At J.P. Morgan, Risk, Return at Work on Multifactor Equities

Adam McCullough: Hi, I'm Adam McCullough. I'm a passive strategies analyst with Morningstar. We're here at the Morningstar Investment Conference with Yasmin Dahya.

Yasmin, thanks for coming here today.

Yasmin Dahya: Thanks for having me.

McCullough: Yasmin is the head of America's beta specialist team at J.P. Morgan Asset Management. We're here today to talk about multifactor equity funds. I think to start off, can you walk me through JP Morgan's approach to multifactor equity funds and how you think about putting together these types of portfolios?

Dahya: The lens in which we approach multifactor construction is really from the idea upon what are the opportunities that exist in market cap that can be improved upon, and ultimately the goal being can you create a better core equity allocation. I would segment that on two different opportunities that our process focuses on: the risk dimension and the return dimension.

From a risk standpoint, what we're really trying to address in our process are the concentrations of risk that can present themselves in a market-cap index. As an example, and I think this is something that investors are familiar with, if you look at the S&P 500, the top 150 stocks make up three quarters of the allocation. It's a lot more like the S&P 150 than it is the S&P 500. That insight extends to sector allocations and region allocations. We believe the goal of an index is to have a diversified capture of the equity market. Our process diversifies risk across sectors, regions, and stocks. We think of that more like a defense step really. And where I see that adding value is more in volatile or down markets. That's the risk opportunity in our process.

The second is the return, which really centers around much of what we talk about in the factor investing space. This is about accessing compensative factors like value, quality, and momentum. We do so in an integrated fashion. Using those factors to narrow your universe down to own a stock we think will enhance return relative to the whole universe. I think of that more as an offense step. If you put those two things together, ultimately I think of the investment objective as better risk-adjusted returns over a market cycle. One of the features we talk a lot about with clients is up down capture--being able to participate with market upside, but having superior downside capture.

McCullough: You're targeting well-vetted factors that have the potential for excess returns, but also reining in some of the concentration risk associated with market-cap-weighted indexes and funds.

Dahya: Yes. I would say when you look at the landscape of funds out there, it becomes a question of what makes us different, it really is that combination of both the risk and the return elements in our process coming together. What you often see is an investment processes focus on one or the other. When we think of a core world, we see value in having both.

McCullough: So to that point, it is a very different approach. What are the pros and cons of this approach versus your peers or other funds out in the market?

Dahya: I think if you're targeting a better risk-adjusted returns, I absolutely see the risk dimension is adding a lot of value to that. One consideration that I speak to clients on is the idea of tracking error. By definition of our process, we are more evenly weighted across sectors, regions, and stocks. I see that as having more balance and stability. Now what that means is when market cap is very concentrated, we'll look different from market cap. Clients really need to think about how they view tracking error and the role of these products in their portfolio.

I would mention on that point, though, that I see that tracking error as essentially the point of the part of the process. You're diversifying those risk concentrations when they present themselves. It's also knowable tracking error in the sense that because the process has more balance, you know when you're going to see tracking error present itself. It's when market cap is more concentrated. I do think there's levels to talk about with clients, but it really does come down to where do you think about the role of these types of products in your portfolio.

McCullough: It's almost framing it as relative versus absolute risk in a portfolio.

Dahya: Yes. Ultimately, it goes to this question of, sort of where we started, which is I think of this as indexation 2.0. Blank slate, not constraining yourself to market cap. How would you create a factor-based portfolio? From that lens, you would see value in having both of those two dimensions.

McCullough: Very fair point. Yasmin, great information. Thank you for being here.

Dahya: Thanks for having me.