At a time when correlations are high and assets seem to rise and fall in lockstep, factor-based investing has been garnering a lot of attention. By focusing not on individual stocks but on attributes such as market capitalization, style and performance relative to the market, proponents of factor-based investing argue that an investor can enjoy better performance and relatively low correlation between the individual factors. Academics have been crunching the numbers for years—layering their research over a traditional passive strategy creates a compelling recipe for investors that has been labelled enhanced or “smart” beta.
It’s not exactly a new idea—value investing, for example, which focuses on the cheapest stocks, has been around for decades. But in the exchange-traded fund (ETF) space, factors are being used to create products that help investors zero in on areas of the market they believe will outperform, rather than just passively riding the ups and downs.
BlackRock (BLK) Inc. (BLK)’s iShares, Charles Schwab Investment Management and Northern Trust Corp.’s FlexShares are among those that have recently launched ETFs based on investment factors such as value, profitability, size and momentum.
The launch of these ETFs follows on the success of factor giant Dimensional Fund Advisors, which has, for years, spun academic research into long-term returns. Dimensional has seen $11 billion in inflows in the first half of 2013—among the highest of any of the 10 largest mutual fund companies.
The trend to factor-based investing could be a boost for ETF providers looking to get a foothold in the pension space. For example, iShares worked with the Arizona State Retirement System on some of its products—the pension fund seeded three of them with $100 million each. This kind of collaboration shows just how serious providers are about bringing ETFs to the institutional space.
As equity markets get harder to read, it seems as if investors are turning back to the ivory tower for some direction and a little academic wisdom mixed in with their passive approach.