Roundtable 'Market Cap Weighted & Factor Investing': Factor investing in practice

September 11, 2023

Between 2018 and 2020, many factor-driven portfolios underperformed. What macroeconomic changes have influenced this? And what lessons can we draw from this?

These and other questions were discussed in the Round Table 'Market Cap Weighted & Factor Investing', in which six experts, chaired by Erik Hulsegge, exchanged insights.

This is part 2 of the report.

By Hans Amesz

Between 2018 and 2020, many factor-driven portfolios underperformed. Has this led to new insights, reallocations or adjustments?

Rozemuller: 'I remember that low vol turned out very differently than expected at a certain point, probably due to some kind of black swan events. As an industry, we have to keep in mind that your strategy can be messed up for all sorts of reasons you haven't considered. You can have an opinion on assets or sectors, or even individual stocks, but ultimately it's about choosing the specific strategy or sector or stock at the right time.'

Borovkova: 'We should not only look at the performance of the various factors, but also assess them in the context of the global economy. For example, investors tend to forget that the “growth” factor thrives when interest rates are low and “value” does not. Now we are entering a period of higher interest rates and then the reverse applies.'

Are factors just coincidence or do they actually contain rationality?

Rozemuller: 'I think that factors and themes can be a kind of self-fulfilling prophecy to a certain extent. If everyone jumps on the bandwagon, the valuation will rise, but at some point investors will get disappointed and leave. This means that you must diversify and not limit yourself to one factor or one theme. Make sure you stay rational and rebalance, because that's the only way to avoid getting out at the bottom and trying to get back in when it goes up again.'

Borovkova: 'I believe Warren Buffett said that you have to take losses until they turn into profits.'

If everyone jumps on the bandwagon, the valuation will rise, but at some point investors will get disappointed and leave. This means that you must diversify and not limit yourself to one factor or one theme.

Rozemuller: 'Some people really try to hold on to their losses until they make a profit. If you do that with a single stock strategy, you're doomed to fail. It will probably work in a much more diversified portfolio.'

Huij: 'With regard to all relevant factors that exist, we have consistently established that you can actually earn factor premiums without taking on high risk. We therefore think that the hypothesis that there is a risk-based interpretation of the existence of factor premiums is not very likely. The existence of these premiums, I think, is more in the behavioral sphere. It is also interesting in this context that many investors, even seasoned investors, seem to confuse good companies with good investments. What creates the behavioral biases of investors that give rise to the existence of factor premiums? Perhaps the tendency of investors to walk away after a short period of underperformance also plays a role.'

In a pension fund, who should make the decision to invest in certain factors?

Vijver: 'That is the board, which is fed with information from advisers. You have experienced professionals here versus part-time board members, who are not seasoned investors. There is an enormously skewed relationship there, which is a major problem. Compared to about five years ago, there is a significant improvement. Professional investors such as pension funds must now have investment cases, which state, among other things, whether they want to invest passively or actively, whether they want a segregated mandate or a fund, a higher or lower tracking error, ESG standards, et cetera. With that you go from 'push' to 'pull'.'

Lesné: 'With a pension fund, just like with a central bank, an independent board is very important in order not to be influenced too much by banks and fiduciaries, for example.'

We prefer a good spread over scientifically proven risk-return factors to the use of macroeconomic variables.

Macroeconomic changes have had a major impact on equity returns in recent years. Do you somehow factor macro factors into portfolio construction?

Huij: 'Factors tend to behave differently in the different cycles of the economy. The problem with applying that insight is first of all that you have to be able to accurately predict the business cycle, which is very difficult. And second, almost all studies done in this area overlook the trading costs associated with rebalancing. We believe in diversification and a buy-and-hold strategy.'

Voermans: 'No, we prefer a good spread over scientifically proven risk return factors to the use of macroeconomic variables. We mainly make products with a low tracking error and low turnover. Macroeconomic factors cannot be put to good use in this.'

Lesné: 'We see investors trying to time the market and entering and exiting based on that. That is extremely difficult. In terms of trading costs, it might be helpful to bet big in order to overcome those costs, so to speak.'

Rozemuller: 'I am more of an agnostic investor, which means that I do not try to predict the market and do not look too much at macroeconomic conditions. One of my favorite forms of investing is equal weight. Because the portfolio will react to macroeconomic conditions, the portfolio tells me what to buy and what to sell. This agnostic way of investing looks good in the long run, but like any other strategy, you have to be able to ride it out. A disadvantage of equal weight is the trading costs. So you have to think about the rebalancing strategy and keep the frequency of rebalancing as low as possible.'

Read part 1 of the Round Table 'Market Cap Weighted & Factor Investing' here. Part 3 will appear on Thursday 14 September.