PLANSPONSOR - October 2017 - 40

DB FOCUS
The Middle Ground
A
fter years of receiving disappointing
returns from the great majority
of traditional active equity
managers and paying high fees in return,
many U.S. corporate defined benefit (DB)
plan sponsors have voted with their wallets
and opted for the simplicity, and market
returns, of passive equity strategies at
minimal cost. There is a middle ground,
however, known, among other names, as
" factor " investing. Factor investing is a different
way to look at the markets, so as to
seek out the forces that drive investment
returns. And, experts say, besides the prospect
of better risk-adjusted returns at lower
cost than with active management, it can
shed new light on the best path to meeting
pension obligations.
Factor investing can operate at a high
level, to guide long-term strategic asset
allocation for a plan overall, as well as show
sponsors links from their plan's needs and
goals to trends in the global economy and
financial markets. " Some of our clients
have specific macroeconomic views and
need to build their portfolios to accommodate
those, " notes Brad Smith, partner
in the Atlanta office of consultants NEPC.
NEPC works with five sets of macro
factors for setting top-down asset allocation:
economic growth, real interest rates,
inflation, currency and illiquidity. These
are further broken down into 14 subfactors.
" There is a strong link between
the behavior of specific factors and what's
likely to drive future returns, " Smith says.
" Some corporate DB clients are
more sensitive to economic growth, " he
explains, " while other investors, such as
endowments and foundations, are more
sensitive to inflation. Inflation measures
can be a key metric for corporation
pensions, too, depending on the extent
of their liability hedging strategies. And
for those with large portfolios of private
equity or private debt, the illiquidity
factors come into play. "
Factor tools can complement traditional
mean-variance optimization and
economic scenario analysis, Smith says,
noting that the traditional asset-class-only
approach does not show key relationships
among sub-factors and can reveal gaps or
overweights in the asset allocation of the
40 PLANSPONSOR.com October 2017 Art by Edward Carvalho-Monaghan
Factor investing blends active and passive management styles
overall portfolio.
Factors also come into play at the asset
class level-in performance measurement
and portfolio design, as well as
portfolio management, both for equities
and fixed income. A factor approach
to managing equities dates back to the
late 1970s, with the first applications of
computer technology. The method has
gone in and out of fashion, and has had
various names: quantitative management,
" black box " investing and, more recently,
factor investing and smart beta.
Stated simply, detailed financial and
market information about individual
stocks is fed into databases, and quantitative
managers develop rules to build
portfolios from stocks having the desired
characteristics, or factors. Financial
researchers' efforts have unearthed
hundreds of factors over time, and, while
the worth of most signals has proved
fleeting, a handful have captured persistent
outperformance, with respect to
company fundamentals, value, growth,
company size and quality, and to market
behavior, momentum and low volatility.
http://www.PLANSPONSOR.com
PLANSPONSOR - October 2017

Table of Contents for the Digital Edition of PLANSPONSOR - October 2017
