Andrew Ang, head of factor investing at BlackRock, is a well-known expert on what factors are, how they work, and the best way to efficiently implement them in a diversified strategy. He is a keynote speaker at this year’s Inside Smart Beta & Active ETFs conference taking place in Boston this week. Here Ang shares some of his insights wth us on all things factors.
ETF.com: You often say factors are a more efficient way to invest. Why is that always the case?
Andrew Ang: I like to think of factors as being investors' best friends.
We've always wanted to buy cheap securities, find and participate in trends, look for companies of high quality earnings. We're able to do that today with modern technology across thousands of stocks.
And, implemented very efficiently, they can be put it into transparent, easy-to-trade and tax-efficient vehicles like ETFs. All of those things mean we can gain access to these sources of returns efficiently.
What's new today is the delivery vehicle and the access, rather than the ideas themselves. These factors are all tried and true. But they've been transformative because we've been able to deliver them in new ways.
ETF.com: The innovation is in things like ETFs?
Ang: Yes, things like ETFs, and being able to pull lots of data sources together to create efficient indices.
One analogy I like to use is to think of factors like a smartphone. On my smartphone there's little that's new because we had hotels and airlines and maps, even the phone itself, cameras, we had all of that 30, 40 years ago. None of that is actually new. But the ability to put all of those things onto a phone has transformed my life. Factors are the phone.
We can now take all of these familiar, economically intuitive concepts of buying cheap, finding trends and gravitating to safety with minimum volatility strategies like the applications on our phone.
The innovation is in using them in transformative ways, being able to access them through data and technology.
ETF.com: Let's talk about value. Some say it needs to be redefined in a new economy. Some say all factor investing, in the end, boils down to value—buying cheap, watching it grow, selling high. Value certainly hasn’t worked in a while. What’s your take on this factor?
Ang: Value is one of half dozen important factors. I would never advocate that you should only do value. But value does have an important place, and it hasn’t done well over the last two years.
In 2018, our research shows that the drawdown of value was the fourth-worst since we started tracking this data that began in 1925; that's amazing—the fourth-worst in close to 100 years. It's not unprecedented; there are worse episodes. The worst one was 1999, and the 2018 episode was about half as bad as that.
Value started to stabilize in the fourth quarter of 2018. It has slightly underperformed this year, but it's nothing unusual. We've seen episodes of value underperformance before, often characterized by being in a very late economic cycle or during economic slowdowns in the middle of a recession.
If you take the top six to eight worst episodes for value over the past 100 years, they look just like the one we’re in. We’re in a late economic cycle that's been quite prolonged.
Value companies typically have a lot of fixed capital. They're very efficient at manufacturing goods or producing services, which gives them economies of scale, and they tend to do best in earlier in the cycle. Those same fixed costs mean they're more inflexible, and therefore other companies tend to outperform them late in the cycle. This is entirely consistent with economic theory.
ETF.com: Should investors reconsider their exposure to value at this time?
Ang: The drawdown for value, you should stay the course. It's a very important part of being a factor investor.
But please, let's not only do value. Take an active role with factors, and you could use that time variation of value and other factors across the business cycle to incrementally add returns with factor rotation.
ETF.com: How do you effectively rotate and mix factors? Northern Trust did a study recently that found a lot of institutional investors struggle to make factors work for them, and one of the big problems is in mixing them. You can dilute their impact or, worse, offset their premium with other factors. What’s the best way to do this?
Ang: This is a great point. What used to be a question of what (what is a factor) has evolved into a question of how (how to implement them).
We first should take a view on what factors ought to be appropriate for us. We said that a diversified, strategic allocation to multiple factors might be appropriate. You might think about slowly rotating those across time.
Sometimes we might dilute that factor exposure unintentionally, but we ought to maintain that efficiency and maximize that factor exposure.
There are three ways investors should do this.
First, know what you own. Understand the factors that are in your portfolio.
Second, ask if those factors are appropriate for you [based on your goals]. Otherwise, change the mix or change the active managers in your mix.
Third, evaluate how to get from the factors you own today to their optimal by looking across the whole spectrum of investments and vehicles available to you.
ETF.com: It's no easy job to be a factor investor. It's hard to imagine mom-and-pop-type investors figuring all this out.
Ang: That's true for all investments. It's very similar to running a restaurant.
If you think about what's required there, you need a recipe, but it also matters how you construct that recipe. You need access to great ingredients, so you want efficient vehicles and the ability to trade efficiently. Then, finally, the chef matters. That's putting all the pieces together.
That's a guideline investors can use—what’s the recipe, what are the ingredients, and who's the chef deciding what mix, and what factor fund to use.
ETF.com: And how many dollar signs are on that menu also matters a lot.
ETF.com: You speak often about factors on the conference circuit. Is there a question about factors or smart beta investing that you get often? Any confusion or myth about the space that just won't die?
Ang: The biggest question I often get is about passive versus active, or alpha versus beta. Those are outdated notions. Everything is an active decision. And factors are certainly the best active investment ideas. We've always had these ideas of buying cheap and finding trends and holding lower-risk securities.
It's not a question of “either/or,” it's a question of “and.” We should be using index and factors and alpha all in our portfolios deliberately. They have different purposes, different levels of transparency and, as you alluded to, different levels of cost. They all play important roles in our portfolios.
Factors are active. We’ve put them into more efficient vehicles and we’ve democratized access to these time-tested sources of returns. The frontier is doing factors in an active way, rotating factors through the business cycle, getting more proprietary and more diversified insights into different factor products.
But let's be clear that factors are active. All decisions of investments, in fact, are active.
Contact Cinthia Murphy at [email protected]