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. Recently, the same authors published a second article in the journal Practical Applications that proposes a model for integrating factors with a traditional asset allocation methodology. (Note: The articles are published in English only.)
This summary will provide some background on factor investing and insight into the Mackenzie Multi-Asset Strategies Team's innovative approach to using factors. As you will discover, 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.
- The reality is that factor exposures have always come along with any investment portfolio or strategy. These exposures, however, are not always very clear and often drift over time.
- 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.