Exposure to generic asset pricing factors can help deliver risk-adjusted returns, according to Ryan Taliaferro, senior vice-president and director of investment strategies at Acadian Asset Management, speaking during the Canadian Investment Review’s 2024 Risk Management Conference.
These products tend to be available off the shelf in commercially available risk models and are typically marketed by exchange-traded funds and other vehicles designed to gain access to one of these factors, he noted. “The formula that you would use to invent that single data item is well known [and] well understood, so it’s easy to do and the fees turn out to be considerably less than active management fees.”
Taliaferro suggested portfolio managers keep generic factor exposures in their actively managed portfolios because many have positive characteristics and it’s fairly easy to identify the subset that are risk factors. “Good systematic managers who are already thinking about liquidity and time variant exposures are actually much better suited to handle [these factors] than if they were to be extracted and . . . centralized somewhere else.”
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Well-known, value-based examples of small-cap stocks that grow quickly tend to do worse in terms of the returns on their common shares, he added. “If in the recent past, your balance sheet has grown quickly, that tends to be a negative signal. And that’s fairly robust. . . . While the small cap starts off by showing a pretty good spread with lots of opportunities for stocks picking, farther down the cap spectrum, the spread decreases, becoming sharper on the asset growth side and then quickly collapses.”
If a generic bulk beta product — often in an ETF — is engineered specifically to have low fees and needs to be ready for large volumes, essentially just mega and large caps, it won’t have much efficacy, said Taliaferro. “If you really want the exposure to work, you’re going to need to be able to manage liquidity down the cap spectrum.”
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Generic factors can predict returns primarily in smaller, harder to trade stocks, which is why liquidity management is vital, he said, adding the optimal exposure will be time varying rather than static. “The best use of these things, I think, requires understanding not just of the risk and return profile — which are different [and] . . . do favour proprietary over generic — but I don’t think, at least on the first path, you would say you should use zero generics out.”
It’s actually very easy for managers to purge generic exposure, he noted. “However, it does drive turnover and there will be related costs associated with that as you keep trying to make sure the portfolio is clean of these various generic exposures. And I think [that] very likely lowers the average return in a way that would be hard to replace.”
Read more coverage of the 2024 Risk Management Conference.