PLANSPONSOR - October 2017 - 41

In the performance measurement
role, factors provide sponsors with a view
of their portfolio's returns that complements
traditional market benchmarks.
" We run an analysis on a plan's total
equity portfolio, to see what exposures
it has to value, growth and momentum, "
says Christina Bargeron, equity research
consultant in the Philadelphia office of
Willis Towers Watson. " We consider
what factors [the plan] wants and needs,
in terms of its beliefs and risk and return
goals. Then the question is: 'Are these
the exposures to these risks that you
intended?' "
Historically, each major factor has
shown significant outperformance,
although at different points in market
cycles. " These have been referred to
as 'better beta solutions,' " says Smith.
" Rather than seeking alpha from a traditional
active manager's security selection,
returns are driven from the top down.
And fees tend to be lower, so it's more
efficient than active management. "
In designing portfolios, " Factors are
easy to identify, and then to stress-test as
to how they might behave, " Smith says. " If
a client wanted to build a small cap portfolio
with a value bias in order to provide a
smoother ride, we could show it how [the
portfolio] might be expected to perform
in different market regimes. It might also
reveal that the new strategy [the client is]
considering is correlated with something
it already owns in the fixed-income or
alternatives portfolios. "
As for portfolio management
through factors, while traditional active
managers tend to be oriented to qualitative
choices on the companies they buy, quantitative
managers weigh the statistical
factors behind the companies. As with
traditional active management, the goal
is to assemble portfolios that outperform
the market, but quantitative approaches
have the side benefit of reducing the
high cost of human analysts and portfolio
managers, as well as avoiding their
behavioral biases. Factor-based management
can, therefore, appeal to investors
who see fewer opportunities for alpha in
traditional active management, but do not
want to go entirely passive.
Consultants and managers emphasize
the need for integrated implementation.
" If the plan doesn't have the belief or
governance level to make its own decisions
on combinations of factors, a quantitative
manager might be better able to fulfill a
multi-factor strategy, " Bargeron says.
" We tend to deliver packaged strategies,
as we believe they can earn more
sustainable excess return than a combination
of ad hoc choices, " says Ted Noon,
senior vice president at Acadian Asset
Management in Boston. " If I invest $25
each in strategies in value, momentum,
quality and growth, the stocks on the
value side may have anti-momentum characteristics,
and vice versa. That's capitalinefficient,
and the best way to invest is
at the intersection of those two strategies,
where one manager can oversee the interaction
among factors. "
" With factor-based strategies, you
might not earn higher absolute returns,
but you could earn better risk-adjusted
returns, " observes Harin De Silva, president
of Analytic Investors, a Los Angeles
unit of Wells Fargo & Co. Such strategies
can present challenges in measuring
performance, however. " If you choose a
value strategy, or a quality strategy, there
are dozens of benchmarks, " says de Silva.
" Multi-factor strategies are even harder
to measure. The slow adoption of factor
investing in the DB world is due to uncertainty
over benchmarking them and what
fees to pay. "
Some observers caution that uptake
on factor thinking may have practical
limits. " U.S. corporate defined benefit
plans, for the most part, are fairly
mature in their thinking, " says Michael
Schlachter, senior consultant at Mercer
Investment Consulting in Chicago. " For
those quintessential plans with assets
from $150 million to $1 billion, a board's
top priorities in a given year would
[concern] contribution policy, downsizing
through selective carve-offs, and ways to
KEY POINTS
* Factor investing, also known as
quantitative strategies, or smart
beta, is a type of investing that
seeks out the forces that drive
investment returns.
* Detailed financial and market
information on individual stocks
is fed into databases, and
quantitative managers develop
rules to build portfolios from
stocks meeting qualifications the
sponsor desires.
* In addition to the possibility
of better risk-adjusted returns
at lower cost than with active
management, factor investing
can shed new light on the
best path to meeting pension
obligations.
* DB sponsors may not want
to upset mature investments
with factor investing, but using
this strategy could bring a
sponsor closer to its investment
objectives.
reduce PBGC [Pension Benefit Guarantee
Corporation] premiums. As to factors,
there might be an allocation of 5% or
10% to a low-volatility strategy as a risk
reducer, but, for these plans, radically
rejiggering the investments around something
entirely new is not something you'll
see all that often. "
Others are more optimistic. " The
way the world has lined up, 'traditional
active managers' has not worked out so
well, " says Matt Peron, managing director
of global equity at Northern Trust Asset
Management in Chicago. " Implementing
a factor program in the right way may not
be obvious, but it offers a logical way to
match up a plan's strategies and can yield
better risk-adjusted returns.
" In 2035, they may look back and ask
'Remember when all we had was 60/40?' "
Peron adds. " I think the future will be in
factor portfolios. " -John Keefe
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