Factors making waves

Capital at risk. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

Already at $1.9 trillion in AUM today, we project factor strategies will rapidly reach $3.4 trillion by 2022.1

Admit it, you’ve felt it. Being part of something growing, energizing, and bigger than ourselves. At a concert, with the roar of the crowd reflecting the energy of the band. On a catamaran, zipping across the water with the wind whistling in the sails. And still one of my favourites because I grew up in Australia—anticipating the perfect wave, on which to bodysurf onto the beach.

Factor investing—investing in broad and persistent drivers of returns—is like that wave. I believe we’re at the beginning of this movement with much, much more growth to come.

BlackRock recently published research estimating current and past growth of factor-based investment strategies over the last five years. Factors have experienced 11% organic asset growth—approximately three times the growth of the asset management industry, on average. These growth rates are expected to continue, projecting growth to reach $3.4 trillion in five years.1

1 Source: BlackRock as of 31/12/2017

The swell

Our research focused on flows into three major forms of factor investing

  • Smart Beta: Transparent, rules-based third-party index-based versions of factor investing, most conveniently accessed through ETFs. Investors often use Smart Beta ETFs to replace underperforming traditional mutual funds, or to seek enhanced returns or reduced risk relative to market-capitalization index benchmarks. Smart beta has grown at close to 20% over the last five years.
  • Proprietary Factors: These contain proprietary factor signals, as opposed to the fully transparent insights in index Smart Beta strategies. These are typically accessed through factor-based mutual funds. Investors can use proprietary factor strategies to complement traditional active and index strategies. Over the next five years, we expect Proprietary Factor strategies to grow at 7%.
  • Enhanced Factors: Dynamically managed strategies in long-short and multi-asset form. Enhanced Factor strategies are often used by investors seeking low or zero-correlation return strategies or to replace hedge fund allocations. We forecast this to be the fastest growing area of factor investing, at 20% to reach $650 billion by 2022.

Industry factors AUM($B)

factors-making-waves-chart

Source: BlackRock, Simfund for mutual fund data, BlackRock for ETF data, eVestment and Preqin for institutional and alternative data. Mutual fund and ETF data as of 12/31/17, eVestment and Preqin as of 9/30/17. Excludes fund of funds. Enhanced factors data is likely underrepresented given limitations of institutional and alternative data sources. Projections exclude the impact of beta.

Carve the flow

Interest in factor-based strategies is seen both from global institutional and retail investors.

Industry factors 2017 AUM by channel ($B)

factors-making-waves-chart

Source: BlackRock, Simfund for mutual fund data, BlackRock for ETF data, eVestment and Preqin for institutional and alternative data. Mutual fund and ETF data as of 12/31/17, eVestment and Preqin as of 9/30/17. Excludes fund of funds. Enhanced factors data is likely underrepresented given limitations of institutional and alternative data sources.

  • Global institutions hold more than $1 trillion in factor strategies.2 In particular, they account for a disproportionate share of Enhanced Factor Strategies as they continue to seek diversified sources of returns.
  • At $740 billion, the U.S. Wealth segment is the fastest growing channel due to the dominance of rapid Smart Beta ETF adoption. 2 The structural shifts to greater transparency, the move to lower fees, and increased regulatory scrutiny will likely accelerate this change.
  • International Wealth ($155 billion AUM) is a smaller but growing market with a mix of all three forms of factor products. 2 Recent regulatory changes, such as MIFID II, have resulted in similar dynamics that facilitated the rapid adoption of Smart Beta ETFs in the U.S Wealth market. As a result, we expect the adoption of Smart Beta ETFs, and ETFs more broadly, to continue in the EMEA region as investors come to grips with this new regulation.

2 Source: BlackRock, Simfund for mutual fund data, BlackRock for ETF data, eVestment and Preqin for institutional and alternative data. Mutual fund and ETF data as of 12/31/17, eVestment and Preqin as of 9/30/17. Excludes fund of funds. Enhanced factors data is likely underrepresented given limitations of institutional and alternative data sources.

A market shift 

In the EU, the implementation of MIFID II has resulted greater transparency requirements for investments, as well as a greater focus on the cost of these investments. In this new regulatory backdrop, smart beta ETFs may prove a valuable tool to add to an investor’s toolkit for a variety of reasons.

Smart Beta ETFs are transparent, index-based versions of factor investing. They provide exposure to well known-drivers of long-term returns, such as value, quality, momentum, size and reduced volatility. As a result, Smart Beta ETFs may help investors outperform the market at a low-cost while providing investors complete transparency on their investment.

 

Making waves

The proliferation of factors is not only due to factors being used as an investment, but also as essential elements of portfolio construction. The current approach of investing along asset classes can double count risks and may not deliver effective diversification that investors need. Based on solid economic rationales, factors could form the foundation of the portfolio of the future. In five years, we believe a significant fraction of investors will likely be using factors directly to construct more robust portfolios and to pursue specific investment objectives.

Factors have the potential to revolutionize the investment landscape as investors challenge the status quo—and these projections are far from the crest of where we believe factors are going. To see our views around structural trends supporting future growth, read our full report.

Factors are here and growing – let’s go catch the wave.

Andrew Ang
BlackRock's Factor-Based Strategies Group

MKTG0818E-580455-1822910