Thursday, October 17, 2019

Things BlackRock is Asking: "WTF: Where are the factors?"

BlackRock has  $7 trillion ($6.96 T at the end of Q3) in its various offerings including the 350 or so iShares ETFs.
From BlackRock's blog:

by Holly Framsted  
Head of US Factor ETFs
Investors increasingly are using factor strategies, but you wouldn’t know it from their portfolios. Where are the factors? 

My colleagues and I have written repeatedly about the fact that factors are long-term drivers of investment returns.  Given this, it’s no surprise that investors are increasingly adopting factor strategies in their portfolios. In fact, we’ve seen record inflows YTD with over $18 billion in investments in iShares Factor ETFs. Logic would follow that investors’ portfolios exhibit meaningful factor bets or tilts. Yet, their actual exposures tell a very different story.

After analyzing the factor exposures of nearly 10,000 portfolios, my colleagues Andrew Ang, PhD, who is the head of BlackRock’s Factor Based Strategies Group, and Patrick Nolan, CFA discovered that investors have barely any factor exposure in their equity portfolios. But viewing their whole portfolios—across equities, bonds, and potentially alternatives and other investments—they may have too much exposure to economic growth.

In my recent conversation with Andrew, we dug a bit deeper into this finding and what it means for investors.

Holly: Before we dive into the results of your study, can you help us understand what factors are?

Andrew: Sure. Factors are broad and persistent drivers of returns. We see the effects of factors across asset classes and geographies—so they are broad, and they have exhibited persistently rewarded returns over long time periods. There are two main types of factors: macro factors, like economic growth, real rates and inflation, which explain the majority of the returns across many asset classes, and style factors, which allow us to select securities which potentially offer higher risk-adjusted returns within each asset class than the broad market. Style factors include value, quality, momentum, low size, and minimum volatility.  While investors get exposure to both macro and style factors through their asset allocation, we often find that they focus more attention on style factors.

Holly: In your research, you analyzed approximately 10,000 portfolios. What were some of the main takeaways regarding how investors are allocated to factors?

Andrew: The most surprising insight was that while we have identified a variety of different factors that have historically driven returns over the long-run, investors currently only have meaningful exposure to two of these factors. The first is a macro factor – economic growth. And they probably have too much exposure to economic growth meaning that their portfolios might lose more than they intended when the economy slows. Not surprisingly, stocks are sensitive to changes in economic growth, and thus stocks tended to be the primary driver of risk in the portfolios analyzed.
The second is that within equities, investors barely have any style factors. The only style factor they have meaningful exposure to is low size, or more commonly thought of as smaller companies. However, we were very surprised to learn of the lack of diversification across style factors within the portfolios. Investors could potentially enhance returns or reduce risk by adding meaningful value, quality, momentum or minimum volatility factors.

Holly: What’s the rationale behind these concentrated exposures?...