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New EDHEC Survey On Equity Factor Investing Calls Risk Techniques Into Question

Date 23/01/2018

In a new survey conducted among investment professionals between June and September 2017, EDHEC-Risk Institute and ERI Scientific Beta have analysed the interests and motivations for investing in new forms of equity factor strategies. The 114 respondents together have at least USD 2.5 trillion in AUM and span all regions of the world (52% from Europe, 28% from North America and 20% from other parts of the world). In one of the more striking findings in the survey, there is a contradiction between score-based factor design choices and the statistical beta-based risk analysis. Analysis of the extreme risk of factor portfolios is still fairly basic and does not really allow the extreme risks to be appreciated.

Amongst other key findings:

  • Multi-factor strategies tend to be implemented in a passive investment context. Even when dynamic, factor investing is generally based on risk budget management rather than active views of returns.
  • Investors have a good understanding of the impact of market beta, the conditionality of factors’ exposures to the market and the usefulness of measuring and controlling market beta. This concern largely dominates topics that are the subject of buzz in the market, but are not as important for investors, such as factor timing or the maximisation of factor intensity through portfolio concentration.
  • In spite of its limitations, the score-based approach dominates. Even though factor investing was founded on analyses in terms of betas, the measurement of betas is still in a minority and is rudimentary.
  • Although valuation-based methods have been widely criticised in academia both for the value bias introduced and for their effectiveness, and methods based on momentum are often highly sample-dependent and criticised for their arbitrary aspect, investors still favour these two approaches.
  • When evaluating their control of dynamic factor investing, most investors think that they have poor control of the sophisticated techniques for measuring and integrating the variations in betas and premia in the allocation.
  • Performance analysis is consistent with risk analysis and favours the multi-factor beta or score approach. The analyses combining factors with sectors and countries are only reasonably widespread, even though there are quite well developed factor investing offerings based on controlling these three dimensions.

Commenting on the survey, Professor Noël Amenc, CEO of ERI Scientific Beta, said that, “While investor interest in dynamic factor investing is growing, it should be recognised that the techniques used for risk measurement or risk control do not yet correspond to the state of the art. In the same way, in spite of the lack of academic or empirical evidence supporting factor timing, it is favoured by a considerable share of investors, and within this framework, approaches are used that lack sophistication and are not necessarily appropriate for capturing factor premia regimes.”

Professor Lionel Martellini, Director of EDHEC-Risk Institute, said, “We hope that the EDHEC Survey on Equity Factor Investing will enable investment professionals to learn and understand the interests and motivations for investing in these new forms of equity factor strategies. We see from the survey that investors, and especially asset owners, are ultimately aware of the difficulties and the technical progress to be achieved to master dynamic factor allocation. It is EDHEC-Risk’s ambition to keep on producing applied academic research on the subject so as to enhance our collective understanding of the benefits and limits of dynamic approaches to factor investing.”

A copy of the EDHEC Survey on Equity Factor Investing can be downloaded here