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I view myself as a conductor. I deliver investment outcomes in terms of factors — broad, persistent drivers of returns. I think factors are going to be transformative but in order for them to be very wide-spread, we need data and technology. We need efficient investment vehicles. The way that I see data and technology is very similar to my phone, my smartphone.
And I love my smartphone. So we can deliver those types of intuitive investment styles across the world. We can trade them with ruthless efficiency and we can help them to achieve investment outcomes. Risk management has always been part of the DNA of this firm and factors have been central to that. Reducing risk or enhancing returns. Increased diversification. And factors help to meet those goals.
The opinions expressed are current as of January 1, and are subject to change. Yet passive strategies are far from perfect. They may appear to be cheap and prevent unpleasant surprises resulting from poor active calls. However, they ultimately lead to chronic underperformance relative to the market, especially once costs accounted for.
However, there are other concerns too. For example, due to their public transparency, passive strategies are prone to arbitrage. And their recent growth in popularity entails a risk of overcrowding. Also, because passive investing ignores decades of academic insights on factor premiums, replicating the market index implies investing a significant part of a portfolio in securities with negative expected returns.
Moreover, truly passive strategies cannot take sustainability considerations into account as they involve active investment choices. Meanwhile, the rise of computational power and the ability to store and process an ever-greater amount of data at low cost have profoundly changed the way financial markets operate. One of the most important transformations has been the emergence of quantitative investment strategies.
The rise of quant has, in turn, enabled new breeds of rules-based active selection approaches to emerge. Factor investing is one such example. The issues inherent in active and passive strategies have been instrumental in the rise of factor investing.
Many investors view factor investing as a third method of investing. It has features that are similar to passive investing, such as it is transparent, rules-based and low-cost nature. But, like active investing, it continuously aims to outperform the market. Targeting proven factors in an efficient way is clearly worth the effort, even after the effects of management fees, taxes, trading costs and investment restrictions. Allocating to multiple factors thereby increases the probability of success.
The factor investing label encompasses a wide variety of investment solutions that can be put to work in many different ways, using a broad array of investment vehicles. In short, factor investing offers a compelling alternative to traditional active and passive investment strategies. But, there are different approaches to factor investing, some more efficient than others. Enhancing returns One of the most important transformations in the financial industry in recent years has been the massive shift from active to passive investment strategies.
However, that shift has raised a number of concerns. For instance, although going down the passive route may be cheap and prevent unpleasant surprises from poor active calls, it ultimately leads to chronic underperformance once costs are taken into account. Passive strategies also expose investors to significant arbitrage risk. Against this backdrop, many investors have turned to factor investing in a bid to achieve superior risk-adjusted returns while keeping costs relatively low.
Reducing downside risk Risk reduction has risen high on the priority list of most investors in recent years. Products exploiting the low-volatility or low-risk factors could be an ideal tool to help them do so without foregoing return potential. Virtually unknown barely a decade ago, low-risk investing has become a broadly accepted and adopted approach in recent years.
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