The extraordinary performance of mega-cap tech stocks has significantly impacted factor returns, creating both opportunities and challenges for systematic investors, according to Invesco. 

 

The findings come from Invesco’s ninth annual Invesco Global Systematic Investing Study (link here), based on the views of 131 institutional and wholesale investors that collectively manage $22.3 trillion. It reveals a growing sophistication in investors’ use of systematic strategies as they adapt to complex and fast-changing market dynamics.

 

Tech stock dominance requires systematic investing rethink

Invesco found factors aligned with the success of large tech companies such as Momentum, Growth and Quality have performed exceptionally well over the past year, while Value underperformed. Now, concentration risk has driven a turnaround with more than half (52%) of investors increasing their allocations to Value in the past 12 months as they seek a potential hedge.

 

“The exceptional recent performance of mega-cap technology stocks has made investors rethink factor strategies as they observed challenges around concentration, factor rotation, risk management and balancing exposures,” said Georg Elsaesser, senior portfolio manager, Quantitative Strategies at Invesco. 

 

“These challenges have demonstrated the essential necessity of risk management. There is a huge difference between observing momentum in a few large stocks and the idea of harvesting a momentum factor premium.”

 

Adaptability has enabled systematic investors to perform well in this environment. Over the past 12 months, 46% of systematic investors reported outperformance over both traditional active approaches and market-weighted strategies, contrasting with underperformance of just 8% and 6% respectively.

 

Need for adaptability drives increased sophistication

The need to react quickly has led to increased uptake of techniques that enable portfolios to immediately adapt to sudden changes in the macro environment. Four-fifths (80%) of respondents cited factor tilting strategies as very valuable, while 67% highlighted the importance of asset class and sector rotation models.

 

The key driver for pro-active factor allocation, cited by four-fifths (82%) of investors, is the desire to adapt to economic cycles. This is also reflected in the rebalancing of factors weights, with nearly all (91%) investors now adjusting their factor weights over time, an increase from three quarters (75%) in 2023. 

 

“We have seen a somewhat more aspirational approach to factors over the past years, reflecting growing sophistication amongst investors in translating cyclical factor characteristics into diversified factor portfolios,” added Elsaesser. “We are observing greater agility in factor allocations over time with a long-term strategic view. Investors broadly stay away from short-term tactical factor allocations.” 

As markets become more changeable, investors’ time horizons are also decreasing. While 40% of investors still assess performance on a standard 3–5-year time horizon, a third (32%) now use a 2-to-3-year horizon, up from less than a quarter (23%) in 2023.

 

The rise of alternative asset classes 

Invesco found a clear trend towards more diverse systematic investor portfolios, including a significant uptick in the use of alternative asset class strategies. The study reveals 40% of investors now apply a systematic approach to real estate (vs. 31% in 2023), 36% to commodities (vs. 26% in 2023) and 34% to both private equity and infrastructure (vs. 32% and 28% in 2023 respectively).

 

This diversification is enabling investors to build more holistic and integrated multi-asset allocation models. An institutional investor from Europe noted, "Our systematic approach now spans both liquid and illiquid assets. This holistic view allows us to better manage overall portfolio risk and capture cross-asset opportunities that we might have missed before."

However, the application of systematic strategies to less liquid assets can create challenges, particularly considering liquidity constraints rank as the first- and fourth- most important considerations for institutional and wholesale investors respectively when building multi-asset portfolios. 

 

Systematic investors are addressing this by using tools such as liquid proxies or derivatives, which enable them to adjust overall exposure to less liquid asset classes such as real estate, whilst retaining the ability to quickly rebalance. 

 

“We have systematic tools for various asset classes, but the challenge is actionability when risks are identified,” explained a North American institutional investor. “We're developing processes for illiquid exposures to have similar performance thresholds and exit strategies as liquid assets."

 

The data revolution continues 

Underpinning the rise of increasingly diversified and sophisticated systematic portfolios is a data revolution transforming the way investors make allocation decisions. The availability of increasingly diverse data sources to inform portfolio allocations has made this possible. 

 

While macroeconomic data (97%), fundamental company financials (81%), and technical analysis indicators (76%) are most often used, the integration of alternative data sources is also gaining momentum, with a quarter (23%) of respondents including alternative data such as satellite imagery, shipping data and weather information in their models. 

 

AI also continues to be deployed in more parts of the investment process. Relative to other investment styles, systematic/factor strategies are viewed as those most likely to benefit from AI. 

 

“AI is rapidly evolving from a peripheral tool to a cornerstone of modern investment strategies, and its capacity to analyse huge volumes of data to spot patterns, identify trends and provide rapid insights makes it well-suited to systematic investing,” said Elsaesser. “Challenges including data quality, security, and transparency remain, though, as well as the search for true sustainable alpha potential within AI-based process enhancements.”--TradeArabia News Service