20 years of factor investing: a smoothing of market peaks and troughs
Investing in factor premiums is challenging. Factors are cyclical and there can be setbacks from time to time. But there are recipes for success. This is demonstrated by the example of a systematic and sustainable Swisscanto investment strategy, which is celebrating its 20th anniversary this year.
Authors: Veronika Hofmann, Product Specialist, and Fabian Ackermann, Portfolio Manager
Discipline, over many years: This is a fundamental requirement when investing in factor premiums. That is because the investment strategies that exploit certain characteristics of securities to generate above-average returns are cyclical. Setbacks in several factors - as we have seen in 2019 and 2020 - are always to be expected.
Combination is recommended
Given this cyclicality, a steady investment in factor premiums pays off. However, as different factors perform differently in different market phases (see chart below), a combination of factors is recommended. If one factor underperforms in a particular market phase, the other factors may often compensate. This can smooth out volatility, reduce overall risk and lead the portfolio to more stable returns.
Searching for the optimal mix of premiums over time
Performance of different factor premiums since 1998
In our fund ‘Swisscanto Equity Fund Systematic Responsible World Enhanced’ (see box below), we have also given equal weight to the individual factors in our multifactor model. This enables us to reduce the timing risk.
Avoid emotional investment decisions
The Swisscanto 'Equity Fund Systematic Responsible World Enhanced' pursues an active, systematic and sustainable multi-factor strategy. This is based on the factors of value (undervalued equities), quality (high-quality equities) and momentum (equities with a positive price trend). In addition, elements of indexed investment strategies are integrated to avoid unwanted cluster risks, and the broad diversification of securities tends to reduce the risk of individual stocks. Finally, a rigorous systematic approach avoids the emotional investment decisions that often lead to sub-optimal investment results.
Since its launch 20 years ago, the investment strategy has beaten its benchmark (MSCI World ex Switzerland) 15 times, including twelve years in a row. As of 31 October 2024, the Enhanced sub-fund's assets have grown to more than CHF 2.9 billion. Portfolio manager Michael Bretscher sees this result as a testament to the strength and consistency of the investment strategy.
A deceptive glance into the crystal ball
This works better than the proverbial crystal ball: style rotations, in which fund managers try to time factors with an eye to the future, are often less successful. Particularly when transaction costs are taken into account, there is little added value. Research also points in this direction. For example, one study examined the performance of US mutual funds between 2000 and 2016. The aim of the study was to analyse the extent to which variation in factor exposure influences future performance.
The results showed that a sample of the 20% of funds with the most volatile factor exposure underperformed a sample of the 20% of funds with the most stable factor exposure by an average of 1.47% per year. In other words, fund managers who frequently change the factors in the fund tend to achieve poorer returns than those who stick to their factors for a longer period of time.
What makes our approach different
Our portfolio management team has been recognising the unique opportunities and challenges of factor premia for two decades. Here are some of the key features of our approach:
- Systematic investment strategy: the fund uses a proprietary, quantitative stock selection model that is based on the factors of value, quality and momentum, which are given equal weight. The three factors are established and have proven to be reliable sources of long-term outperformance.
- ESG-integrated investment approach : Sustainability is an integral part of our investment strategy. The fund has a more comprehensive ESG profile than the benchmark and is in line with the Paris climate target.
- Broad risk diversification: By simultaneously considering the three factors of value, quality and momentum, we aim to reduce risk and select high-quality, low-valued securities with positive momentum. This should lead to a high level of diversification and controlled risk.
- Transaction cost approach: Limiting transaction costs is crucial for factor strategies. We achieve this through the integrative multifactor approach by avoiding conflicting transactions. On the other hand, we integrate transaction costs into the optimisation process to keep costs as low as possible.
- An impressive track record: our experienced portfolio management team has consistently outperformed the benchmark over the years. The strategy has proven to be robust and adaptable, even in turbulent market phases.
Building on this foundation, our commitment to innovation and continuous improvement remains undiminished. We will continue to rely on our dynamic factor research to identify new sources of alpha that can deliver attractive risk-adjusted returns to our investors over the long term. We are looking forward to the next 20 years.
Learn more on the fund:
Swisscanto (CH) Equity Fund Systematic Responsible World Enhanced FA CHF Link
