This book brings simplicity to passive investing, smart beta, and factor investing, which is the fastest growing type of investment in the asset management industry. The subject has a strong academic foundation but often taught and presented in a quite complex and unorganized way.
In recent years, index and factor investing solutions have been bestsellers. But factor investing success is not a foregone conclusion, and there are plenty of quirks and misprints in the literature. Do investors need a novel approach? The book provides answers to some of these questions in an open and objective fashion.
Index fund management is increasingly taught in finance courses at universities. For market practitioners including trustees and investors, this book facilitates an increased understanding of how to invest in index and smart beta strategies, how to implement them, and what to be aware of with concrete and practical real-world examples.
Fadi Zaher is responsible for LGIM's Index Solutions. His role includes defining and leading LGIM's Index Solutions across ESG, factor based investing and tailored index strategies. Prior to that, he was Head of Fixed Income Strategy and Research at Barclays Wealth and Investment Management, Head of Bonds and Currencies at Kleinwort Benson, and held other senior positions at various financial institutions in the past 12 years. In his earlier career, Fadi worked at the European Central Bank and was previously a researcher and senior lecturer of finance and econometrics in Sweden. Fadi graduated from Lund University and holds a PhD in financial economics and MSc in economics.
1 Introduction: What we talk about in factor investingPART I2. Stepping up to factor investing2.1. History of significant advances in indices and indexed funds2.2. Growth and adaptation of factor strategies2.3. The taxonomy of risks and returns2.4. Factor investing versus traditional index and active2.5. The misconception of factor investing in the press 2.6. Consideration when looking at factor investing2.7. Concluding remarks3. Architecture and art of indexation3.1. Why index architecture matters3.2. Representativeness of the index strategy3.3. Modularity of an index3.4. Availability: the amount of stocks and bonds outstanding3.5. Stock and bond weightings3.5.1. Market value weighting3.5.2. Equal weighting3.5.3. Price weighting3.5.4. Outcome-oriented weighting: Tilting and optimisation3.6. Index maintenance and operations 3.7. Replication and management of index funds3.7.1. Trading strategies3.7.2. Securities lending3.7.3. Cash management3.8. Crowding risk of index funds3.9. The capacity of index funds3.10. Concluding remarks4 Equity Factor Investing: Value Stocks4.1 Schools of value investing4.2 The value and growth debate4.3 Intrinsic value4.4 Systematic screening approaches4.4.1 Benjamin Graham screen4.4.2 Price-to-book screen4.4.3 Price-to-Earning screen4.4.4 Price-to-sales ratio4.4.5 Comparison and combination of screens4.4.6 What constitutes good screen criteria? 4.5 Behavioural drivers of value factor4.6 Market structure and reward for risk4.7 Considerations for value investing4.8 Concluding remarks5 Equity Factor Investing: High Quality5.1 Investment horizon for quality5.2 Quality factor screens5.2.1 Profitability screen5.2.2 Asset growth and investment screen5.2.3 Leverage screen5.2.4 Earning accruals screen5.2.5 Corporate governance screen5.2.6 Combined quality screens among practitioners5.3 Drivers of the quality premium5.4 Quality and valuation of stocks5.5 Consideration for quality strategies 5.6 Concluding remarks6 Equity Factor Investing: Low Risk6.1 Why considering low volatility factor investing?6.2 Low-risk factor approaches and construction6.3 Common low volatility factor indices6.4 Behavioural drivers of the factor premium6.5 Market structures driving the factor premium6.6 Considerations when implementing low volatility strategies6.7 Low volatility in asset allocation6.8 Concluding remarks7 Equity Factor Investing: Momentum7.1 Evolution of momentum investing7.2 Rules-based momentum index strategies7.2.1 Cross-sectional momentum strategies7.2.2 Time series momentum strategies7.3 Market-based index strategies7.4 Behavioural drivers of momentum premium7.4.1 Herding behaviour7.4.2 Representativeness and Confirmation bias7.5 The reward for risk and market structures7.6 Consideration for momentum strategies7.7 Concluding remarks8 Equity Factor Investing: Size8.1 Defining the size factor8.2 Construction of size-based index strategy8.3 The existence of the size premium 8.4 Risk-based explanation of the size premium 8.5 Non-risk based explanation 8.5.1 The January effect 8.5.2 Inefficient pricing 8.5.3 Attention, coverage and transparency 8.5.4 Behavioural drivers of the size factor 8.6 Criticism of the size premium 8.7 Considerations when investing in small size 8.8 Concluding remarks 9 Equity Multi-Factor Investing 9.1 Factor cyclicality and diversification 9.2 Blending the factors into multi-factor strategy 9.2.1 The top-down approach 9.2.2 The bottom-up approach 9.3 So which approach is best? 9.4 Multi-factor indices in the market 9.5 Timing the factors 9.5.1 Factor sensitivities and factor dynamics 9.6 Considerations when timing the factors 9.7 Multi-factor portfolio analysis 9.7.1 Portfolio return-based style analysis 9.7.2 Security-based style analysis Concluding remarks 10 Fixed Income Factor Investing 10.1 Why factor investing in fixed income? 10.2 Drivers of bond risk and return 10.3 Misconception when thinking of bond factors 10.4 What are the factors in bonds? 10.5 Government bond style factors 10.5.1 Size factor for government bonds 10.5.2 Quality factor for government bonds 10.5.3 Value factor for government bonds 10.5.4 Momentum factor for government bonds 10.5.5 Low volatility factor for government bonds 10.6 Corporate bond style factors 10.6.1 Quality factor for corporate bonds 10.6.2 Value factor for corporate bonds 10.6.3 Momentum factor for corporate bonds 10.6.4 Size factor in corporate bonds 10.6.5 Low volatility factor for corporate bonds 10.7 Multi-factors strategies in corporate bonds 10.8 Considerations when building bond factors 10.9 Concluding remarks 11 Multi-Asset Alternative Risk Premia 11.1 Why are we thinking of ARP? 11.2 Fund manager types in ARP 11.3 Taxonomy of ARP strategies 11.4 Carry premia across assets 11.4.1 Currency carry premium 11.4.2 The commodity carry premium 11.4.3 The bond carry premium 11.4.4 Other carry premia 11.5 Value ARP strategies 11.5.1 Currency value premium 11.5.2 Commodities value premium 11.5.3 Fixed income and equities ARP value premia 11.6 Momentum and trend-following strategies 11.7 Portfolio construction of ARP strategies 11.8 Access to ARP strategies 11.9 A consideration when selecting ARP 11.10 Concluding remarks