. It is already smart because it widens the set of opportunity, but the smart side of the equation is mainly related to how you build portfolios,” he explained.
Providing a concrete example, Mr. Russo continued: “Imagine you want to invest the value premium in the equity. You are going to buy value stocks, but then if you weight those stocks by market cap, you just have a value portfolio. If you, on the other hand, you weight those stocks to minimize volatility, minimize average correlation, or ease contribution to risk, now you have a smart value portfolio, because you have smart portfolio construction in it.”
Implementing Factors Across Asset Classes
We believe that the corporate and government bond spaces are a good environment to play the broader beta concept
Mr. Teo spoke of the investment model he uses in his work – a model built on six broad market factors to which he cultivates exposure: three types of equities, two types of interest rates, and real estate. “If you like, you could say that these are still not fundamental, but they are exposed to more elementary factors like growth, interest rate or duration, and illiquidity, but the challenge here has always been that the more fundamental you get, the more difficult it is to access the market,” he said.
This broad construct allows for the decomposition of every investment made, so that each investment can be expressed as a combination of these market factors. “It enables us to have a governance structure that is at the top of the house, controlling the overall risk of the organisation, but delegating a lot of freedom to management. We don’t have to worry about asset classes, or about specific investments,” he explained.
On the corporate bond markets and fixed-income universe, Mr. Teo clarified that, while he agrees with Mr. Martellini on the theory of risk premia (See Interview above), he sees three nuances: “First, regarding corporate bond size, because they are a combination of normal bonds and equities and corporate spreads have an equity-like behaviour, we think it is closely related to equity in terms of the risk premiums that we can harvest. Second, fixed income, by which I mean sovereign bonds or safe and liquid paper that you hold for liquidity and safety, represents a practical problem: why would we apply factor investing with an asset class that is meant to be your safety and liquidity pocket? It can complicate life tremendously. And finally, it is possible that for some factors, FX-based is the most liquid.”
Mr. Russo took a different tack, saying that in his experience, factor investing is mostly a question of equity. “We believe that the corporate and government bond spaces are a good environment to play the broader beta concept, because indices are not really well-designed, because they have exposure to very high debt securities, because they weight securities for the size of the debt, which is very good for liquidity, but still few have overexposure to high debt, so we can do better by weighting securities by other variables,” he said.