How Painful Can Factor Investing Get?
Current vs Past Agonies
August 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- A classic long-short, multi-factor portfolio has lost close to 20% since 2018
- The drawdown is within expectations, but the recovery period is abnormally long
- However, it’s difficult to argue for structural changes that make factor investing unattractive
SEEKING DIVERSIFICATION THROUGH MULTI-FACTOR PRODUCTS
Investors have flooded into multi-factor strategies over the last several years.
The latest FTSE Russell smart beta study found that 71% of the investors surveyed used such products, up from 49% in 2018. Single factor products were in far less demand. The two most popular – Low Volatility and Value – were used by only 35% and 28% of respondents, respectively.
This is understandable. Since individual factors are as cyclical as equity markets, multi-factor strategies offer diversification benefits and help moderate risk. For example, the Value factor generated negative excess returns in nine out of the last 10 years, constituting a lost decade for Value investors.
Still, while diversifying across factors yields more consistent performance, multi-factor strategies are not immune to significant drawdowns. The last 18 months have not been kind to factor investors, and multi-factor products – with an almost 20% decline – have provided little relief.
So just how painful can factor investing get? Placing the current drawdown in long-short, multi-factor products into historical context offers some insight.
THE CURRENT STATE OF FACTOR INVESTING
With outperformance so elusive in recent years, investors have poured almost $1 trillion into smart beta products – long-only strategies with factor tilts – in hopes of generating alpha. While smart beta differs from the long-short portfolios constructed in factor investing’s foundational academic research, asset managers have launched liquid alternative mutual funds and exchange
