A growing number of investors who use investment factors in their portfolios are incorporating ESG in the pursuit of enhanced returns.
Invesco, the fund manager, surveyed institutional investors who apply investment factors and found there had been a rapid increase in appetite for incorporating ESG to drive returns.
This year, 78% of the factor investors who were surveyed indicated they incorporated ESG in their factor allocations. Invesco said demand from beneficiaries had previously driven this growth but that there is now a belief among institutions that ESG potentially enhances long-run investment performance.
The demand for ETFs using investment factors is set to rise, with nearly half of investors (46%) saying they would be more likely to invest in a factor ETF if it incorporated ESG.
There is still some debate, however, about whether ESG is truly an investment factor. A minority of respondents from the study believed ESG is an investment factor, replicating the characteristics of factors such as value and quality. But the more commonly held view, according to Invesco, is that ESG is completely independent of investment factors.
Many investors found ESG had created a factor bias in their portfolios - for example by leading to higher than intended weightings to the quality factor over the value factor in equity portfolios. Out of the total respondents, approximately two-fifths had analysed whether ESG had created a factor bias in their portfolio, and nearly two-thirds uncovered a bias.
Invesco said that investors who had not completed an analysis may be unaware of how the incorporation of ESG affects their factor exposures and ultimately the return profile of the portfolio.
Georg Elsaesser, senior portfolio manager, quantitative strategies at Invesco, said: "Factors can help in decomposing the impact of ESG on a portfolio. We have to consider both the risks of not including ESG and the risks of including ESG. Both ways, factors can help.”
Other findings from Invesco’s sixth annual Global Factor Investing Study were include that low yields have helped drive an increase in allocations to fixed income, with the majority (55%) now using factors in fixed income. This is up from 40% last year.
Nearly half (45%) of Investors said the low yield environment has made the use of factors within fixed income portfolios more attractive, offering an opportunity for additional sources of return and diversification. For the majority 52%, factor investing in fixed income includes the use of both investment factors (such as value/quality) and macro factors (such as duration/inflation), whilst 23% are only using investment factors and a quarter look at factors solely through a macro lens.
Elsaesser said the post-pandemic period “tested some of the assumptions around the benefits of factor investing. However, most investors report that adopting a factor approach has been successful and there has evidently been a strong uptake towards factor investing strategies”.
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