Interview with Baer Pettit

MSCI and the Growth of Factor Investing

Equity factor investing was pioneered in the 1970s based on research, data and analytics created by Barra – today an MSCI company.  In recent years, MSCI has developed a broad range of indexes and analytical models that provide institutional investors with tools for evaluating factors and incorporating factor strategies into their portfolios.

Baer Pettit is a Managing Director and head of MSCI’s Product Group.

 

Baer, let’s start off with a definition.  What is a “factor”?

In simple terms, a factor is any characteristic of a stock (such as its size or its forecast earnings growth) that explains its risk and expected return.  Research has shown that stocks that reflect certain risk factors have, over time, provided a higher return than the overall market.

 

How does that work?

Factor investing can expose investors to specific risks (in addition to market risk, which can’t be diversified away) and historically some of those risks have delivered extra return.  Of course, there is no guarantee that any factor will continue to outperform, and all factors have demonstrated periods of historical underperformance as well.  If an investor believes that a factor that has historically outperformed the market will continue to do so, then the investor may be interested in building a portfolio that is exposed to the factor or seeks the return of the factor.

 

Are there different types of factors?

Yes.  There are three main categories:  macroeconomic, statistical and fundamental.  Fundamental factors – which capture characteristics such as liquidity, dividend yield and earnings quality – are the most commonly used today.

 

Are some factors better than others?

We focus on factors that tend to persist over several economic and market cycles.  Our business is about  providing our clients with tools that help them understand the risk and return characteristics of these factors as efficiently as possible in their own portfolios.

 

Can factors be used by both active and passive managers?

Absolutely.  For active managers, MSCI offers factor models for long, medium and short-term time frames.  These models provide risk forecasts over each investment horizon.

For passive investors, such as index fund managers and ETF providers, MSCI offers a family of indexes that track the performance of six factors that have been rigorously tested and shown to have outperformed the broad market over long-term investment horizons.  These six factors are Value, Low Size, Low Volatility, High Yield, Quality and Momentum.

 

What are you working on now?

We are continuing to break new ground with regard to our factor research.  A study we recently conducted for Japan’s Government Pension Investment Fund – the largest pension fund in the world – explored ways to use factor strategies alongside traditional active and passive allocations.  In March, we introduced a new series of indexes, MSCI Diversified Multi-Factor Indexes, which use Barra risk tools to maintain optimal exposure to a diversified set of factors while keeping risk at the level of an underlying parent index.

So what’s next?

We will continue to collaborate with our clients, and to innovate.  No other firm has the breadth of experience or capabilities we have in the factor space.  Our clients count on us to be a few steps ahead of their needs for new and innovative products and services, and that’s where we intend to be.

 
MSCI Factor Models for Active Investors
Approach:  Calibrate factor models to different investment time horizons
Long-Term:  Track portfolio risk through different economic and market cycles
Medium-Term:  Commonly used for performance attribution and risk monitoring
Short-Term:  Designed for analyzing risk in short term portfolios, such as daily trading and risk monitoring
MSCI Factor Indexes for Passive Investors
Approach:  Construct indexes that track of the performance of six factors that have historically outperformed the broad market over long periods of time
Value
Low Size
Low Volatility
High Yield
Quality
Momentum

DIVERSIFIED MULTI FACTOR INDEXES

MSCI diversified multi-factor indexes combine MSCI factor indexes into a single blended index.

Factor Indexes

Our Factor Indexes are systematic rules-based indexes that represent the return of factors that have historically earned a persistent premium over long periods of time—such as Value, Low Size, Low Volatility, High Yield, Quality and Momentum.

Research Paper - Foundations of Factor Investing

Factor investing has become a widely discussed part of today’s investment canon. This paper is the first in a three-paper series focusing on factor investing.