After thoughtful and extensive research, an investor
concludes that people will double their consumption of cheeseburgers over the
next three years. “How can I monetize this information?” he wonders. One way
would be to invest in cheeseburgers directly, purchasing shares of McDonald’s
Corporation or Burger King Holdings Inc.
Or, he could just zero in on the ingredients by investing in
cattle, milk, wheat, lettuce and tomatoes. The analogy is imperfect, but
investing at the level of ingredients, or factors, has been around forever.
Sponsors hope that an informed factor approach, both in setting overall
strategies and in day-to-day investing, can make portfolios more secure against
the next big drawdown.
Although plan sponsors and their consultants and
managers had done their best to fully
diversify their portfolios, few were satisfied with the results in 2008—even
those who had added hedge funds, private equity and other such alternative
assets in response to the last financial crisis, in 2001 to 2003. Advisers and
asset owners are coming to realize, though, that the fault may lie not with the
idea of diversification but with limitations in technique.
“There is ample room for improvement, by shifting the focus
from asset-class diversification to factor diversification,” Antti Ilmanen, a
managing director at quantitative investment specialist AQR Capital Management,
wrote in the Spring 2012 Journal of Portfolio Management.* Stated simply, a
factor perspective goes beyond traditional asset class categories and looks at
the essential drivers of portfolio performance to quantify the risks associated