Blackrock is one provider offering this approach with a strategy that purchases the factors of value, quality, momentum, low vol and dividends.
Dave Gibbons sets out his stall. “All of these factors have been proven to work in the long run, but they have periods where the drawdowns can be pretty significant and long lasting,” he says. “The factors have their own cyclicalities, so combining them makes a lot of sense because you are diversifying your downside risk.” This works by devising a set of signals that identify under-appreciated, underowned parts of the market.
The second approach to buying factors is more pragmatic. Pound cost averaging means some units might be bought high initially and some will be bought later on when valuations fall. The trouble here is that this approach is facing headwinds with the great popularity of low volatility approaches pushing up prices to the point that some are talking of a crash.
Rob Arnott, chief executive of Research Affiliates, the California-based consultant and pioneer of smart beta indices, gave the following plainly-worded warning in February: “We foresee the reasonable probability of a smart beta crash as a consequence of the soaring popularity of factor-tilt strategies.”
Indeed, figures released in October from Blackrock’s iShares division reported that 2016 had already set a new record for smart beta ETF inflows, gathering $7.6bn. Most of this has gone into low vol and dividend strategies.
For this reason Redington is against a fully-passive approach. Samuels says: “As a strategy it has performed in a rising market, which is not what it is designed to do.” He favours a measure of active management to access low volatility safely.
“You can still create something that can create a nice income from low vol, but maybe you kind of lose a little on the volatility side. So it has more volatility than the index so it is not exposed to these expensive stocks.”
Arguably again, such pricing pressures already exist in market cap equities, which might explain the results of the Cass Business School research.
TPT’s Smart challenges this notion of market cap and not value or quality for example, as the true form of passive investment.
“There is nothing to say that market cap investing is the true form of passive; it is just one way of doing less active management,” she says. “In a cost constrained world, it is very sensible to look at different metholdogies for getting exposure to the equity market in as low a way as you can, while paying as low fees as you can.”
