How Investors Are Using Factors Now

October 09, 2018

Holly FramstedRecently BlackRock released its Factor Box tool, which allows users to search hundreds of mutual funds and ETFs for their exposure to six key factors: value, size, momentum, quality, dividend yield and low volatility. 

It's a powerful tool for financial advisors and individual investors, who can't always access the wealth of research on factor investing available to institutional investors. recently spoke with Holly Framsted, head of U.S. smart beta for BlackRock, to talk about the Factor Box tool, how insurers and advisors differ in their ETF use, and other conversations she's having with clients about factors right now. We're seeing a lot of issuers slashing prices on their smart-beta ETFs lately. What impact do you see this having on the space moving forward?

Holly Framsted: Price is obviously an important and timely topic in the ETF landscape. But in the case of smart beta in particular, you really should be aware of what it is you're paying for. 

We've spent a lot of time this year thinking through why clients are anchored on fee as their kind of first go-to. And what we've come to is that it's because there aren't very many widespread tools that allow you to fully evaluate factor products. Seeing a particular fund's specific factor exposures has actually been quite difficult for the financial advisor community and home offices within wealth advisories; that's why we created the Factor Box tool Do you find those advisors are using smart beta ETFs to complement vanilla, indexed exposure, or to replace it?

Framsted: A bit of both. I've yet to talk to a client who's selling everything they own and buying a whole portfolio of smart beta. In reality, we tend to see factor [products] complementing both active and passive allocations. Depending on the problem the advisor is trying to solve, they may replace an active manager, or some beta exposure instead, to make that purchase.

That being said, smart beta—like multifactor funds—can be a really important part of the core portfolio. It doesn't have to be on the fringes. Often, you'll see them paired alongside an IVV (iShares Core S&P 500 ETF). Or maybe the client decided that their large growth or value manager is underperforming, so they replace that core exposure with a single-factor or multifactor strategy, and also reduce cost. Is institutional use of factor ETFs different than retail use?

Framsted: Yes. Institutions have been some of the leading investors in ETF factor strategies. Some large pensions, for example, have restructured their entire portfolios around factor strategies. We're also having conversations with large insurance companies about the benefits of minimum volatility, for example.

But institutional adoption is more nuanced. That's because institutions can access commingled trust funds, separate accounts, and other various structures besides ETFs to leverage factors. If that's the case, why would they use a factor ETF at all?

Framsted: It depends on the client, but a lot of the institutional use cases for exchange-traded funds generally also apply in the case of factors. For insurance companies, for example, that buy ETFs, the contracting process for a commingled trust fund or an SMA and the associated potential illiquidity aren't what they're looking for. So the liquidity that ETFs provide can be really compelling. We've seen insurance companies in particular increase their use of ETFs. What are you hearing from insurers on what they're looking for from ETFs?

Framsted: With insurance companies, the conversation most often centers around risk mitigation and their equity allocation. For many insurers, their equity allocation is a higher capital charge. Therefore, they need to be very intentional about how they're spending that capital.

So most start with leveraging minimum-volatility strategies or high-dividend-yielding strategies, because they look similar to bonds, and most of an insurer's general account tends to concentrate in bond portfolios. When they take on equity risk, many insurers don't want to step too far away from that spectrum; but maybe they need to increase their income in a fairly low-yielding environment.

At the same time, we're also seeing insurers think differently about how they can maximize that capital charge they're taking. The thinking goes: If you're going to take a higher capital charge, then you should make the most out of that investment. So then be a bit more aggressive in your equities; ensure you're achieving the maximum potential outperformance for the charges you're taking on. So we're equally having conversations with insurers about the return-seeking end of the spectrum.

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