Fidelity Canada explains how strategy can be adapted to different needs to enhance client experience
The concept of factor-based investing is not new. Dating back to the 1960s, the idea of focusing on what factors drove stocks was the foundation to what factor-based investing has become today. Back then, an importance was placed on market and company risk, but as the industry evolved and more information became available, more risks started to be identified and ultimately, more factors created. Now, factor-based investing has become more common as product producers aim to offer more customizable approaches to fit individual investor needs.
“In the early 2000s factor-based investing started taking off,” said Andrew Clee, vice president, ETFs, Fidelity Canada. “Essentially the thesis is: identify market anomalies that go against the market hypothesis that says we should be able to outperform broad indices, reduce volatility or enhance the yield. If we can capture these risk premiums, the strategies have the opportunity to outperform or offer superior risk-adjusted returns over time.”
When it comes to factors, there are a number that have evolved out of the analysis from the early days. Dividends, low volatility, quality, value, momentum and size are all strategies that investors can employ with various products on the market.
Factor-based ETFs have become one of the fastest growing areas within the ETF landscape. For Clee, he believes it is because of factor strategies putting an importance on the client experience and allowing for tailored solutions that meet the individual needs of investors. “Historically, when ETFs launched, 90-95% of the market was in market-cap weighted ETFs, whether the S&P 500 or TSX. Back then, we were essentially saying one size fits all. The conclusion was that every investor should be invested in the S&P 500 or S&P/TSX. We are now getting past one-size fits all and allowing clients to tailor portfolios to their unique circumstances.”
Clee says that certain factors can help different types of investors by allowing advisors to create a customized portfolio and address specific circumstances. “A retiree for example, who lives on their RRSP as source of income has different requirements than an investor who is 30-years-old with a 30-year investment horizon. If you have a client nearing retirement, income might not be a requirement but reducing volatility is, so a low volatility ETF makes sense. Similarly, if you had a retiree that did need income, a dividend ETF would allow them to enhance the yield or income distribution on a monthly basis. If you take high quality, that allows you to create a higher quality company profile in your portfolio. With factors we can address unique needs of each investor.”
Given current demographics and market conditions, Clee says that dividend and low volatility strategies are the most popular, with momentum and quality starting to see growth. “I think where we are in the market cycle and with demographics, dividends makes sense given an aging profile and with interest rates low, we are seeing clients move into dividend-focus products to enhance yield.”
As for challenges in the space, Clee notes that factors can be cyclical and while there is research to show that over the long term they tend to outperform the broad market, there can also be underperformance. “You need to understand why you own the ETF. If it’s to address income needs, there could be periods where dividends could underperform or over perform based on moves in the business cycle. I think that cyclicality can be a challenge.”
For advisors looking to incorporate factor strategies into their clients’ portfolios, Clee says the most important thing is to know each client’s unique situation. By determining both short and long-term goals, advisors can create the most customized solution for the client. “I think factor ETFs can play a pivotal role in the portfolio construction phase because they allow for customization at a more personal level than a passive ETF.”
Clee also notes that factors can be used by an advisor in an asset allocation manner as they can use them to express a certain view towards the market and can be used as part of a long-term approach to outperform a passive strategy.
For Clee, he believes that factor-based investing will continue to grow as the industry embraces goals-based solutions. “Looking at trends around the world, the industry is looking at how a client gets to their end goal. Factor-based plays a role in that, in how to build a portfolio that meets the risk/return objectives of the client and their unique goals. I think that will lead to more growth in the factor-based investing space.”
