A proliferation of systematic indices that track individual equity risk premia is driving some structuring desks to take a more granular approach as they aim to deliver investment styles in purer form and attract interest from investors with a solely regional mandate.
For JP Morgan, which this month began selling its risk factor indices in exchange traded fund format through Societe Generale’s Lyxor platform, the solution has come in the form of a regional approach. By tracking MSCI Europe, JPM officials believe the indices provide cleaner exposure to individual investment styles.
“Our main objective is to generate clean and pure exposure to risk factors and that has led us to focus on a regional approach rather than the global approach that most other solutions take,” said Arnaud Jobert, executive director, equity derivatives structuring at JP Morgan. “We believe that to get outperformance, you need to do it through more granular investment styles.”
The majority of equity risk premia products track MSCI World, reflecting the global nature of sophisticated funds that were among the first to embrace the products.
Some providers of global factor funds are already mulling expansion along regional lines.
“The global approach appeals to a lot of sophisticated users and we think it makes a lot of sense, but some are keen to have products with a US or European perspective,” said Vincent Denoiseux, director and quantitative strategist for passive asset management at Deutsche Asset and Wealth Management.
He notes that the firm expects to launch regional versions of its strategies in the coming months. The German dealer currently lists four MSCI World-benchmarked factor ETFs on its db X-trackers platform, tracking value, quality, momentum and low beta. Assets under management total US$150m with almost US$60m in the value strategy.
The global approach is not something that JPM has ruled out as it plans to expand its value, quality, momentum, small cap and low beta products in the future. But rather than applying the methodology to a global index, the firm will create global versions from regional building blocks to avoid country biases.
For example, Jobert notes that global value strategies typically focus on lower-capitalised companies and currently generate a strong bias towards Japan. Meanwhile, momentum strategies generate a strong bias towards US stocks.
“A lot of factors behave very differently when you apply them across regions. When you look at Momentum from a global perspective, it really becomes a CTA product rather than a factor product,” he said.
But many believe that the global approach will continue to be the preferred route given the sophisticated nature of the products.
“We don’t think that one is better than the other, but it makes sense to start global and then expand the range to appeal to those that are constrained by a regional mandate,” said DeAWM’s Denoiseux.
Granularity
It isn’t just at the regional level that strategy differences are beginning to emerge. JPM aims to deliver targeted exposure by selecting just 40 stocks of the 440-constituent benchmark for its value index. By contrast, the MSCI’s own value index, which is tracked by a variety of exchange traded funds, covers around half the market cap of the entire index.
“By just picking the top decile for each strategy, it means we can offer something with a much richer factor content, which makes the use of these building blocks particularly efficient for expressing a tactical overweight view on a given style,” said Jobert. “The free cashflow yield that is generated by our value strategy is therefore bigger than what you may see in potential alternative value indices.”
But DeAWM prefers the diversified approach, investing in the majority of MSCI stocks for each strategy.
“We favour the tilted approach that takes long and short positions across the index rather than a very narrow and targeted approach as it’s quite similar to what active managers do,” said Denoiseux.
Denmark’s US$35bn PKA pension fund opened the floodgates to risk factor investing more than two years ago when it turned its back on traditional asset allocation and applied a risk premia approach across its entire equity portfolio. But the preference has shifted for fund-based solutions as a replacement for some active participation or market cap weighted passive investments.
“Dramatically modifying your entire asset allocation towards risk factors is not an easy task as it requires a lot of conviction and approval,” said Denoiseux. “The majority of investors are keeping a traditional perspective and looking at a bucket allocation process. Most are treating risk factors as strategic beta that can replace or complement equity allocation.”
While some aim to time shifts between factors based on market indicators – something that JPM aims to encourage through monthly research – the majority of investors continue to opt for a more diversified approach.
“We like the diversification across the separate funds and many investors are buying baskets of individual factors. In this landscape, to be simple is quite beautiful,” said Denoiseux.
