PLANSPONSOR - June/July 2019 - 44

DB FOCUS
Equity
Factor
Investing
Groups of 'signals' help
sponsors shape their
plan's liability profile
I
nstitutional investors are always looking
for an edge to improve their portfolio
performance. A current candidate
when it comes to equity investing is the
use of factors. Factor investing brings
quantitative rigor to sizing up the returns
of stock markets, to gauging the success
of active managers, and to building distinct
portfolios. There is no consensus
on how many factors drive stocks or how
exactly to define those factors, but their
application to equities adds a new analytical
dimension to traditional equity styles
and gives sponsors greater precision and
transparency in understanding what
moves their portfolios.
Financial economists have identified
hundreds of individual quantitative
signals, most of which are fleeting, but
the science has bundled up the enduring
ones and grouped them into factors: value,
momentum, quality, company size, and
volatility. Practitioners also track factors
for dividend yield and stock liquidity.
" Conventional indexes weighted
by companies' market values have exposures
to factors but, there are better ways
to home in on them, " says Mark Stahl,
senior vice president at Callan in San
Francisco. Indexes and portfolios based
on single factors contain hundreds of
stocks but only represent a small fraction
of broad market indexes.
The graph (next page) illustrates how
different equity factors exhibit timing
and amplitude of their performance,
drawing on factor indexes developed for
the Russell 1000 universe. The data show
excess returns vs. the Russell 1000 for
rolling three-year periods (for the sake of
simplicity, only a few factors are shown).
Excess returns of stocks with a strong
low-volatility factor weight were the best
throughout the period and especially so in
2014 through 2017. For the same interval,
stocks demonstrating a high-yield factor
were especially weak but recovered in
2015 as low volatility lost ground. Valueoriented
stocks performed better early in
the period but weakened later on.
" Over short periods, factors can show
high correlation to one another, " notes
Feifei Li, head of investment strategy at
Research Affiliates, a publisher of factor
indexes, in Newport Beach, California.
44 PLANSPONSOR.com June - July 2019 Art by Claudi Kessels
" When companies with a strong quality
factor are doing well and attracting inflows,
they are probably doing well in momentum
at the same time, as we saw in 2018. "
Individual factors can be potent and
require handling with care. Momentum
strategies call for frequent trading and thus
incur high transaction costs.
Jay Love, a partner in the Atlanta
office of Mercer, says value has been one
of the most effective factors over the long
term but has slipped out of favor.
" Moreover, the quality factor is hard
to define, and it might correlate highly
to other factors such as value in 2018, "
notes Stahl.
" Through crowding and more money
flowing into a given factor, its premium
could erode, " observes Jon Pliner, head
http://www.plansponsordigital.com/plansponsor/june-july_2019/TrackLink.action?pageName=44&exitLink=http%3A%2F%2FPLANSPONSOR.com
PLANSPONSOR - June/July 2019

Table of Contents for the Digital Edition of PLANSPONSOR - June/July 2019
