Factor investing has become one of the most popular topics in institutional investing today, but there are still few asset managers that have adopted strategies that include anomalies, such as value, low volatility or small cap, as they are described in academic literature.
Do Factors Outperform?
Yet those that have do seem to outperform, says Eduard van Gelderen, who until recently was Chief Investment Officer of APG Group and Chief Executive Officer of APG Asset Management.
In 2014, Van Gelderen published a research paper with his friend, Joop Huij, Senior Vice President at Dutch asset manager Robeco and Associate Professor of Finance at Rotterdam School of Management.
In this paper, they looked at a large set of United States mutual funds and found only a small group of strategies showed patterns that were consistent with anomalies described in academic literature.
“[Factor investing] gets a lot of attention, but the first conclusion from the study that I did with Joop is that there’s only a small percentage of [funds] that implements factors,” Van Gelderen says.
“But if you look at whether there is a performance difference between the group that implements factors and the group that does not, then the answer is ‘yes’.
“The group that implements factors has better results, but it remains a very small group.”
Now, Van Gelderen and Huij have revisited the study to see if things have changed over the last few years.
But despite all the attention factor investing has received, this seems not to be the case.
“Now, with the follow-up study, we can add another two years of data, and actually the initial conclusions still stand,” he says.
Asked why not more funds have implemented theses anomalies, as there is evidence that they are persistent, even after they have been described, Van Gelderen says this hasn’t been clarified yet.
“It is an interesting point. Actually, we should dive into it to see how we get those results, because it could be that a much larger group is interested in factor investing, but they might fail at the execution stage. That is not reflected by the data right now, but that may well be the case,” he says.
“Take a group like AQR, for example. It is interesting to see that they publish their full findings. If you ask [AQR founder Cliff Asness]: ‘Why do you do that? You expose the whole thing!’, then he will reply: ‘That may be so, but the execution is so complex that we have no issues with publishing these factors.’ And that has proven to be true, when you look at the results.”
What the research shows is that if you take three or four factors together, then the outcome is better than singling out one factor. But timing between factors? For now, that’s very difficult
But Van Gelderen also points out there is little incentive within the industry to promote an academic approach to factor investing more widely.
“A more cynical answer would be that many asset managers have no benefit in promoting these strategies,” he notes.
“Look, you can say that factor investing is perhaps not passive, but it is still alternative betas so the fee thereon will be lower than on current [strategies]. From a business model point of view, there is no incentive to say: ‘Let’s push that.’
“And let’s face it, there are periods, we have just left one behind us, when factors simply do not work or do not perform so well. Value investing can be seen as a factor, but it hasn’t done well in recent years.
“You can say that it is less bad when you take multiple factors and diversify across them, but if it takes a long time to come back, then you might start to have doubts.”
Asked whether factors can be timed, he answers cautiously.
“Well timing, I think, is very difficult,” he says.
“What the research shows is that if you take three or four factors together, then the outcome is better than singling out one factor. But timing between factors? For now, that’s very difficult.”
University of California
Van Gelderen has already left APG when I meet him, but he still prefers to catch up outside the pension fund’s asset management building at the Zuidas in Amsterdam, because it is only a bike ride away from his home.
And that is not just a figure of speech.
Van Gelderen may have been running the investment arm for one of the largest pension funds in the world at €452 billion (A$675 billion), but when the interview ends, he gets on his bike to cycle home, suit and all.
But all that will change soon, because in May this year he announced he was leaving APG to take on an equity and real assets role with the University of California’s Office of the Chief Investment Officer of the Regents, swapping Amsterdam for San Francisco.
The office runs pension, endowment and retirement money for all of the university’s campuses and business schools, adding up to roughly US$100 billion in assets.
Van Gelderen does not beat around the bush when asked why he decided to leave APG and join the University of California.
“I felt I had too much of a managerial role and, to be honest, my heart is not really in that. My whole career, I’ve always worked in financial markets and I found that I was too far removed from it,” he says.
“Basically, as a board member of APG Group we do a lot, but little is about investing.”
Jagdeep Singh Bachher, who heads up the Office of the Chief Investment Officer of the Regents at the University of California, asked Van Gelderen a while ago whether he was interested in joining his team, but Van Gelderen said the timing wasn’t right.
“There is a global network [of asset owners] and, of course, we know the likes of AustralianSuper and GIC well. We were also in touch with the University of California,” he says.
“Three years ago, Jagdeep had already asked: ‘Won’t you come over to my side?’ But then I had just been appointed as CEO of the asset management team here and I thought it would be a bit harsh to say so shortly after that: ‘I’m out of here.’”
But now, he felt it was time to get more hands-on with investment issues again.
Van Gelderen is also attracted by the access to the university’s deep knowledge base.
“During my career I have always been on the innovative side, so I wanted to be there where new things happen,” he says.
“What I like about this is that it really is part of the university, so you also have access to the Haas School of Business, for example. There’s lots of brainpower in the university in the field of business and investments.
“But there are also lots of start-ups that come out of the university; there’s lots of intellectual capital which can be invested in.”
Van Gelderen will conduct a review of the equity portfolio and the university has already been reducing the number of external managers it uses.
But he will also look at the split between active, passive and quantitative strategies, which could see factor investment strategies being implemented at the university.
In recent years, if you had a standard asset mix and you had allocated that passively, then your total returns would have been very good. But the danger is that you will take that as a proxy with the idea that if we extrapolate that into the future, then we will be okay.
But Van Gelderen says passive investing is not without risk.
“In recent years, if you had a standard asset mix and you had allocated that passively, then your total returns would have been very good,” he says.
“But the danger is that you will take that as a proxy with the idea that if we extrapolate that into the future, then we will be okay.
“We are in a whole different world now than we have been in the past 10 years; rates will eventually rise again and then you get very different results. I think most pension funds realise that.”
Besides, he says, focusing solely on passive investing could come at the expense of losing valuable skills.
“Those funds that have completely focused on passive management in recent years, you may wonder if they still have the skill set in-house to go to an active policy.
“What I think is really dangerous is if these funds suddenly become active again and adopt a view of the market. I think there is no chance of that working out.”
Van Gelderen on Knowledge Management
For Van Gelderen, these choices between active and passive or in-house and external management have many touch points with an area of study close to his heart: knowledge management.
He has written in the past on the subject with Ashby Monk, an Executive and Research Director of the Stanford Global Projects Center. Monk is also Senior Adviser to the Chief Investment Officer of the University of California and Van Gelderen is looking forward to working more closely with him.
“Knowledge management is about: ‘How do you make sure you have the right knowledge within an organisation that is relevant for investing?’” he says.
“There is actually very little known about knowledge management within the asset management industry. But now with all the new technology, including big data and machine learning, we know that it will really change the way we manage assets.”
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.