Asset Allocation and Factor Investing: An Integrated Approach
Early in 2018, Alain Bergeron from the Mackenzie Multi-Asset Strategies Team co-authored an article titled: "Asset Allocation and Factor Investing: An Integrated Approach" in The Journal of Portfolio Management, Third Edition 2018, at jpm.iijournals.com. Given the interest in the article, the same organization published a second article in the journal Practical Applications that discusses the practical implications of the concept. (Note: The articles are published in English only.)
This summary will provide some background on factor investing, asset allocation and portfolio construction for different macroeconomic regimes. As this article shows, factors can complement traditional methods of portfolio construction, especially when they are properly integrated as a component of a larger risk management and asset allocation framework.
What are factors?
- Factors are the underlying drivers of risk and return across assets and asset classes.
- They can be macro oriented (GDP, inflation etc.) or style-oriented (e.g., Value, Quality, etc.).
- Factors are not directly investable, but factor exposures are a by-product of investing in assets.
- Some factors perform better than others depending on the market environment.
Why should I care?
- Factor exposures contribute to the risk/return characteristics of your portfolio, whether or not you consider them explicitly in portfolio construction.
- Harnessing factors allows for an enhanced set of risk-management and return-generating tools.
- Understanding and managing factor exposures is emerging as an important element in total portfolio management.
- It has become a necessary component of any advanced asset allocation practice.
How are investors using factors today?
- Many institutional investors have embraced factor investing in the last decade or two.
- The proliferation of strategic or "smart" beta products has put the spotlight on factor investing and made it more accessible in the form of ETFs and mutual funds.
- Investors may attempt to use certain factors to achieve a specific investor outcome, permanently tilt their portfolios in favor of factors they believe will outperform, or try to trade factors to take advantage of a short-term market view.
- How best to incorporate factors into total portfolio management, and what that means for traditional methods of asset allocation, remains a highly debated topic.
- Useful as they may be, deliberately managing portfolio factors adds a layer of complexity to the portfolio management process.
- For those who intend to use factors effectively, it is imperative to do so according to a process grounded in thorough research that is complementary to a robust risk management system.
What is Mackenzie doing in factor investing?
- The Mackenzie Multi-Asset Strategies Team is committed to incorporating best practices into all areas of multi-asset portfolio management, including this dimension of factor investing.
- To that end, we have implemented an approach that integrates factor investing with strategic and tactical asset allocation and manager selection.
- In our view, investors should continue to use asset classes as the building blocks for forming portfolios, but they should combine them in a way that balances expected asset class risk, return, and correlations with adherence to a preferred set of factor exposures.
- Our approach preserves the benefits of investing in observable and directly accessible asset classes while permitting us to express a factor view and account for the risk in that factor view.
- In short, we have added factors to our tool kit in a way that is quantifiable, accountable and consistent with our risk management and asset-allocation framework.
- This is just one example of how we are continuously enhancing our tool kit and practices to deliver the best possible experience for our clients and partners.
For a deeper dive, please consult the full paper: "Asset Allocation and Factor Investing: An Integrated Approach" at jpm.iijournals.com and the article in Practical Applications. Of note, the papers explain the concepts that underlie our approach to illustrate the practicality. It is not a direct description of the process we use to manage portfolios.