Factor investing – a different approach
16 November 2016 | Portfolio construction
James Norton: Factor investing is known as many things: smart beta, enhanced indexing, and alternatively weighted strategies. But how does it work for investors? I am James Norton, Senior Business Development Manager at Vanguard and I am joined by Brian Wimmer, Vanguard Senior Investment Strategist. Brian, regardless of the different labels, factor investing is on the increase. Why is that?
Brian Wimmer: Well, first of all, we have seen over the last two to three years, I would say, a growing understanding. Part of that is the increase in the amount of products, but also part of that is an increase in the education that is available. Investors are starting to realise how they can potentially use factor products to tailor the risk and return characteristics of their portfolio.
James Norton: So we have four factor ETFs at Vanguard, how did we choose those strategies?
Brian Wimmer: Well, the interesting thing is you look back at the academic literature, you find that there are over 300 factors that have been identified. Now, certainly, all 300 of these don't necessarily deserve a place in a portfolio, so we need to reduce the list. So we do that by asking ourselves a few questions:
- Is there an enduring logical rationale behind certain factor strategies?
- Have we seen empirical evidence both through long periods of time and in different geographic regions that would demonstrate performance that is favourable for certain factor strategies?
- Can we take some of those factor strategies and actually implement them in real world portfolios?
James Norton: Our ETFs are quite different to our competitors. They are global, for a start. Why is that?
Brian Wimmer: Well, when we think about any form of investing at Vanguard, we start with diversification as one of our key tenets. So when we talk about factor strategies, given that we have seen different factors provide improved performance around the world, not just in specific locations, we then can apply that global mentality to factor products and give investors, ultimately, that diversification that they're looking for.
James Norton: Another big difference is that the ETFs don't track an index. Why are we using an active quant strategy in managing these funds?
Brian Wimmer: It is important to first explain what we mean by “active quant process” in this case. We're not talking about a portfolio manager making holistic or sweeping changes in a tactical portfolio. This is really about a long-term strategy, but the need of the portfolio manager is to do two things:
- Manage exposures to certain factors
- Also manage transaction costs within the portfolio
By using an internal quant process, we feel like we have the flexibility to do that, perhaps better than we could have if we were utilising an external benchmark.
James Norton: Thanks, Brian.
At Vanguard, we have selected factors that we believe are enduring, we have gone for greater global diversification, and we have taken an active approach for more consistent factor exposure.
Thanks for watching.
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