(May 30, 2013) – It is not an asset class or risk element, but according to MSCI research, this factor is crucial to scaling risk-based investment to the largest institutional funds: investability.
The index and analytics firm has released a study commissioned by Norway’s Ministry of Finance on risk-factor investing for funds over $100 billion. The paper, “Harvesting Risk Premia in Large Scale Portfolios,” supported earlier studies showing that risk premia does exist. Low volatility and small cap stocks performed better, on average, than their mercurial and massive counterparts. Likewise, the paper suggested that investors can gain alpha above public equity benchmarks by riding momentum and seeking out value.
But the extra margins from those strategies, MSCI found, can easily be frittered away on implementation costs, including trading charges, liquidity, investment capacity, and cost of replication.
“Factor investing may entail high costs and significantly reduce net return on the portfolio, in particular when the portfolio is large,” the authors stated. While the study did not delve deeply into investability factors and concrete costs, it did find that some risk premia may be better deals for giant institutions than others. Value, small size, and low volatility stocks tended to scale better than momentum strategies.
“For decades, academic research has demonstrated that risk factors can deliver substantial excess returns in comparison to cap-weighted equity market portfolios over a long horizon,” said Remy Briand, managing director and global head of MSCI’s index and environmental, social, and governance research teams. “However, these academic studies remain largely theoretical. In this report, we investigate for the first time implementation issues for risk premia strategies and their investability for very large scale portfolios.”
Norway is proving itself a leader in risk-factor investing. Norges Bank Investment Management (NBIM), which presides over $721 billion of state funds, including the Norway Government Pension Fund-Global, released its own research on equity risk-factor modeling earlier this month.
Related profile: Yngve Slyngstad, chief executive officer of Norges Bank Investment Management