Institutional investors in Asia Pacific are showing increasing interest in applying factor investing to fixed income assets, despite a number of challenges facing this approach, according to this year’s Invesco factor investing study released Monday.
The study conducted interviews with 241 pension funds, insurers, sovereign investors, asset consultants, wealth managers and private banks from around the world which say they are “factor-users”.
Together these investors managed $25.1 trillion in assets as of March 31. Seventy-three of these respondents are based in Asia.
Invesco noted that 76% of institutional investor* and 75% of wholesale investor** respondents based in Asia Pacific believe that factor investing can be applied to fixed income as an asset class, ahead of the global institutional average of 70%. The study also asserted that 32% of institutional investors and 29% of wholesale investors in the region added to fixed income factors over the past year, without stating from what base level.
Invesco argues that many more institutional investors will adopt these strategies in the near future, said Stephan Quance, global director of factor investing at Invesco.
He added that factor investors are generally satisfied with the results with this approach, and that investors have been looking to adopt more factor investing in Asia Pacific and globally due to a desire to reduce risk, increase returns and reduce cost. Such strategies are usually being priced below traditional active approaches and above pure market replication, Quance noted.
It’s worth noting that Invesco offers several factor-based products in its broader factor product array, so it stands to potentially benefit from a rise in institutional investor engagement.
While factor investing has gained a lot of ground in the equity space, there are sizeable challenges when it comes to applying the approach to fixed income instruments, Quance and other experts noted.
“Despite demand for the application of factor strategies within fixed income, a shortage of appropriate products is still evident, with nearly nine in 10 respondents describing this asset class (fixed income) as not well covered by current factor offerings, [in terms of both] quantity and quality of available offerings,” he said.
There were also concerns related to the lack of consensus around definitions as well challenges related to data and modelling, he added.
Indeed, the Bureau of Labor Funds (BLF) in Taiwan had been mulling an investment mandate that would employ an enhanced indexing, or smart beta, strategy for its overseas bond portfolio, having already done so with some of its equity investments.
However, the pension fund said in June that it would not go ahead with the idea this year because it could not find the right benchmark, despite holding discussions with international index providers.
One issue is that the factors used in fixed income are more technical than those used for equity instruments. For example, the factor “carry” in the equity space is linked to the dividend yield of the stock, while in fixed income it is related to the shape of the relevant yield curve and price gain on the bond, said Arom Pathammavong, managing director for indices at FTSE Russell.
There are also practical obstacles for index companies when it comes to collecting data for compiling the benchmark. Stock markets are highly transparent and liquid, but it’s an over-the-counter market for bonds, so the bid-offer spread will be wider than on stocks, he said. And not all bonds trade every day.
The study also found that 79% of Asia Pacific respondents and 84% of global investors think that factor investing can be used to address the environmental aspects of asset portfolios.
Most investors believed that elements of environmental, social and governance (ESG) could be incorporated through factor investing, particularly environment aspects. Some respondents have embraced ESG investing within the context of multi-factor portfolios, as these can highlight the correlation between ESG factors and other factors such as quality and low volatility, Quance said.
Factor models allowed the investors to incorporate quantitative ESG criteria in a relatively low-cost manner. One such investor implements ESG and multi-factor investing via a custom index, as this offered more transparent implementation, among other benefits, he noted.
BLF handed out a five-year NT$42 billion ($1.4 billion) ESG investment mandate early last year, which tracks the FTSE4Good TIP Taiwan ESG Index.
*Institutional investors are defined as pension funds (both defined benefit and defined contribution), sovereign wealth funds, insurers, endowments and foundations.
**Wholesale investors are defined as discretionary managers or model portfolio constructors for pools of aggregated retail investor assets, including discretionary investment teams and fund selectors at private banks and financial advice providers, as well as discretionary fund managers serving those intermediaries.