MAXIMISING FACTOR EXPOSURE WHILE CONTROLLING VOLATILITY
New index research paper: maximizing factor exposure while controlling volatility
Multi-factor indexes are important tools for investors seeking diversified exposure to factors that have historically outperformed the market over long periods. However investors may want to maximize their exposure to the underlying factors while still maintaining a market-like risk profile.
To meet this need, we recently launched the MSCI Diversified Multi-Factor Indexes, which combine four academically researched factors with strong historical excess returns — value, momentum, size and quality — with a control mechanism designed to keep volatility in line with the market. This control mechanism also aims to ensure the index has adequate investability and capacity characteristics that can be replicated by passive strategies.
KEY RESEARCH TAKEAWAYS
- Individual factor indexes have outperformed their parent market-capitalized indexes over the past 40 years.
- The MSCI Diversified Multi-Factor Indexes aim to diversify the risk from a single factor without diluting the strength of the exposure to targeted factors, while seeking to provide market-like volatility over time.
- Over a 16 year period from 1998 to 2014, the MSCI World Diversified Multi-Factor Index returned 9.8% annually, double the 4.9% return of the parent MSCI World Index, while retaining market-level risk. Individual factor indexes may undergo significant periods of underperformance; a multi-factor approach helps smooth out returns and mitigate that risk.