By Georg Elsaesser*

IN recent times, factor investing has emerged as a third pillar of investing alongside traditional stock picking alpha-strategies and market cap-weighted passive. Investing across these three pillars is not a question of right or wrong, but rather of making the best possible choice from a broad set of opportunities for investors seeking to achieve their individual return/risk targets.

With factor investing, investors look to improve risk and return expectations for their portfolios by targeting specific performance characteristics of a security. A factor can be thought of as any characteristic of a financial asset that is an important determinant of its risk and return. Whether value, size, momentum, volatility, quality or dividend yield - each of these factors plays a role in the performance of an investment.

It is no surprise that factor investing is growing rapidly as an investment strategy, complementing traditional alpha-seeking strategies and passive-investing strategies. Not only are more investors adopting factor strategies, but as investors gain experience, they are increasing their use of them. This is one of the key findings from Invesco’s annual Global Factor Investing Study, which is based on face-to-face interviews and discussions with more than 300 institutional and wholesale factor investors around the world — including financial advisors, pension funds, private banks and insurance companies.

Appetite for factor investing in the Middle East

Focusing on the Middle East, factor investing is growing on a broad scale. Factor strategies, still usually applied to equity markets, are increasingly being used by regional investors.

An investor’s “factor journey” tends to be linked to their level of knowledge about factor investing. Their first factor investments are often easy-access smart beta-type single factor approaches, and as levels of sophistication increase more bespoke factor solutions, such as actively managed multi-factor strategies, tend to be favored.

As oil prices fluctuate and market volatility, amid global economic uncertainty, persists, major regional investors are looking for ways to better manage their portfolios. They are turning to factor investing as a valuable toolkit.

While factor investing is quantitative in nature, unlike traditional quantitative trading strategies, which use proprietary trading algorithms to gain alpha and outperform a benchmark index, factor investing is more transparent in that investors know which factor is contributing to their overall portfolio.

Barriers to adoption have fallen and institutional investors are already making organizational changes, specialist hires and changes to front and back office. Furthermore, the terminology is becoming more standardized and the use of factors has become an attractive way of expressing individual portfolio requirements on topics of interest such as environmental, social and governance (ESG) matters or regionally important exclusion criteria.

When it comes to applying a single or multi-factor approach, equity single factors are an efficient way to establish liquid, transparent factor exposures, equity multi-factor strategies, on the other hand, seek to balance the volatility of individual factors while building on their long-term outperformance. Multi-asset approaches are of increasing interest these days, especially given lower levels of diversification between equities and bonds. Hence, a factor lens across the asset allocation might be helpful to (re-)introduce additional diversification.

There are several benefits of the above approach. For institutions, single factor approaches are driven by the desire to reduce or minimize complexity and to keep costs low. This is particularly relevant for newer factor investors and smaller institutions with limited internal resources. However, multi-factor strategies are increasingly demanded and available in various shapes and forms for all investor groups including institutional and wholesale. Finally, for wholesale investors, the drivers are very similar, with lower costs cited as an even stronger driver for single factor usage.

In essence, the outlook for factor investing in the region is clearly positive given the existing factor investors’ commitment to extend their investments and the willingness to consider factor strategies across the board.

* The writer is Senior Portfolio Manager, Quantitative Strategies at Invesco