Facing the prospect of an extended low-return environment, increasing numbers of asset owners are refocusing their portfolios on risk factors, rather than asset allocation.
Institutional assets invested using MSCI Inc.'s factor-based indexes totaled $123 billion as of March 31, up 29% from a year earlier.
Industrywide investment in factor-indexed approaches was an estimated $400 billion to $500 billion as of March 31. That's up from $100 billion to $150 billion as of the same date in 2013 and $10 billion to $15 billion in 2011, MSCI estimated.
Assets in risk-factor investing might be only a drop in the bucket compared to total global institutional assets. But total assets invested using the approach - a significant proportion of which is from institutions — increased more than 30-fold in the five years ended March 31, noted Brett Hammond, MSCI's managing director and head of fixed income and multiasset applied research, based in New York.
Factor-based investing assumes that risk premiums — the return resulting from holding assets that carry risk — can be identified by a wide array of factors beyond simple equity market risk.
Once identified, investment managers capture those risk premiums systematically through passive factor-based replication strategies or through portfolio construction based on a combination of risk factors.
Often termed smart beta by marketers, the investment approach combines market beta and alternative risk premiums culled from a wide range of risk factors, including value, size, momentum, value, low volatility and quality.
Consultants said a large and growing group of quantitative, passive, hedge fund and other alternative investment managers have jumped into factor-based investing or are significantly beefing up their capabilities because of growing client demand.
Laurence D. Fink, chairman and CEO, BlackRock Inc., New York, for example, said in an April 16 earnings call that his firm has seen increased interest among institutional and retail clients for factor- or model-based investing.
“We've had more dialogue on our model-based, factor-based products (now) than we've had in five years,” said Mr. Fink on the call.
“This is an area I believe is finally going to see accelerated growth.” (BlackRock on April 30 announced the launch of five factor-based exchange-traded funds through its iShares division.)
BlackRock managed $4.774 trillion as of March 31. Of that, $129 billion was managed in smart beta strategies.