Factor investing: Drivers of active returns

About SatrixSatrix is the leading provider of index-tracking investments products in South Africa, with over R90 billion in assets under management invested in our range of segregated mandates, exchange traded funds (ETFs) and unit trusts. Satrix has been managing factor-based portfolios for institutional investors since 2007. Over the years, we have accumulated vast insights into crafting factor-based investment strategies, which have high predictability and reliability through all market cycles.

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Factors are intuitive, well understood and measurable investment ideas that explain stock behaviours over long periods of time. They are critical in helping investors achieve their investment goals, be they generating above-market returns, managing risk or enhancing diversification.

Factor investing can be defined as a systematic approach to investing by targeting persistent and recognized drivers of excess returns.

What arefactors?

“FACTOR INVESTING IMPROVES THE PREDICTABILITY OF RETURNS AND IS REVOLUTIONISING THE INVESTMENT INDUSTRY”.

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of factor investingEvolution

1970’s 1980’s 1990’s 2000’s 2010+

1960’s to 1980’s CAPM model challenged as research reveals that markets are inefficient and the market (beta) is not the only driver of stock returns.

1990’s Research by Fama and French demonstrated that besides the market factor, the Size of a company and Value are also important drivers of its stock price.

2000’s Empirical evidence proves that past winners on performance are most likely to be the future winners, and so the Momentum factor emerges.

2010+Factors such as Quality and Low Volatility increase in popularity.

Rise in factor investing driven by:

1. Demand for transparency, consistency and lower fees.

2. Research showing that a large percentage of active returns can be explained by exposure to factors.

3. Technology allows improved systematic access to fundamental data.

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This strategy provides through-the-cycle exposure to best-in-class companies, which can be identified by using common financial metrics like return on equity, debt to equity and earnings quality.

Quality

Stocks that have outperformed in the past tend to exhibit strong returns going forward. A momentum strategy is based on relative returns from six months to a one-year time frame.

Momentum

A defensive variant of Value, this strategy focuses on stocks which have high dividend yields. These attractive yields provide a steady form of income to investors, contributing meaningfully to long-term total returns.

Yield

A portfolio consisting of stocks with low beta and/or low absolute volatilities can provide consistent outcomes through its ability to protect performance during deep correction cycles, providing lower drawdowns.

Low Volaitility

Aims to capture excess returns from stocks that have low prices relative to their fundamental value. This is commonly tracked by price to book, price to earnings, dividends, and free cash flow.

Value

Historically, portfolios consisting of small-cap stocks exhibit greater returns than portfolios with just large-cap stocks. Investors can capture size by looking at the market capitalization of a stock.

Size

Pillars of factor investing:

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“EXPOSING YOURSELF TO A DIVERSIFIED MIX OF FACTORS OVER TIME ENABLES MORE PREDICTABLE OUTPERFORMANCE”

Unleashing the power of factor blendingThere are many practical applications of factor investing that we can use to unleash valuable insights and enhanced predictability for investors.

An understanding of a portfolio’s exposure to the various factors is critical, and can reveal a portfolio’s mix of factor exposure as well as pure alpha. Adding or reducing factor exposures is key to enhancing targeted exposures and mitigating the negative effects of unintended factor exposures.

There are different ways to blend factors:Single factor blending: Blends uncorrelated single factors to produce a diversified, transparent factor portfolio.

Multi-factor blending: Blends multiple factors at a stock level to achieve a diversified equity portfolio, with enhanced factor purity and better trading efficiencies.

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Single factor blend

Quality

MomentumValue

Quality

MomentumValue

Multi factor approach

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ValueFama & French (1996)

MarketSharpe (1964)

Low VolatilityClarke, Da SIlva & Thorley (2006)

SizeFama & French (1996)

YieldLintner (1956), Gordon (1959)

Fama & French (1988)

MomentumJegadeesh & Titman (1993)

QualityNovy-Marx (2013)

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DRIVERS OF RETURNSDRIVERS OF RETURNS

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Before an investment strategy can be considered a factor, it must go through academic scrutiny, which involves validating the originally published findings using different datasets, across different regions and even across different asset classes.

There must also be a sound theoretical or economic explanation for the existence of a factor. These explanations fall into three categories, namely Risk Compensation, Behavioural Biases and Structural Impediments.

In the same way that investors can expect higher returns by investing in more risky assets like the equity market, so too can investors expect higher equity returns by targeting factors within their equity investments.

FACTOR PREMIUMS ARRIVE THROUGH A COMBINATION OF RISK COMPENSATION, STRUCTURAL IMPEDIMENTS, OR BEHAVIOURAL BIASES BY THE AVERAGE INVESTOR.

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Factor performance and the economic cycleThe South African experience

Contraction RecoveryLate cycle Recession

FACTORPERFORMANCEWhile the long-term premium delivered from each factor is positive, it is also cyclical. The cyclicality is largely due to the different market drivers for each factor that yield outperformance during different periods. The risk of being exposed to a single factor is extended periods of poor performance, and it is therefore important to diversify exposure to factors and blend allocations across multiple factors.

Momentum

Value

Quality

Low volatility

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OVERALL BENEFITS OF INVESTING WITH FACTORS

Why partner with Satrix?Our solutions: Our approach is wholly solutions oriented. We are able to customise and build unique portfolios for our clients. Understanding their specific investment needs enables us to tailor unique risk-profiled solutions across a range of factors, building blocks, asset classes and solutions.

Our systems: We have developed proprietary in-house systems that allow a small team to efficiently manage a large number of portfolios thereby allowing us to pass on these efficiencies to clients.

Our skill: As the largest and most experienced index investment management team in South Africa, we are pioneers in indexation and have been accumulating vast insights into crafting factor-based investment strategies since 2007. We have accumulated these insights using our extensive expertise in portfolio construction, and collaborating with global experts.

Our scale: We provide significant benefits of scale when it comes to operational excellence and trading.

Enhanced diversification

Greater control

Enhanced predictability

of returns

Reduced cost

Above-market returns

Reduced risk

!Improved

transparency

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Satrix in a nutshell

MARKETS TRADEDWORLDWIDE45

80 PORTFOLIOS

MANAGED16UNIT TRUSTS

41SEGS

9INTER-NATIONALETFs

14

11 TEAM MEMBERS177 COMBINED YEARS

OF INDUSTRY EXPERIENCE

INDICES TRACKED40 Source: Satrix Managers, January 2019

ASSETS UNDERMANAGEMENT

R90 BILLION* 0

102030405060708090

*AUM represents all assets managed in CIS vehicles (Satrix ETFs and Unit Trusts), as well as assets managed via segregated mandates by Satrix as a division of Sanlam Investment Management.

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Satrix investment team

Helena ConradieChief Executive Officer  BSc, MSc (Cum Laude), CFAIndustry experience: 22 yrs

Adriaan van NiekerkSenior Portfolio ManagerBCom, BSc (Hons), CFAIndustry experience: 18 yrs

Henriqueco VisserChief Technology OfficerBSc (Mathematical Stats)Industry experience: 19 yrs

Duma MxengeBusiness Development ManagerBCom (Hons), FAPMIndustry experience: 14 yrs

Lauren JacobsPortfolio ManagerBBusSc (Finance)Industry experience: 13 yrs

Kingsley WilliamsChief Investment OfficerBSc Hons (Computer Science)MBA (Finance)Industry experience: 19 yrs

Johann HugoHead : Portfolio ManagementBCom (Hons)Industry experience: 38 yrs

Jenny AlbrechtChief Operating OfficerBCom, CFAIndustry experience: 21 yrs

Nonhlanhla MpheloSenior Portfolio ManagerBCom (Accounting)BCom Hons (Finance)Industry experience: 12 yrs

Yusuf WadeeHead: Exchange Traded ProductsBEconSc (Actuarial, Mathematics)BSc Hons (Mathematics)Industry experience: 18 yrs

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55 Willie van Schoor Avenue, Bellville, Cape Town , 7530 Tygervalley

Duma Mxenge E institutional@satrix.co.zaW institutional.satrix.co.zaT +27 21 950 2100

Contact

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Satrix Managers (RF) (Pty) Ltd (Satrix) a registered and approved Manager in Collective Investment Schemes in Securities and an authorised financial services provider in terms of the FAIS. Collective investment schemes are generally medium- to long-term investments. Unit Trusts and ETFs the investor essentially owns a “proportionate share” (in proportion to the participatory interest held in the fund) of the underlying investments held by the fund. With Unit Trusts, the investor holds participatory units issued by the fund while in the case of an ETF, the participatory interest, while issued by the fund, comprises a listed security traded on the stock exchange. ETFs are index tracking funds, registered as a Collective Investment and can be traded by any stockbroker on the stock exchange or via Investment Plans and online trading platforms. ETFs may incur additional costs due to it being listed on the JSE. Past performance is not necessarily a guide to future performance and the value of investments / units may go up or down. A schedule of fees and charges, and maximum commissions are available on the Minimum Disclosure Document or upon request from the Manager. Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. Should the respective portfolio engage in scrip lending, the utility percentage and related counterparties can be viewed on the ETF Minimum Disclosure Document. The Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The index, the applicable tracking error and the portfolio performance relative to the index can be viewed on the ETF Minimum Disclosure Document and/or on the Satrix website. Performance is based on NAV to NAV calculations of the portfolio. Individual performance may differ to that of the portfolio as a result of initial fees, actual investment date, dividend withholding tax and income reinvestment date. The reinvestment of income is calculated based on actual distributed amount and factors such as payment date and reinvestment date must be considered.

*AUM represents all assets managed in CIS vehicles (Satrix ETFs and Unit Trusts), as well as assets managed via segregated mandates by Satrix as a division of Sanlam Investment Management.