Factors that drive investments may show fund managers up
A growing focus on what is known as factor investing promises to provide those willing to track these indices a cheaper way to earn market-beating returns.
And, for those wedded to investing with active fund managers, a focus on the factors that drive their performance can reveal a lot, including a better way for many investors to blend different managers' funds together.
It may also leave some unit trust fund managers explaining why they are not managing your money as you would expect them to, or what they do to earn their fees.
Factor investing, also known as smart
beta investing, uses certain rules to identify shares with similar characteristics that are expected to outperform the return you would earn if you invested in the entire market through an index like the JSE all share index (Alsi).
Factor investing mimics the common investment styles followed by active-fund managers who invest in, for example, value shares, or the shares of quality companies, or small companies' shares. A quality share is, for example, identified as one of a company with low debt, which is profitable and whose profits are growing steadily.
Factor investing is a step up from investing in indices that track a market on the basis of the size of the shares, as the Alsi or top 40 do. The investment industry refers to this kind of investing as rules-based, as it follows rules, but it isn't as entirely passive as tracking an index like the Alsi is, as the decision to only invest in shares of a certain kind is an active bet.
Factor investing is growing globally and in SA, Peter Weidner, the head of multi-factor solutions at US-based manager Wells Fargo, told a Satrix conference this week. He says from 1967 to 2018, investing in any one of five factors in global markets — value, momentum, quality, low volatility and small size — have all generated average returns higher than those of the MSCI world index.
In SA, the COO of investment manager Colourfield, Shaun Levitan, presented research to fellow actuaries in 2016 showing that tilting your share selection to the size, high profitability and value factors in the South African market would have delivered returns of, respectively, 0.9 percentage points, one percentage point and three percentage points a year higher than the market over the past 20 years. These are average returns over a long period and, if you invest in a factor fund, remember that the style it mimics can, like the style of an active-fund manager, be out of favour for a long time, during which you may underperform the general market.
At some point, however, your exposure to certain types of shares is expected to deliver good returns and then, on average, your returns over a long period are expected to be better than the market.
Interrogation of the analysis may reveal that a manager has succumbed to “style drift”
While Colourfield manages money for the likes of retirement funds, managers like CoreShares and Satrix offer individual investors low-cost funds that invest in individual factors. They also offer multifactor funds that identify the shares which represent more than one factor.
Their multifactor funds are both new, but Fairtree's Smart Beta Prescient Fund, which focuses on three factors, has a three-year return so far of 5.3% a year, ranking it 30th out of some 300 local general equity funds. In the meantime, however, the single-factor funds and tools like one launched by Satrix this week that can analyse local equity funds' exposure to the different factors should give us better insight into our investment decisions.
Single-factor funds can be used as a benchmark against which an active-fund manager's performance can be measured to determine whether it is indeed able to deliver performance better than what a rules-based or smart beta process can.
Discretionary investment advisers, who put portfolios together for financial advisers' clients, and multimanagers, who combine different funds for managers, can also use factor analysis to determine if equity funds are indeed being managed the way you are led to believe they should.
A demonstration of Satrix's tool this week revealed surprising results, such as that two well-known value funds do not have any significant exposure to shares typically regarded as having the characteristics of a value share, such as high-dividend yields.
Kingsley Williams, the chief investment officer at Satrix, says the tool can analyse both the individual share holdings in a fund or the past returns generated by the fund to determine the fund's style factor.
The caveat is that managers may have a style that differs from the textbook version, managers may only reveal their top 10 holdings, skewing the analysis, or their share selections may be paying off at the point at which the analysis is done.
But an interrogation of the analysis may reveal that a manager has succumbed to “style drift” — when a fund no longer sticks to its stated investment style or philosophy.
Knowing if a manager's style has drifted is important if your portfolio is a combination of managers who are supposed to have different investment styles delivering different returns at different times and a smoother overall outcome.
Many South African investors hold a combination of unit trust funds managed by favoured asset managers who have big brands. Investors often do not know if these managers' investment styles complement one another or double up on the same strategy. Analysing the factors to which each manager is exposed can reveal which manager's styles complement each other and give you a more diversified investment portfolio.
Factor funds can also be used as a low-cost addition to your portfolio to increase diversity if you have too much exposure to a certain style through your current managers.