DECIPHERING FACTOR-DRIVEN RETURNS

THE CHALLENGE

How can I avoid paying too much for factor-driven returns?

It is important to differentiate between active returns and alpha returns. Active return, or excess return above a benchmark, is not just driven by alpha (security selection and factor timing of the manager) but also by factor exposures.

What you see is not what you get, and it is important to understand the sources of returns to ensure that the high fees are associated with ‘pure alpha’ that cannot be replicated with a low-cost solution.

THE ACTION

Through decomposing the drivers of returns, we identified that a large portion of the excess returns generated by some alpha-seeking managers could be tied to static exposures from factors, and not from ‘pure alpha’.

Example of manager return decomposition

Manager return decomposition

Source: BlackRock, as at May 2020.
For illustrative purpose only.

Case studies are for illustrative purposes only; they are not meant as a guarantee of any future results or experience, and should not be interpreted as advice or a recommendation.

THE OUTCOME

The client opted to reduce reliance on some alpha-seeking managers, and instead take control of their own tactical views by using indexing to intentionally target specific factor and market exposures.

WHY INDEXING?

Recognising that the outperformance was frequently tied to static factor tilts, the client realised that they were potentially overpaying for returns.

By taking a more balanced allocation across index, factors and alpha, the client was able to maximise the efficiency of their risk and fee budget.

Risk: There can be no guarantee that the investment strategy can be successful and the value of investments may go down as well as up.

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