Finance

Unlocking the Return Potential in Factor Investing

Published

4 weeks ago

January 26, 2020

What is the best way to predict success?

In baseball, the game’s strategy was forever changed when Oakland Athletics traded in the standard scout’s intuition for a data-driven approach. It was a switch that eventually led the team to an impressive 20-game winning streak, depicted in the movie Moneyball—it also kickstarted a broader revolution in sports analytics.

Similarly, successful data patterns are also being discovered by experts in the investing world. One such framework is factor investing, where securities are chosen based on attributes that are commonly associated with higher risk-adjusted returns.

Factor Investing 101

Today’s infographic comes to us from Stoxx, and it explains how factor investing works, as well as how to apply the strategy in a portfolio.

Factor Investing infographic

A Selective Approach

There are two main types of factors. Macroeconomic factors, such as inflation, drive market-wide returns. Style factors, such as a company’s size, drive returns within asset classes.

Analysts have numerous theories as to why these factors have historically outperformed over long timeframes:

Rewarded risk
Investors can potentially earn a higher return for taking on more risk.

Behavioral bias
Investors can be prone to acting emotionally rather than rationally.

Investor constraints
Investors may face constraints such as the inability to use leverage.

Astute investors can capitalize on these biases by targeting the individual factors driving returns.

The Common Style Factors

Based on academic research and historical performance, there are five style factors that are widely accepted.

Size: Smaller companies have historically experienced higher returns than larger companies
Low Risk: Stocks with low volatility tend to earn higher risk-adjusted returns than stocks that have higher volatility.
Momentum: Stocks that have generated strong returns in the past tend to continue outperforming.
Quality: Quality is identified by minimal debt, consistent earnings, steady asset growth, and good corporate governance.
Value: Stocks that have a low price compared to their fundamental value may generate higher returns.

It is becoming more straightforward for investors to implement these factors in a portfolio.

How Can You Apply Factor Investing?

All investors are exposed to factors whether they are aware of it or not. For example, an investor who puts capital in an ESG fund—targeting companies with good corporate governance—will have some level of quality exposure.

However, there are various approaches investors can take to implement factors intentionally.

Single Factors

Factors perform differently over the course of a market cycle. For example, low volatility stocks have historically performed well during market downturns such as the 2008 financial crisis or the 2015 sell-off.

Investors can consider macroeconomic information and their own market views, and adjust their exposure to individual factors accordingly.

Multi-factor

Factors tend to exhibit low or negative correlation with each other. For a long-term strategy, investors can combine multiple factors, which increases portfolio diversification and may provide more consistent returns.

Long-short

For each factor, there are investments that lie on either end of the spectrum. Experienced, risk-tolerant investors can employ a long-short strategy to play both sides:

Hold long positions in attractive securities, such as those with upward momentum
Hold short positions in unattractive securities, such as those with downward momentum

This diversifies potential return sources, and reduces aggregate market exposure.

Capturing Factors Through Indexing

Active managers have been selecting securities based on factors for decades. To capture factors with precision, managers must carefully consider numerous elements of portfolio construction, such as the starting investment universe and the relative weight of securities.

More recently, investors can access factor investing through another method: indexing. An indexing approach provides a framework for capturing these factors, which helps simplify the investment process. Based on objective rules, index solutions provide a higher level of transparency than some active solutions.

Not only that, their efficiency makes them more suitable as tools for building targeted outcomes.

The Future of Factors

In light of indexing’s various benefits, it’s perhaps not surprising that exchange-traded factor products have seen immense growth in the last decade.

In addition, there’s still plenty of room for factor ETF expansion in equities and other asset classes. Only about 1% of factor ETFs invest in fixed income, and 70% of surveyed institutional investors believe factor investing can be extended to the asset class.

As solutions continue to evolve, factor products could become the foundation of many investors’ portfolios.

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Finance

Intangible Assets: A Hidden but Crucial Driver of Company Value

Intangible assets – such as goodwill and intellectual property – have rapidly risen in importance compared to tangible assets like cash.

Published

2 weeks ago

February 11, 2020

Jenna Ross

Intangible Assets Take Center Stage

View the high resolution version of this infographic by clicking here

In 2018, intangible assets for S&P 500 companies hit a record value of $21 trillion. These assets, which are not physical in nature and include things like intellectual property, have rapidly risen in importance compared to tangible assets like cash.

Today’s infographic from Raconteur highlights the growth of intangible asset valuations, and how senior decision-makers view intangibles when making investment decisions.

Tracking the Growth of Intangibles

Intangibles used to play a much smaller role than they do now, with physical assets comprising the majority of value for most enterprise companies. However, an increasingly competitive and digital economy has placed the focus on things like intellectual property, as companies race to out-innovate one another.

To measure this historical shift, Aon and the Ponemon Institute analyzed the value of intangible and tangible assets over nearly four and a half decades on the S&P 500. Here’s how they stack up:

Intangible vs. Tangible Assets

Source: Aon

In just 43 years, intangibles have evolved from a supporting asset into a major consideration for investors – today, they make up 84% of all enterprise value on the S&P 500, a massive increase from just 17% in 1975.

The Largest Companies by Intangible Value

Digital-centric sectors, such as internet & software and technology & IT, are heavily reliant on intangible assets.

Brand Finance, which produces an annual ranking of companies based on intangible value, has companies in these sectors taking the top five spots on the 2019 edition of their report.

Rank	Company	Sector	Total Intangible Value	Share of Enterprise Value
1	Microsoft	Internet & Software	$904B	90%
2	Amazon	Internet & Software	$839B	93%
3	Apple	Technology & IT	$675B	77%
4	Alphabet	Internet & Software	$521B	65%
5	Facebook	Internet & Software	$409B	79%
6	AT&T	Telecoms	$371B	84%
7	Tencent	Internet & Software	$365B	88%
8	Johnson & Johnson	Pharma	$361B	101%
9	Visa	Banking	$348B	100%
10	Alibaba	Internet & Software	$344B	86%
11	Nestle	Food	$313B	89%
12	Procter & Gamble	Cosmetics & Personal Care	$305B	101%
13	Anheuser-Busch InBev	Beers	$304B	99%
14	Verizon	Telecoms	$300B	83%
15	Comcast	Media	$276B	92%
16	Mastercard	Banking	$259B	99%
17	Novartis	Pharma	$252B	101%
18	Walmart	Retail	$252B	68%
19	Unitedhealth	Healthcare	$245B	94%
20	Pfizer	Pharma	$235B	98%

Note: Percentages may exceed 100% due to rounding.

Microsoft overtook Amazon for the top spot in the ranking for 2019, with $904B in intangible assets. The company has the largest commercial cloud business in the world.

Pharma and healthcare companies are also prominent on the list, comprising four of the top 20. Their intangible value is largely driven by patents, as well as mergers and acquisitions. Johnson & Johnson, for example, reported $32B in patents and trademarks in their latest annual report.

A Lack of Disclosure

It’s important to note that Brand Finance’s ranking is based on both disclosed intangibles—those that are reported on a company’s balance sheet—and undisclosed intangibles. In the ranking, undisclosed intangibles were calculated as the difference between a company’s market value and book value.

The majority of intangibles are not reported on balance sheets because accounting standards do not recognize them until a transaction has occurred to support their value. While many accounting managers see this as a prudent measure to stop unsubstantiated asset values, it means that many highly valuable intangibles never appear in financial reporting. In fact, 34% of the total worth of the world’s publicly traded companies is made up of undisclosed value.

“It is time for CEOs, CFOs, and CMOs to start a long overdue reporting revolution.”

—David Haigh, CEO of Brand Finance

Brand Finance believes that companies should regularly value each intangible asset, including the key assumptions management made when deriving their value. This information would be extremely useful for managers, investors, and other stakeholders.

A Key Consideration

Investment professionals certainly agree on the importance of intangibles. In a survey of institutional investors by Columbia Threadneedle, it was found that 95% agreed that intangible assets contain crucial information about the future strength of a company’s business model.

Moreover, 98% agree that more transparency would be beneficial to their assessment of intangible assets. In the absence of robust reporting, Columbia Threadneedle believes active managers are well equipped to understand intangible asset values due to their access to management, relationships with key opinion leaders, and deep industry expertise.

By undertaking rigorous analysis, managers may uncover hidden competitive advantages—and generate higher potential returns in the process.

Finance

Visualizing the Current Landscape of the Fintech Industry

The fintech industry welcomed multi-billion dollar investments in 2019. Where is the most growth, and how are incumbents dealing with digital disruption?

Published

4 weeks ago

January 28, 2020

Iman Ghosh

Visualizing the Current Landscape of the Fintech Industry

Since the introduction of the first credit card with a magnetic stripe in 1966, financial technology has come a long way. Silicon Valley may not have birthed the term “fintech”, but it has certainly helped catapult its applications into the mainstream.

Leveraging everything from basic apps to the blockchain, the changing dynamics of fintech are creating new investment opportunities everyday, growing its appetite with every new megadeal.

Today’s graphic from Raconteur highlights the global growth of the fintech industry, the services with the most staying power, and major M&A developments of the past year as traditional institutions scramble to deal with this digital disruption.

How Fintech Levels the Playing Field

Over the past five years, digitally-enabled financial technology services have delivered convenient and cheaper access to financial services to millions of consumers.

What draws consumers towards using fintech?

Attractive rates and fees (27%)
Easy access and account setup (20%)
Variety of innovative products and services (18%)
Better service quality and product features (12%)

This new implementation of technology is democratizing financial services for the masses, a strong contrast to accessing them through traditional brick-and-mortar institutions.

How Fintech Fares Across Borders

On average, 64% of the world’s digitally active population has used at least one fintech service. But China and India surpass this benchmark by a mile—in a survey of 27,000 consumers across 27 markets, both countries demonstrated a 87% fintech adoption rate.

Russia and South Africa are in close second, with 82% adoption respectively. On the other hand, France and Japan are tied at the low end of the spectrum with only 35% fintech adoption.

The trajectory of mobile payments and digital wallets in China can help put high Asian adoption rates in perspective. Thanks to services like Alipay and WeChat, 890 million unique mobile payment users are essentially transforming China from a cash economy to a digital one.

Which Services Have Caught Consumer Attention?

Just like “Googling” is synonymous with looking up information online, the term “Venmo-ing” has become an American verb for paying someone back via a digital wallet.

That’s why it’s no surprise that money transfer and payments are by far the most rapidly growing fintech services, shooting up from 18% to 75% global adoption in just four years. Here’s how global average adoption rates differ by fintech service, across time:

Fintech Category	2015	2017	2019
💸 Money transfer and payments	18%	50%	75%
💰 Savings and investments	17%	20%	34%
📋 Budgeting and financial planning	8%	10%	29%
🛡️ Insurance	8%	24%	48%
💳 Borrowing	6%	10%	27%

Source: EY Global Fintech Adoption Index 2019

Insurtech has steadily gained traction in the market. Digital insurance solutions provide personalized and on-demand coverage plans for clients, using bots and machine learning to assess risk levels. As a result, this sub-segment has been attracting large funding rounds due to the time—and money—it helps free up for firms.

According to CapGemini, incumbents in the financial industry see wallets and mobile payments from fintech providers as the most significant offerings impacting their companies. That may be why they’re resorting to big moves to protect their business.

Deals and More Deals

Major financial institutions made some serious plays in 2019, in the way of mergers and acquisitions of fintech companies:

FIS bought the payments processing company Worldpay for $35 billion, valuing the company at $43 billion when debt is included. (Reuters)
The London Stock Exchange Group plans to acquire financial markets data provider Refinitiv for $27 billion, in the hopes of rivaling Bloomberg. (Reuters)
Global Payments bought the payments processing company Total System Services for $21.5 billion, planning to provide services to over 1,300 financial institutions. (Bloomberg)
Fiserv acquired payments processing company First Data for $22 billion—the two companies combined are a backbone of Wall Street’s financial technology. (WSJ)
Visa purchased the payments authentication company Plaid for $5.3 billion in January 2020, in hopes of strengthening its relations with financial institutions. (CNBC)

As billions of dollars exchange hands, it’s been noted that many of these plays were made by established incumbents to curb the threat posed by fintech startups.

At the same time, however, it’s also clear that traditional institutions want to tap into what fintech startups are doing right.