Beyond active and passive management
Denis Panel – Head of Multi Asset, Solutions and Quantitative Investments, BNP Paribas Asset Management
Behavioural biases explain why many investors both professional and amateur make mistakes. They are irrationally attracted to scarce probabilities. They are attracted to what they are familiar with. They have a tendency to underestimate the relevance of fundamental analysis and they are generally reluctant to change their minds. This is why we have to do things differently.
This belief has led our experts to develop a new generation of systematic strategies, called smart beta or factor investing.
Factor investing has sparked a profound transformation in asset management
Previously, investors could only choose between active investment management – focused on searching for sources of performance – and passive investment, which emphasises transparent portfolio construction by tracking a given index.
Factor investing now provides investors with a new option offering the best of these two worlds: strong performance potential and high transparency in security selection.
These strategies use research findings which have identified particular investment styles that humans generally follow – these are the so-called factors. Factors cover, for example, investing in quality companies, buying cheaply priced or good value stocks, buying lower-risk stocks and momentum investing. These factors have been shown by academic research to be associated with long-term outperformance. They are also generally underpinned by a rational economic justification.
While buying attractively priced stocks can be a winning long-term strategy, it is not perfect. As humans, our investment style is often a victim of our emotions and this can lead to subjective decisions.
Factor investing uses systematic implementation to remove all subjectivity from investment decisions. By investing in this unemotional and structured way, and using large investment universes, it is possible to take advantage of market inefficiencies.
In fact, many of these inefficiencies arise because other investors are too focused on, for instance, beating the benchmark index or they have simply been carried away by the latest market trend. Additionally, regulatory constraints can negatively influence investment decisions.
Most investors end up ignoring performance potential that can be captured efficiently with unemotional, systematic factor strategies.
How BNPP AM has the expertise to tackle this specific challenge
Since 2008, BNP Paribas Asset Management (BNPP AM) has been at the forefront of the factor-investing revolution, thanks to its extensive and diversified research capabilities.
The experience of BNPP AM in both active and passive investing is a key advantage in creating solutions that are both innovative and useful to investors.
Investors can now choose between different factor investing strategies across various asset classes:
The Guru range is a set of high-conviction fundamental strategies relying on three factors: Quality, Valuation and Momentum. Using the consensus of thousands of equity analysts on large universes with few constraints, these strategies have provided good returns until now by simply returning to the basics of equity investing: invest in good companies and you should obtain good returns over the long term. The excellent track record since 2008 should prove this.
The Low Volatility product range is a set of strategies using only one factor, Low Volatility, for simple, filter-based stock selection. This factor relates to the counter-intuitive finding that risk does not pay in equity investing and that choosing less risky stocks can actually improve both the risks and the returns of an equity portfolio. These defensive solutions are complementary to a diversified portfolio, mostly across difficult market regimes.
The DEFI range (Diversified Equity Factor Investing) uses four factors, Low Volatility in addition to the three factors used for the Guru range. It provides market-timing free, blended equity solutions which are adjusted to take into account the relative risk of the benchmark index. Their aim is to outperform the index or a peer group at a pre-defined level of relative risk. We believe the strength of this approach means it is particularly suitable for the core investments in a portfolio.
The Bond World Income strategy applies the factor-based approach to fixed income markets – credit and government bonds. It relies on the low-risk factor – similar to the low volatility approach to equities – to build a bond portfolio.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.