By Cedric Tang, head, asset owner group, North Asia
Factor investing has proven to be an effective and efficient mechanism in recent months to make the most of the diversity offered by China’s fast-recovering stock market while the global economy struggles under the weight of growing coronavirus cases.
The growing use of factor index data in the portfolio construction process and the continual increases in the size of assets tracking these indexes serve to emphasize the success of factor investing. Further, our analysis shows [see charts below] that Quality and Momentum factors, in particular, outperformed the parent FTSE Russell benchmarks in both the China A and non-A shares markets.
Cumulative Relative Performance (vs FTSE Total China Connect Index) – Gross Total Return (USD)
Source: FTSE Russell as of June 30, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Cumulative Relative Performance (vs FTSE China ex A Shares Index) – Gross Total Return (USD)
Source: FTSE Russell as of June 30, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Indeed, while Quality and Momentum have done well globally they have been especially successful in helping drive the performance of stock markets in the US and China. There are two key reasons for this: For one, these factors gained ground other factors such as the (Low) Size in the third quarter as investors chose stocks offering high returns on assets (ROA) and low exposure to debt and megacaps.
Additionally, larger weightings to outperforming sectors such as Technology and being underweight in the struggling Financial sector, which has been hit hard by a persistent low-interest rate environment globally also helped Quality and Momentum excel, with the former benefiting the most thanks to the sustained popularity of companies with strong finances
The right fit
Factor investing has become increasingly common in China’s equity markets - the world’s second largest, behind only the United States, with a total market capitalization of over USD 10 trillion.[1]
Numerous global investors managing Chinese funds of stocks listed in Hong Kong as well as in the country’s massive mainland market use active strategies that deploy factor considerations. Meanwhile, quantitative investment strategies typically associated with hedge funds and specialist fund managers are becoming more widespread, fueling the launch of factor-based ETFs, including on the mainland.
Furthermore, multi-factor solutions are ideal for those who take a long-term view and prefer to diversify their risk to avoid the cyclical downside of focusing on individual factors whilst still capturing various risk premia. Investors looking to invest in companies that meet specific environmental, social and governance objectives can also turn to factors aimed at sustainable finance or mitigating climate change.
To be sure, as these charts show, there is a clear dispersion of performance among different factors. And it’s important to understand that factors will perform differently throughout an economic cycle, or under different market growth or stress: for instance, the Size factor performed differently for A and non-A shares while Pure Volatility showed long-term risk premia in the A-shares market.
Cumulative Relative Performance (vs FTSE China A Free Index) – Gross Total Return (CNY)
Source: FTSE Russell as of 30 June 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
So, while individual factors have their ups and downs, and returns from factor investing can be cyclical, it is advisable to look at the performance of factors over the long term. Investors can also use a rotation strategy to switch among factors to counter the downsides—just like one would do to address the cyclical nature of certain industries or sectors.
Growing appeal
It is this versatility, which serves a range of investment goals, that makes factor investing worthy of consideration. For investors with a specific risk-return requirement, single-factor solutions are ideal as they allow for achieving a certain level of exposure to a coveted factor or, by the same token, neutralize undesired exposure to other factors.
There has been similarly growing demand for multi-factor indexes, which use a mix of factors combined in a variety of methodologies to target and achieve precise exposures to certain risk or alpha factors. These combinations can be of two or three or even four or five factors with varying tilts to each of these factors, and these designs have proven to be more efficient than market cap indexes from a risk-return standpoint.
Cost savings is another reason for the growing popularity of the smart beta strategy, which, as a recent survey shows, is increasingly replacing costly active fund management strategies. In 2019, global smart beta adoption rates reached a record high of 58 percent with multi-factor index-based strategies reported as the most widely adopted smart beta equity strategies.
[1] FTSE China Equity Indexes Presentation, FTSE Russell – July 2020
© 2020 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) MTSNext Limited (“MTSNext”), (5) Mergent, Inc. (“Mergent”), (6) FTSE Fixed Income LLC (“FTSE FI”), (7) The Yield Book Inc (“YB”) and (8) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “MTS®”, “FTSE4Good®”, “ICB®”, “Mergent®”, “The Yield Book®”, “Beyond Ratings®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, FTSE Canada, Mergent, FTSE FI, YB or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell products, including but not limited to indexes, data and analytics, or the fitness or suitability of the FTSE Russell products for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell products is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing contained in this document or accessible through FTSE Russell Indexes, including statistical data and industry reports, should be taken as constituting financial or investment advice or a financial promotion.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This publication may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB and/or their respective licensors.
