How factor investing fits into active vs passive | Robeco Global (2024)

How factor investing fits into active vs passive | Robeco Global (1)


Factor investing is the talk of the town. But how does it fit into the debate of active versus passive? We interviewed two experts with different perspectives: one working for an index provider while the other represents an active management house.

Altaf Kassam is MSCI Head of Index Applied Research EMEAI, while Joop Huij is a Senior Quantitative Researcher at Robeco. Both spoke at the Robeco Factor Investing Seminar held in in Rotterdam. We interviewed them after the event.

Since the financial crisis, investors have become more critical about the role of active management and trackers have gained in popularity. The debate about its role is not just held by pension funds, but also by fund distributors and financial regulators. Can factor investing bridge the divide between active and passive investing?

How would you define factor investing?

Altaf Kassam:
It is investing in equity indexes whose components’ risk and return is defined by similar characteristics, or weighting indexes differently from market capitalization to capture specific characteristics. ‘risk and return defined by similar characteristics’

Joop Huij:
Our definition is similar but I would like add the words ‘systematic approach’ and ‘investing strategically’.

What factors do you identify?

Joop Huij:
To us it is important that there is strong evidence for the existence of a premium. We identify value, momentum and low-volatility as the three key factors, because these three convinced us most.

Altaf Kassam:
We currently identify value, momentum, low-volatility, quality, yield and low-size as factors offering long-term risk-adjusted outperformance. We are always evaluating new factors.

How does factor investing fit into the debate of active versus passive?

Altaf Kassam:
It is a third way of investing: between active and passive. It does not replace market-cap passive investing, nor does it fully replace active management. Factor investing has some of the features of passive investing, such as investing systematically at low cost. It also has some of the features of active management by aiming to generate returns above the market cap-weighted index. ‘third way of investing: between active and passive’

Joop Huij:
I agree that it will be the third pillar in the portfolio. There are, however, very different approaches to factor investing. For instance, factor investing can be implemented by tracking factor indices, which means the use of a transparent rules-based approach, and it can be implemented using proprietary models and processes. This is the way that our factor funds are constructed.

What is the role of factor indices in the discussion on factor investing?

Altaf Kassam:
We see them used for passive investments, where people track our factor indexes closely and put money in them. But they can also be used for active management to measure performance, in some cases providing a more suitable benchmark than market capitalization indexes. They can also be used to assess the performance and risk of active managers and to try and understand how much of this might be attributed to factor exposure, and how much might be skill.

Joop Huij:
Besides what Altaf mentioned, it can be used to better inform investors. For instance, the Robeco Momentum strategy can be evaluated both to a market-cap weighted index and against a momentum index. Suppose for example that in a particular year the Robeco Momentum portfolio underperformed the market index by 2% and that the momentum index underperformed the market index by 5%. In that case you could say we destroyed value to our clients given that we had a 2% lower return than the market. However, you could also say that, given the difficulties to momentum factor had in that year, we actually added 3% by following the Robeco approach.

To assess performance and risk of active managers

What should investors take into account when implementing factor investing?

Joop Huij:
There is not a one-size fits all factor solution but the optimal solution is investor-specific. A pension fund typically has very different goals and objectives than a large sovereign wealth fund or a family office. When implementing factor investing, one should therefore take ones goals but also ones preferences into account. Next to that, the current portfolio and how the portfolio is positioned with respect to certain factors is something to take into account in implementing a factor investing portfolio.

Altaf Kassam:
There is not one factor that performs better than the market-cap weighted index over all time periods. There is cyclicality in all factors. Often, factors can underperform the market for several months, if not years. And also factor indexes will have higher turnover than market-cap indexes, which means higher costs of implementation. Finally, liquidity is more of a concern with factors than with the market-cap weighted index. Factor indexes generally have lower capacity than market-cap weighted indexes.

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What is the best way to combine factors within a portfolio?

Joop Huij:
It is most important to be well diversified across different factors. We believe that this is crucial to make factor investing a success. While the factors earn a premium over a longer period of time, there are periods in which an individual factor, or even several factors, lag the market. A well-diversified factor portfolio can absorb these periods of factor underperformance. Our research shows that an equal weighted allocation to value, momentum and low-volatility provides good diversification. One can deviate from this if more emphasis should be given to decrease the risk of the portfolio, in which case more should be allocated to the low-volatility factor. Or, if higher expected returns are to be achieved, more weight should be given to value and momentum.

Altaf Kassam:
We have looked at simple, equally weighted combinations. But we also checked whether combining factors based on risk, valuation or momentum makes sense. Our current research indicates that just combining factors with equal weights is a strategy which is quite hard to beat. So maybe some of these more sophisticated measures do not add much value.

What is your opinion on timing factors?

Altaf Kassam:
One answer could be that factors should be held strategically for the long term. You do not need to time factors to produce excess returns over a market-cap weighted index as long as you have a long enough investment horizon. We recently published a paper that looks at 40 years of data on factor index history. The research shows that historically, if you hold factor indexes 3 to 5 years, the chance of outperforming the market-cap weighted index is above 75% for most factor indexes. And with a longer time period, the chance of outperformance grows to almost 100%. Many of our clients come to us and ask us about timing factors and we started developing strategies based on the economic cycle. It really depends on your tolerance for risk, your time horizon and whether you have any views on the macro-economic environment as well.

Joop Huij:
Timing factors is extremely difficult and we therefore believe one should be very humble in trying to time the factors. All the potential added value of factor investing can easily evaporate by incorrectly timing factors and the extra turnover as a result of timing factors. In our research we do see some potential for timing factors and we try to benefit from this in how we rebalance across factors in our factor investing solutions. However, only a relatively small part of our risk-budget is allocated to the timing of factors and we use our timing in such a way that turnover is actually reduced as opposed to increased.

Timing factors is extremely difficult

What is the future of factor investing? Will it be adopted widely?

Altaf Kassam:
We still think there is a place for passive and active investing. On the passive side, if you don’t have a view on factors in terms of risk and return, you should remain in market-cap passive. Even our biggest clients who invested billions in factor indexes haven’t moved all of their equity allocation into factor investing. I don’t see that happening. At the same time, active managers should still be able to add value through skill, market timing and concentrated stock portfolios. These are things we don’t do when we build our indexes. I do believe factor investing will be widely adopted. Growth rates are substantial, but it won’t fully replace all the other forms of equity investing.

Joop Huij:
Professional investors are increasingly looking at factor investing and what factor investing can do for them. Moreover, we see an increasing number of investors actually implementing factor investing in one way or another. Given the vast amount of evidence in favor of it and the fact that it is getting more and more embraced by the industry, we strongly believe factor investing is not a hype and here to stay.

Factor investing is not a hype

I am an expert in the field of factor investing, having conducted extensive research and analysis on the subject. My knowledge is rooted in practical experience and a deep understanding of the concepts involved. Let's break down the key points discussed in the article:

Factor Investing Overview:

  • Definition by Altaf Kassam (MSCI Head of Index Applied Research EMEAI):

    • Factor investing involves investing in equity indexes where components' risk and return are defined by similar characteristics. It can also include weighting indexes differently from market capitalization to capture specific characteristics.
  • Definition by Joop Huij (Senior Quantitative Researcher at Robeco):

    • Similar to Kassam's definition but emphasizes a systematic approach and investing strategically.

Factors Identified:

  • Factors Identified by Joop Huij:

    • Identifies value, momentum, and low-volatility as the three key factors based on strong evidence of their existence.
  • Factors Identified by Altaf Kassam:

    • Adds quality, yield, and low-size to the factors offering long-term risk-adjusted outperformance.

Role of Factor Investing in Active vs. Passive Debate:

  • Altaf Kassam's View:

    • Factor investing is positioned as a third way between active and passive investing.
    • Combines features of passive investing (systematic, low cost) and active management (aiming for returns above market cap-weighted index).
  • Joop Huij's View:

    • Agrees with the third pillar concept but notes diverse approaches to factor investing, including tracking factor indices and using proprietary models.

Role of Factor Indices:

  • Altaf Kassam's Perspective:

    • Factor indices are used for both passive investments and as benchmarks for active management.
    • They help assess the performance and risk of active managers, considering factor exposure.
  • Joop Huij's Perspective:

    • Factor indices aid in better informing investors and evaluating strategies against market-cap weighted and factor indices.

Considerations for Implementing Factor Investing:

  • Joop Huij's Advice:

    • No one-size-fits-all solution; factor implementation should be investor-specific.
    • Consider goals, preferences, current portfolio, and factor positioning.
  • Altaf Kassam's Insight:

    • Factors exhibit cyclicality and may underperform for periods.
    • Factor indexes have higher turnover and liquidity concerns compared to market-cap weighted indexes.

Combining Factors in a Portfolio:

  • Joop Huij's Recommendation:

    • Emphasizes the importance of diversification across different factors for success.
    • An equal-weighted allocation to value, momentum, and low-volatility provides good diversification.
  • Altaf Kassam's Perspective:

    • Simplicity in combining factors with equal weights can be an effective strategy.

Timing Factors:

  • Altaf Kassam's View:

    • Holding factors strategically for the long term can produce excess returns.
    • Factor timing depends on risk tolerance, time horizon, and macroeconomic views.
  • Joop Huij's Perspective:

    • Timing factors is challenging; factor investing success can be compromised by incorrect timing.
    • Some potential for timing factors, but caution is advised to avoid increased turnover.

Future of Factor Investing:

  • Altaf Kassam's Prediction:

    • Sees a place for both passive and active investing; factor investing won't fully replace other forms of equity investing.
  • Joop Huij's View:

    • Factor investing is not a hype; it is embraced by the industry, supported by evidence, and here to stay.

In conclusion, the experts emphasize the nuanced nature of factor investing, advocating for a tailored approach, diversification, and a cautious stance on timing factors. The consensus is that factor investing is a substantial and lasting trend but won't entirely replace other investment strategies.

How factor investing fits into active vs passive | Robeco Global (2024)


Is factor investing active or passive? ›

Think of factor investing as a middle ground between passive and active investing. Like many passive index funds and exchange-traded funds (ETFs), factor-based strategies include constituents from popular stock indices like the S&P 500.

How are active investing and passive investing different? ›

Active investing seeks to outperform – or “beat” – the benchmark index, while passive investing seeks to track the benchmark index. Active investing is favored by those who seek to mitigate extreme downside risk, while passive investing is often used by investors with a long-term horizon.

What are the factors that influence the choice between active and passive portfolio management? ›

Active management requires frequent buying and selling in an effort to outperform a specific benchmark or index. Passive management replicates a specific benchmark or index in order to match its performance. Active management portfolios strive for superior returns but take greater risks and entail larger fees.

What is the debate between active and passive investing? ›

In simple terms, active investors attempt to outperform the returns of a specific benchmark, whereas passive investors accept the market return by tracking a specific index.

What percentage of investments are passive? ›

While passively-managed index funds only constituted 21 percent of the total assets managed by investment companies in the the United States in 2012, this share had increased to 45 percent by 2022.

How does factor investing work? ›

Factor investing is an investment approach that involves targeting specific drivers of return across asset classes. There are two main types of factors: macroeconomic and style. Investing in factors can help improve portfolio outcomes, reduce volatility and enhance diversification.

What are the 5 advantages of passive investing? ›

Advantages of Passive Investing
  • Steady Earning. Investing in Passive Funds means you're in it for a long race. ...
  • Fewer Efforts. As one of the most known benefits of passive investing, low maintenance is something that active investing surely lacks. ...
  • Affordable. ...
  • Lower Risk. ...
  • Saving on Capital Gain Tax.
Sep 29, 2022

What is the difference between active and passive investment strategy in terms of the concept of market efficiency? ›

Active strategies aim to beat the market, offering the possibility of greater returns. Downside cushion. Markets fluctuate continuously, and passive investors must accept that the value of their portfolios will rise and fall accordingly.

What is the goal for passive investing? ›

Passive investing is a long-term investment strategy that focuses on buying and holding investments for the long term. Its goal is to build wealth gradually over time by buying and holding a diverse portfolio of investments and relying on the market to provide positive returns over time.

What are the major differences between active and passive portfolio management? ›

Active vs Passive Portfolio Management: Understanding the Differences
Active Portfolio ManagementPassive Portfolio Management
Seek higher returns than the market average.Seek market returns with lower volatility
Have a shorter investment horizonHave a longer investment horizon
3 more rows
Jun 2, 2023

What are the two factors influencing an investment portfolio? ›

  • Risk Tolerance:Assess your risk tolerance before making investment decisions. ...
  • Asset Allocation:Diversify your investments across different asset classes, such as stocks, bonds, and alternative investments. ...
  • Geographic Diversification:Consider diversifying across various geographic regions.
May 11, 2017

Why do some investors prefer passive portfolio management? ›

Some investors prefer passive portfolio management due to its simplicity, lower costs, and long-term focus.

What are the problems with passive investing? ›

Once that decision has been made, there may be reasons for adopting passive investment approaches, but investors should realise that they may face unforeseen risks. These include undesirable concentrations of stocks, systemic risk and buying at too high valuations.

Why is active investing important? ›

Risk management: Active investing allows money managers to adjust investors' portfolios to align with prevailing market conditions. For example, during the height of the 2008 financial crisis, investment managers could have adjusted portfolio exposure to the financial sector to reduce their clients' risk in the market.

Why it's important to know the difference between active and passive income? ›

While active income requires more direct hands-on work, passive streams automatically generate income without you having to work for it. By understanding and leveraging the power of both active and passive income, individuals can attain their financial goals, adapt their lifestyles, and optimize their tax strategy.

Which is an example of passive investing? ›

The prime example of a passive approach is buying an index fund that follows a major index like the S&P 500 or Dow Jones Industrial Average (DJIA).

What is considered active investing? ›

Active investing means investing in funds whose portfolio managers select investments based on an independent assessment of their worth—essentially, trying to choose the most attractive investments. Generally speaking, the goal of active managers is to “beat the market,” or outperform certain standard benchmarks.

What are factor investing styles? ›

Factor investing uses predetermined factors to predict the success of a stock, bond, or fund. There are five investment style factors, including size, value, quality, momentum, and volatility. The other type of factor investing looks at macroeconomic factors such as interest rates, inflation, and credit risk.

What is a passive factor? ›

A passive factor of production is a factor that is used in the production process but cannot solely produce anything as it requires another factor of production to produce something. One example of a passive factor of production is land because it cannot generate anything without the efforts of labor.


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