New factor-based strategies might give index managers a way to replicate active returns, turning up the heat on traditional active managers.
In recent years, investment banks and other firms have developed hedge-fund replication strategies that rely on factor exposures. Now, use of these factors is being extended to traditional money management.
Index providers are trying to make the task easier. MSCI Barra has a fleet of factor indexes that aim to deliver market returns plus exposure to one of five factors: momentum; volatility; leverage; value; and earnings yield. The company has licensed the indexes to BlackRock Inc.'s iShares in the U.S. and to Deutsche Bank's db x-trackers in the U.K.
Meanwhile, Russell Investments teamed up with risk and portfolio optimization specialist Axioma Inc. to produce a series of momentum-based indexes in December. Other indexes might be created based on other factors used in Axioma's models, including value, leverage, size and liquidity. In November, Standard & Poor's Financial Services LLC introduced an index that dynamically allocates between the S&P 500 index and a volatility hedge. And FTSE International Ltd. plans to launch a factor index in March.
State Street Global Advisors, in addition to tracking indexes, also has developed custom systematic strategies for capturing individual factors for institutional clients, said Richard J. Hannam, London-based managing director and European head of passive equity. The firm is running $6 billion in such strategies, which include those replicating the Research Affiliates Fundamental Index benchmarks.
And investment banks are getting in on factor replication, too. Deutsche Bank AG and Morgan Stanley have developed factor-based systematic strategies by creating indexes, then offering swap- and derivatives-based investments off the indexes.
“As clients see the benefit from quantitative strategies that dynamically adjust to market conditions, creating these new investment opportunities continues to be an area of focus for us,” Jo Ninian, London-based vice president at Morgan Stanley, said in an e-mail response to questions. She said the bank would consider selling licensing rights on its indexes, too.