They say they want a revolution

The way market participants are investing is changing rapidly for many – on one side we see an increasing need for reduced costs, and on the other, value added is becoming ever more important.

We live in interesting times in financial markets. Changing investment needs are leading to a shrinking share of wallet for so called closet indexers and weaker asset managers that continue to disappoint. At the same time the most successful traditional asset managers are probably at least maintaining their assets and factor based and passive strategies have experienced strong growth. The key agents of this revolution are regulatory changes, client pressure, asset managers desire to meet new needs and last but not least, academia, and consultants.

Not active, not passive, but a new era

In this environment a previously bifurcated world of active and passive management has become even more complex as factor based investing combines aspects of what were clearly demarked as opposing camps and can be thought of as the third pillar. This throws up lots of opportunities for providers and clients to define new needs and how to better meet them. For the Invesco Quantitative Strategies team an example of strategies for this new era are the Invesco Perpetual Enhanced Index funds.

This new era is not as straight forward as it seems – but help is on the way

Factor based investing has emerged as one of the key developments in equity markets and beyond. But unlike equities, regions, or sectors or even themes they seem strangely intangible and are subject to interpretation. Whilst, say, UK equities are – at least at first glance and superficially – clear, Value lies in the eyes of the beholder as does Momentum, Size, Quality, or Volatility. For us a factor is a quantifiable characteristic of an asset that is typically associated with risk and often return. But this is just where the art and science of it are beginning. Whilst it is clear today the definitions and thoughts are still in flux, the understanding and appreciation are increasing.

Why do we expect a return from factors?

This is a key but often underappreciated question. We expect returns from factors for primarily three reasons: as a reward for bearing a risk; because of a behavioural issue; or as a consequence of market structure. These rationales are not mutually exclusive – a particular factor can tap into different aspects. It is also worth noting that the past is not necessarily a guide to the near or distant future and that market structure and human behaviour change. One of the key aspects of earning a reward for risk is that the risk can be thought of as poor returns at inconvenient times. This naturally means that it would be great if those inconvenient times could be identified beforehand – a notion that is now known as factor timing.

How many factors are there and how we combine them?

To an extent the question of how many factors there are is a very tricky one. Academic thought at one point argued for one – the market factor – but then proceeded to identify value, size, and momentum as additional factors and as it has become fashionable to identify new factors over 300 have been “found”. Some of which are as different from each other as beetle species distinguishable only with the help of a microscope. Analysing the returns of major factors, we find that Momentum and Quality/Value are key underlying drivers. We believe that for many intents and purposes multi-factor approaches are superior to single factor approaches and to combinations of single factor approaches which nevertheless also have their place.

All together now – it is about the team

Our investing style is team based not only as far as the people who run the process are concerned but also and in a less literal sense as far as the factors we employ. It is about growing, different perspectives, contribution, and evolution.

Important information

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.

For the most up to date information on our funds, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the ICVC ISA Terms and Conditions, the Annual or Interim Reports and the Prospectus, which are available using the contact details shown. For details of fund specific risks, please refer to the relevant Key Investor Information Documents.