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HARNESSING THE POWER OF FACTORS
November 2017
Jean-Maurice Ladure, CFA
Head of Equity Applied Research, EMEA
KEY QUESTION
2
Does Factor Investing provide a credible
alternative to Active Management?
IMPORTANCE OF FACTORS IN EXPLAINING PERFORMANCE
3
“Approximately 70% of all active
returns on the overall fund can be
explained by exposures to systematic
factors”
-Ang, Goetzmann, Schaefer
Report on Norway’s Government Pension Fund
“Alpha decreases from 18 bps to as
low as 3 bps monthly, a reduction of
as much as 80%”
-MSCI’s award winning research paper
“Can Alpha Be Captured by Risk Premia?”
Ang, A., W. Goetzmann, and S. Schaefer, 2009. “Evaluation of Active Management of the Norwegian Government Pension Fund Global”.
Bender, J., Hammond, B. Mok, W, 2014. “Can Alpha Be Captured by Risk Premia?”. Journal of Portfolio Management, Winter 2014.
Portfolio Return
1960s
Alpha
MarketReturn
1980s
Alpha
FactorReturn
MarketReturn
2000s
FACTOR INVESTING IN THE ASSET ALLOCATION PROCESS
4
• “Third Way” between market-cap
passive and active investment
• Factor Investing is not new:
─ Factors have long been used in risk
models and quantitative investment
strategies
─ They also can explain part of the long
term portfolio performance of
fundamental active investors*
• Factor indexes provide a
transparent, rules-based and cost-
effective method to seek
systematic exposure to Factors
Market Return
Transparent Implementation
Active Return
Passive Investing
DiscretionaryImplementation
FactorInvesting Active
Management
6 KEY FACTORS
*For example, see “Buffett’s Alpha”, NBER Paper, Andrea Frazzini, David Kabiller and Lasse Pedersen, December 2013
DIFFERENT APPROACHES TO CONSTRUCT FACTOR INDEXES
5
Pure
Factors
Mkt Neutral
Factor Indexes
Long Short
Factor Indexes
Optimized Factor Indexes
High Exposure Factor Indexes
High Capacity Factor Indexes
Market Cap Benchmark Indexes
• Higher Factor Exposure
• Higher Complexity
• Lower Investability
MSCI Market Neutral Barra Factor Indexes
MSCI Long Short Barra Factor Indexes
MSCI Enhanced Value Index
MSCI Value
Weighted Index
MSCI ACWI IMI
MSCI Minimum Volatility Index
Examples of existing MSCI factor indexes based on different factor index construction methodologies:
FACTORS SHOW LONG TERM OUTPERFORMANCE
6
COMBINING FACTORS IN THE LONG-TERM
7
USE CASE #1 – TARGETING SPECIFIC FACTORS
8
“ I believe in the long term premium
of some factors and would like to
benefit from a combination of those”
• A common definition of quality companies is “high
profitability, earning persistency, and low leverage”
• Financial quality descriptors are readily available in financial
statement
• Quality companies tend to be expensive
• Leading to the opportunity to combine Quality and Valuation
USE CASE #1 – INVESTING IN QUALITY FACTOR
9
PROFITA
BILITY
EARNINGS
QUALITY
FINANCIAL
LEVERAGE
Financial Quality
MSCI QUALITY MIX: HOW IT PERFORMS
10
Key Metrics
MSCI ACWIACWI
Quality
ACWI Sector
Neutral
Quality
ACWI Factor
Mix A-series
(USD)
Total Return* (%) 5.7 7.1 6.8 7.5
Total Risk (%) 15.4 13.9 14.7 12.9
Return/Risk 0.37 0.51 0.46 0.58
Sharpe Ratio 0.23 0.36 0.32 0.42
Active Return (%) 0.0 1.4 1.2 1.8
Tracking Error (%) 0.0 4.0 2.7 3.3
Information Ratio NaN 0.35 0.44 0.56
Historical Beta 1.00 0.87 0.94 0.83
No of Stocks*** 2417 497 596 2405
Turnover** (%) 3.3 23.1 29.1 20.1
Price To Book*** 2.2 4.3 3.3 2.4
Price to Earnings*** 18.3 16.8 15.7 17.4
Dividend Yield*** (%) 2.3 2.1 2.4 2.5
Period: 31-Dec-1998 to 31-Oct-2017
* Gross returns annualized in USD
** Annualized one-way index turnover over index reviews
*** Monthly averages
The definitions of all statistical parameters are available in the Appendix
Performance (%)
MSCI ACWIACWI
Quality
ACWI Sector
Neutral
Quality
ACWI Factor
Mix A-series
(USD)
YTD 20.2 23.7 20.5 19.1
1 Yr 23.7 24.7 23.0 21.4
3 Yr 8.5 10.3 8.0 9.2
5 Yr 11.4 12.8 11.0 11.7
10 Yr 4.3 7.3 5.5 6.1
Gross returns in USD for the period ending 31-Oct-2017
Returns are annualized for periods longer than one year
USE CASE #2 – EQUITY RISK REDUCTION
11
“ I want to remain invested in equities
but would like to reduce my risk”
USE CASE #2 – EQUITY RISK REDUCTION
12
MSCI Minimum Volatility: How it works?
MSCI MINIMUM VOLATILITY: HOW IT PERFORMS
13
Key Metrics
MSCI ACWIACWI Min Vol
(USD)
Total Return* (%) 5.7 8.3
Total Risk (%) 15.4 10.2
Return/Risk 0.37 0.81
Sharpe Ratio 0.23 0.60
Active Return (%) 0.0 2.6
Tracking Error (%) 0.0 7.9
Information Ratio NaN 0.33
Historical Beta 1.00 0.59
No of Stocks*** 2417 350
Turnover** (%) 3.3 24.7
Price To Book*** 2.2 2.5
Price to Earnings*** 18.3 18.7
Dividend Yield*** (%) 2.3 2.7
Period: 31-Dec-1998 to 31-Oct-2017
* Gross returns annualized in USD
** Annualized one-way index turnover over index reviews
*** Monthly averages
The definitions of all statistical parameters are available in the Appendix
Performance (%)
MSCI ACWIACWI Min Vol
(USD)
YTD 20.2 15.0
1 Yr 23.7 15.1
3 Yr 8.5 9.1
5 Yr 11.4 11.0
10 Yr 4.3 6.9
Gross returns in USD for the period ending 31-Oct-2017
Returns are annualized for periods longer than one year
CONCLUSIONS – AND A WORD OF CAUTION
14
Allocation to Multi Factor Strategies
Investment
Horizon
Investment
Beliefs
Governance
Structures
Diversified
Exposure
• Factor based strategies have historically produced long-term outperformance
but have also experienced significant multi-year periods of underperformance
• Factor investing requires strong investment beliefs that the historical premium
will persist and governance structures to withstand underperformance periods
• Allocating to multiple factors may provide investors with a transparent, flexible
and cost-effective way to seek diversified exposure to a portfolio of risk premia
APPENDIX
USE CASE #3 – RISK/RETURN ENHANCEMENT
16
• The DMF index had higher absolute and risk
adjusted historical performance
• The DMF approach produced higher active
return, higher tracking error and IR
• Total risk and historical beta similar and close to
the parent index
• Turnover similar while DMF index approach had
lower average valuations
Key Metrics
MSCI World
World
Diversified
Factor Mix
World
Diversified
Multiple-factor
Total Return* (%) 5.5 7.8 10.0
Total Risk (%) 15.0 13.9 15.2
Return/Risk 0.37 0.56 0.66
Sharpe Ratio 0.23 0.41 0.52
Active Return (%) 0.0 2.3 4.5
Tracking Error (%) 0.0 2.8 4.1
Information Ratio NaN 0.81 1.10
Historical Beta 1.00 0.91 0.98
No of Stocks*** 1621 1621 448
Turnover** (%) 2.9 30.8 40.1
Price To Book*** 2.2 2.1 1.9
Price to Earnings*** 18.8 17.7 13.9
Dividend Yield*** (%) 2.3 2.6 2.3
Period: 31-Dec-1998 to 31-Oct-2017
* Gross returns annualized in USD
** Annualized one-way index turnover over index reviews
*** Monthly averages
The definitions of all statistical parameters are available in the Appendix
Performance (%)
MSCI World
World
Diversified
Factor Mix
World
Diversified
Multiple-factor
YTD 18.8 19.7 22.5
1 Yr 23.3 22.3 27.3
3 Yr 8.7 9.6 10.8
5 Yr 12.2 12.6 14.5
10 Yr 4.7 5.5 6.9
Gross returns in USD for the period ending 31-Oct-2017
Returns are annualized for periods longer than one year
TRANSPARENCY IN PERFORMANCE ATTRIBUTION
17
2.34
4.17
Risk Indices
VALUE0.30 0.55 0.23
0.35 0.61 -0.02
BtoP Earn. Yield LT Reversal
MOM.0.98
1.19
Momentum
QUALITY0.18 0.07 0.19 0.28 0.080.04 0.06 0.22 0.31 0.00
Leverage Earn. Qlty Inv. Qlty Profitability Earn. Var.
Index: World Diversified Multiple-factorPeriod: 31-Dec-1998 to 31-Oct-2017
Return (%)
Risk (% Std Dev)
Annualized Gross Returns
Total
9.98
15.24
5.51 4.48
15.03 4.08
Benchmark Active
0.04
0.63 0.77 1.70 2.01
0.02 0.28 -0.03
Asset
Selection Selection
Currency Countries Industries
0.07 0.460.14
Growth Liquidity
0.08 -0.03 -0.18
Div. Yield
1.01 0.66
0.31 0.42
Beta Res. Vol.
SIZE1.85 0.77
0.58 0.23
Size Mid Cap
TRENDS IN FACTOR INVESTING
18
OVER USD 210 BILLION IN ASSETS
BENCHMARKED TO MSCI FACTOR
INDEXES AS OF MARCH 2017
Data as of March, 2017 and reported as of June,2017 by eVestment, Morningstar, Bloomberg and MSCI.
4 years CAGR: 40%
0
50
100
150
200
250
Ma
r'1
3
Se
p'1
3
Ma
r'1
4
Se
p'1
4
Ma
r'1
5
Se
p'1
5
Ma
r'1
6
Se
p'1
6
Ma
r'1
7
FACTOR INDEX AUM GROWTH
CAGR: 41%
THE MSCI FAMILY OF STANDARD SINGLE FACTOR INDEXES
19
Factors High Capacity Factor Indexes High Exposure Factor Indexes
Value MSCI Value Weighted Index MSCI Enhanced Value Index
Size MSCI Size Tilt Index MSCI Equal Weighted Index
Momentum MSCI Momentum Tilt Index MSCI Momentum Index
Yield MSCI Dividend Tilt Index MSCI High Dividend Yield Index
Quality MSCI Quality Tilt Index MSCI Quality Index
Volatility MSCI Volatility Tilt Index MSCI Minimum Volatility IndexLOW VOLATILITY
HIGH YIELD
QUALITY
MOMENTUM
VALUE
SIZE
MSCI SINGLE FACTOR INDEXES METHODOLOGY OVERVIEW
20
Index Enhanced Value Equal Weighted Momentum Quality High Dividend Yield Minimum Volatility
Objective
• High exposure to
the value factor +
low exposure to
all other factors
• Negative size
factor exposure +
low exposure to
all other factors
• High exposure to
momentum + low
exposure to all
other factors
• High exposure to
the quality factor
+ low exposure to
all other factors
• High exposure to
dividend yield +
low exposure to
all other factors
• Negative volatility
factor exposure +
low exposure to all
other factors
Selection
• PB + PE + EV/CFO
(except Financial)
• Calculate sector
relative scores
• Select highest
score securities
• By applying equal
weight across the
parent index we
overweight lower
capitalization
parent index
constituents
• 6m and 12m risk
adjusted return
(excluding 1m)
• Calculate scores
across universe
• Select highest
score securities
• ROE + D/E + Low
Earn Variability
(EPS g in last 5Y)
• Calculate scores
across universe
• Select highest
score securities
• Yield (YLD > 1.3x)
• Quality (QTY > 0)
• Persistency
(5Y DPSG > 0)
• Sustainability
(exc top 5% PR)
• Yield Trap (R<<0)
• Security selection
based on min var
optimization
• Covariance matrix
from Barra GEM2
risk model
Weighting • Score x Mkt Cap • Equal Weights • Score x Mkt Cap • Score x Mkt Cap • Mkt Cap Weights• Weights based
on optimization
Constraints • Sector neutral • No constraints • Max 5% Weight • Max 5% Weight • Max 5% Weight
• 1.5% or 20x BM
• Constraints on
countries, sectors
and other factors
Rebalancing• Semi annual /
buffers• Quarterly
• Semi annual /
buffers
• Conditional
rebalancing
• Semi annual /
buffers
• Semi annual /
buffers
• Semi annual /
max 20% TO
Table provides methodology highlights. Details can be found in the Index Methodology books available on msci.com.
WORLD SINGLE & MULTI INDEXES – HIGH EXPOSURE
21
Key Metrics
World
World
Minimum
Volatility (USD)
World Equal
Weighted
World
Enhanced
Value
World High
Dividend Yield
World
MomentumWorld Quality
World
Diversified
Factor Mix
World
Diversified
Multiple-factor
Total Return* (%) 5.5 7.1 8.2 9.9 6.6 8.1 6.8 7.8 10.0
Total Risk (%) 15.0 10.7 16.2 17.2 14.9 15.4 13.4 13.9 15.2
Return/Risk 0.37 0.67 0.51 0.58 0.44 0.52 0.51 0.56 0.66
Sharpe Ratio 0.23 0.47 0.38 0.45 0.30 0.39 0.35 0.41 0.52
Active Return (%) 0.0 1.6 2.7 4.4 1.1 2.6 1.3 2.3 4.5
Tracking Error (%) 0.0 7.5 4.6 5.8 5.7 8.2 4.2 2.8 4.1
Information Ratio NaN 0.22 0.59 0.77 0.19 0.31 0.30 0.81 1.10
Historical Beta 1.00 0.63 1.03 1.08 0.92 0.88 0.86 0.91 0.98
No of Stocks*** 1621 281 1621 396 392 346 298 1621 448
Turnover** (%) 2.9 25.0 16.7 35.6 18.9 95.4 23.1 30.8 40.1
Price To Book*** 2.2 2.5 1.7 1.2 2.1 3.0 4.6 2.1 1.9
Price to Earnings*** 18.8 19.1 22.6 14.7 14.1 22.2 17.2 17.7 13.9
Dividend Yield*** (%) 2.3 2.6 2.3 2.8 3.9 1.7 2.1 2.6 2.3
Period: 31-Dec-1998 to 31-Oct-2017
* Gross returns annualized in USD
** Annualized one-way index turnover over index reviews
*** Monthly averages
The definitions of all statistical parameters are available in the Appendix
Performance (%)
World
World
Minimum
Volatility (USD)
World Equal
Weighted
World
Enhanced
Value
World High
Dividend Yield
World
MomentumWorld Quality
World
Diversified
Factor Mix
World
Diversified
Multiple-factor
YTD 18.8 14.5 19.0 17.6 15.4 29.7 21.8 19.7 22.5
1 Yr 23.3 15.3 22.4 23.3 18.6 32.1 24.2 22.3 27.3
3 Yr 8.7 10.1 8.9 7.8 7.1 13.2 10.4 9.6 10.8
5 Yr 12.2 11.7 12.1 12.9 10.1 14.8 13.2 12.6 14.5
10 Yr 4.7 6.4 4.9 3.9 3.8 6.3 7.7 5.5 6.9
Gross returns in USD for the period ending 31-Oct-2017
Returns are annualized for periods longer than one year
WORLD FACTOR INDEXES – HIGH CAPACITY
22
Key Metrics
MSCI WorldWorld Volatility
TiltWorld Size Tilt
World Value
WeightedWorld Dividend Tilt
World Momentum
TiltWorld Quality Tilt
Total Return* (%) 5.5 6.3 6.9 6.4 6.8 6.6 6.2
Total Risk (%) 15.0 12.8 15.4 15.9 13.5 14.7 14.4
Return/Risk 0.37 0.49 0.45 0.40 0.50 0.45 0.43
Sharpe Ratio 0.23 0.33 0.31 0.27 0.35 0.30 0.28
Active Return (%) 0.0 0.8 1.4 0.9 1.3 1.0 0.6
Tracking Error (%) 0.0 3.5 2.4 3.4 3.8 3.5 1.5
Information Ratio NaN 0.24 0.58 0.27 0.34 0.30 0.43
Historical Beta 1.00 0.84 1.01 1.04 0.87 0.95 0.95
No of Stocks*** 1621 1616 1616 1616 839 1616 1586
Turnover** (%) 2.9 11.5 11.2 17.2 22.7 45.6 11.2
Price To Book*** 2.2 2.4 2.0 1.7 2.4 2.5 2.6
Price to Earnings*** 18.8 17.6 20.2 17.8 15.4 19.8 17.7
Dividend Yield*** (%) 2.3 2.6 2.3 2.7 3.2 2.1 2.2
Period: 31-Dec-1998 to 31-Oct-2017
* Gross returns annualized in USD
** Annualized one-way index turnover over index reviews
*** Monthly averages
The definitions of all statistical parameters are available in the Appendix
Performance (%)
MSCI WorldWorld Volatility
TiltWorld Size Tilt
World Value
WeightedWorld Dividend Tilt
World Momentum
TiltWorld Quality Tilt
YTD 18.8 16.8 18.9 17.2 17.7 22.9 19.7
1 Yr 23.3 21.4 22.8 24.4 22.0 26.8 23.8
3 Yr 8.7 8.4 8.7 8.1 8.1 10.6 9.2
5 Yr 12.2 11.6 12.2 11.9 11.1 13.7 12.5
10 Yr 4.7 5.4 4.9 3.9 5.5 5.7 5.8
Gross returns in USD for the period ending 31-Oct-2017
Returns are annualized for periods longer than one year
TRACK RECORD FOR WORLD FACTORS
23
Performance Relative to the World
YTD 1Y 3Y 5Y 10Y 15Y Since '99 Since Live Live Date
MSCI World - - - - - - - -
Minimum Volatility -4.2% -8.0% 1.3% -0.4% 1.7% 0.8% 1.6% 1.5% 14/04/2008
High Dividend Yield -3.4% -4.7% -1.7% -2.1% -0.9% -0.1% 1.1% -0.8% 31/10/2006
Quality 3.0% 1.0% 1.7% 1.1% 3.0% 1.0% 1.3% 1.6% 18/12/2012
Momentum 10.9% 8.9% 4.5% 2.7% 1.6% 2.3% 2.6% 3.4% 11/12/2013
Enhanced Value -1.2% 0.0% -0.9% 0.7% -0.8% 2.7% 4.4% -1.8% 11/08/2014
Equal Weighted 0.3% -0.9% 0.2% -0.1% 0.2% 2.1% 2.7% 0.6% 22/01/2008
Diversified Multiple-factor 3.7% 4.1% 2.0% 2.3% 2.2% 3.6% 4.5% 1.3% 19/03/2015
Note: Al l returns are in USD, Gross , annua l i s ed except YTD
As of end of October 2017
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