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BlackRock: Factors With Economic Rationale Should Endure

Adam McCullough, CFA

Adam McCullough: Hello, I'm Adam McCullough, a passive manager research analyst with Morningstar. We're here at the 2017 ETF Morningstar conference. I'm here today with Andrew Ang, who is head of factor strategies at BlackRock. Today we're going to ask Andrew about some factor-based strategies, timing, and looking at why we think these factors should perform well going forward. 

Andrew, thanks for being here today.

Andrew Ang: Thank you, Adam, for having me.

McCullough: Absolutely. The first question is, factor strategies have gotten very popular. People are putting money into them. Why should we expect factors to perform as they have in the past going forward?

Ang: We look at several criteria, a checklist, so to speak, for factors. The most important one is this economic rationale of why these factors exist. So it's got to be, therefore, a reward for a risk or comes about through some market structure impediment. Then, finally, a behavioral bias. They have to be there for us to have confidence that these factors will be there for decades to come. Let me just illustrate it with one example.

McCullough: Perfect.

Ang: We have value. These companies tend to be a little bit old-fashioned, production lines and factories. Those are hard to redeploy, hard to get your factory to do something else. Value stocks tend to underperform in recessions when it's hard to transform your company to doing something else. That's the reward for bearing risk.

Some investors tend to be attracted toward high-flying growth companies. They bid up prices too high, so that these high prices come with unrealistic future growth expectations. They shun value companies that have low prices, giving rise to a value effect. Are people going to suddenly stop going against the crowd? Is the value company able to redeploy instantaneously its production lines? No. That gives us confidence that these factors are going to endure for decades to come.

McCullough: That makes a lot of sense. There's a handful of factors that are very persistent. There's about five or six or so. These factors don't all perform well at the same time. You might have value performing well and momentum performing well next. What's a good framework for investors to look at on how to time or tilt factor strategies, and when's the best time to go into momentum stocks or value stocks or quality stocks?

Ang: You're so right, Adam, because factors are cyclical, just like all assets are cyclical. One way to think about that is to use the word 'tilting,' rather than 'timing.' Think about a long-term strategic allocation to multiple factors, say to value and quality, momentum, size, and say minimum volatility, and then gradually rotate your holdings around that long-term strategic benchmark.

You could do that with a variety of signals, valuations. You always want to buy cheap. We can think about relative strength or momentum, and in fact, we have value in momentum of each of those factors. Other signals include dispersion, turnover. You might look at how concentrated those types of signals are. And, of course, very importantly, where you are in the economic cycle. Today, BlackRock is long momentum. We view momentum as having some short-term momentum of itself. Valuations are fair, and the economic environment continues to have relatively high, albeit slightly slowing growth. That all goes well for a momentum factor.

McCullough: Andrew, thanks again for being here today. We really appreciate your comments and insights about factor investing and factor tilting.

Ang: Thank you, it's been great to be here.

McCullough: Absolutely. With Morningstar, I'm Adam McCullough.