Some managers reserve the momentum factor for higher risk portfolios as it can be more volatile, but academic evidence does suggest that over time it produces better-than-market returns.
ESG/SRI – factor or filter?
Much marketing noise has been made about the concept of doing well by doing good – the purported virtuous circle associated with sustainable investing.
Responsible investing is a relatively new discipline, and there is simply not sufficient evidence to support the claim that environmental, social, and governance/socially responsible investing is a segment that will produce a persistent risk/reward premium.
Our approach is to assume that the associated filters and screens will introduce portfolio concentrations, skewed sectoral weightings, active share and associated noise – and that the investor’s assumption should be that such noise will be marginally negative.
That is not to say that there is anything wrong with responsible investing – on the contrary, it is a commendable approach. It is just that the approach should be conscience-led, not performance-led, and end client expectations should be tempered accordingly.
Costs matter
Advisers will be highly aware of the price their clients are paying for their investments, and of the importance of controlling those costs. The higher the price an investor pays to implement and maintain their portfolio, the lower the expected returns will be.
That notion is supported by numerous studies, and the Financial Conduct Authority also provided some ballast here in its 2017 asset management market study.
While the regulator concluded there was “no clear linear relationship” between the performance of active equity funds in the UK and charges, it did find “some evidence that the impact of higher fees for more expensive active funds on average has meant that they underperformed cheaper active funds”.
Systematic rebalancing
Disciplined evidence-based investors will rebalance their portfolios systematically. The cost of doing this with passive funds is minimal, and certainly less costly than the fees active managers incur when altering their funds.
Rebalancing tends to inherently mean banking returns from something that has performed well and reducing exposure to it, and amplifying exposure to an underperforming factor at lower valuations.
What does an evidence-based approach look like?
While the academic conclusions are relatively clear, market practitioners will inevitably adopt their own specific implementation if evidence-based investing.
But not all evidence-based propositions are created equal.
Evidence-based investing has become an over-used term that is often misused. Advisers considering an evidence-based proposition should take a good look under the hood and ensure that the approach suits them and their clients.
Some proponents may do things differently to others, some may only use the approach for part of their portfolio, and some may claim their actively run fund is driven by academic evidence.
