Strategic factor allocation

Jun 30, 2018

By incorporating factor insights into their asset allocations, we believe that investors can potentially construct better-diversified portfolios that may help them meet specific objectives.

One of the primary goals of the asset allocation process is to construct well-diversified portfolios that are designed to meet risk and return targets in a variety of market and macroeconomic environments.

Unfortunately, portfolios that appear diversified from an asset class perspective may be less diversified than investors think, as their risk is often concentrated in one or more macro factors.

Growth dominates

Macro factor decomposition of institutional portfolios

Growth dominates

Source: Aladdin, December 2016. Risk contribution is the risk decomposition of the portfolio by factor, taking into account the correlations between the factors and benefits of diversification, using a lookback period of 15-years. EMEA pension portfolio is based on a representative model portfolio using Mercer, OECD and BlackRock data as of December 2016. US Public Pension portfolio is based on the BlackRock Public Pension Peer Survey. US Insurance portfolio is based on BlackRock FIG Study (SNL Data). ‘Other’ includes risk contributions from style factor exposures and idiosyncratic risks. ‘FX’ is included to show an important source of risk common in institutional portfolios, however we do not consider it a rewarded factor and it is not included in the analysis going forward. See client portfolio components on Page 14 for information on the underlying asset allocation.

To help diversify their factor exposures, investors must understand which factors they own, which factors they want to own and how to adjust portfolios along factor lines.

To analyse an asset allocation through a factor lens, we need a way to translate seamlessly between assets and factors. Although analyses such as these leverage hundreds of thousands of data points, sophisticated tools and models can perform them in a matter of seconds.

Incorporating macro factor insights into the asset allocation process can provide a means to build a diversified portfolio from the ground up or to make adjustments to existing portfolios. Adding a targeted exposure to style factors can introduce an additional potential source of returns.

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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.There can be no assurance that performance will be enhanced or risk will be reduced for [funds/strategies] that seek to provide exposure to certain quantitative investment characteristics ('factors'). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a [fund/strategy] may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.