Two major themes in asset management – factor-based investing and ESG – are causing more institutional and wholesale investors to make asset allocations using ETFs.
Although each theme has its own driver for making ETFs attractive, there could be a “helpful symbiosis” between factor investing and ESG, fund manager Invesco found.
Transparency was key among them.
Invesco found that investors managing active factor-based strategies were in some cases using ETFs rather than swaps or other derivatives executed via an investment bank. Transparency about returns was a reason. But for some investors this was being driven by the additional transparency demands of new or enhanced ESG policy thresholds.
Invesco said some 64% of institutional and 47% of wholesale investors perceived a helpful symbiosis between factor adoption taking place in parallel with ESG adoption. This is because investors believe that incorporating ESG in factor models could help manage short term downside and gain greater upside over the longer term.
However, Georg Elsaesser, a senior quant portfolio manager at Invesco, said: “While ESG and factor investing are becoming increasingly integrated, the concurrent adoption of both appears to be causing challenges for some investors that used to implement them independently of each other. This is especially true as many factor products are not ESG integrated, and most ESG products are not factor strategies.”
The findings are based on interviews with 138 institutional and 100 wholesale factor investors who managed over $25 trillion in assets.
A broader finding was that investors think bond portfolios could benefit from tapping into investment factors that usually apply to equities. The belief that investment factors can benefit bond portfolios has gained wide acceptance, jumping from 59% last year, to 95% this year.
Investors feel alpha generation is made more transparent in factor-based investing due to the rules-based approaches that underpin them and which tap into ‘factors’ such as momentum and value.
Elsaesser said: “The relatively high proportion of respondents either investing in fixed income via factors, or considering their introduction, points to the appeal of more systematic approaches to the asset class.”
Most institutional investors now make use of ETFs in factor investing, said Invesco. ETFs account for an average of 14% of their factor portfolios.
In the wholesale segment more than two thirds of investors make use of ETFs, accounting for half of factor portfolios overall, while for wealth managers ETFs are usually the primary vehicle for gaining factor exposure, making up three-quarters of the average factor allocation.
Traditional ETFs are valued for passive factor allocations due to ease of use and pricing. Smart beta ETFs gain supporters for rules-based approaches that may better meet risk-return objectives than market-weighted allocations.
Elsaesser added: “Looking forward it is also likely that ETFs will play an important role in the ESG space. More recent ESG adopters often lack experience and face implementation challenges and are eager for simple, cost effective solutions. In addition, ETFs do not necessarily have to be passive only, they can also wrap truly active investment strategies and tailored solutions for instance, in order to establish customised ESG integration, including enhanced reporting.”
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