Diversifying into Factor-Based Investment Process with Index ETFsMarket capitalization-weighted indexing methodologies have been around for years, and it is only recently that alternative or smart beta index-based exchange traded funds have gained in popularity as investors and financial advisors seek to diversify into factor-based strategies.

ETF Trends publisher Tom Lydon spoke with Henry Fernandez, Chief Executive Officer at MSCI, and Jana Haines, Head of Equity Index Products for the Americas MSCI, at the Inside ETFs conference that ran Jan. 22-25, 2017 to talk about the innovations in the indexing process.

“We continue to be excited about the globalization of investing,” Fernandez said. “I mean that in this day and age with so much attack on globalism, I don’t think that’s going to affect the global investing in the world. We are also excited about a lot of the work we’re doing on ESG – environmental, social, governance criteria – and investing process, and that’s probably better defined as long-term investing. Of course, you know, we’re very, very keen on working pretty hard on a lot of innovation in the smart beta or what we call factor investing space.”

Unlike traditional beta index investments that rely on market capitalization weighting methodologies, the rapidly growing smart beta or factor investing indexing methodology rely on disciplined screening and weighting process.

“Factor indices and factor investing, generally, is becoming more and more part of the mainstream investment landscape,” Haines said. “When you think about the increased volatility in the market place that we’ve seen last year, you think about the various geopolitical events that we’ve experienced with Brexit, of U.S. elections, about the interest rate shifts in the market. Factor indices and factor investing allows investors to systematically view the investment landscapes through another lens just like, for example country sectors. We now have factors that allow investors yet another view.”

The factor investment methodology help investors diversify away from risks and still participate in upside potential to generate improved risk-adjusted returns in an increasingly uncertain market environment.

Factor based investment strategies are not anything new as active fund managers have executed these same screens in their active open-end mutual fund strategies for decades. However, through factor based or smart beta ETF strategies, the process is automated, providing investors a disciplined approach to market exposure through the cheap and easy-to-use ETF wrapper.

“Factor investing – it’s always been with us for a long time,” Fernandez said. “What we’re working on is the next generation of factors is that every active managers is also a factor investor. What we’re trying to do globally and in indeed various domestic markets of the world is take a lot of that quantitative tools, a lot of that thinking, a lot of that those techniques which were available to institutional investors and make them available to everyone in the world. One way to do that is, obviously, packaging a lot of those investment strategies or industries in an exchange traded fund, so that people can buy them. It’s a democratization of the global investment process and the democratization of the factor investment process globally.”

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