Leveraging Factors to Achieve Superior Risk-Adjusted Returns
The Westwood Managed Investment Solutions team has helped countless institutional investors using a consultative process to develop unique rules-based, outcome-oriented investment solutions for their specific needs and goals. The following case study illustrates how they created a solution for an institutional client with a specific set of challenges.
A consulting firm that provides investment management advice to defined contribution plans sought to enhance their portfolio offerings. While its approved investment platform already included an S&P 500 Index fund, actively managed large-cap value and growth options, as well as an actively managed large-cap core strategy, the consultant sought another approach.
The consultant brought in the Managed Investment Solutions (MIS) team for a discussion about adding a new approach to their approved list of investment choices. They were seeking a replacement for the active large-cap core strategy, one that could offer reduced costs and the potential for greater risk-adjusted returns, compared to the incumbent actively managed investment strategy.
The MIS team discussed with the consultant several different tactics to create a portfolio that could generate enhanced risk-adjusted returns with similar or reduced costs. One way to accomplish this goal was to explore a passive portfolio structure that boosted factor exposure to enhance return potential while effectively managing risk metrics. The plan was to use this portfolio to replace the current large-cap core actively managed fund. Moreover, the consultant wanted a “white label” solution, one that would allow them to market the new strategy with their branding while the strategy was managed by MIS.
Working with the consultant, the MIS team outlined a series of academic factors that could impact performance as well as risk metrics. These included low volatility, momentum, value, quality and market capitalization biases. The MIS team provided a historical risk/return analysis of each factor, and how they interacted with each other, to help identify the most effective ways to incorporate factors into a rules-based portfolio that could achieve the stated performance objectives. Further, the MIS team was able to reduce costs, as a rules-based factor portfolio has a lower management fee than a traditional actively managed portfolio. Using this information, the consultant was able to see how incorporating and weighting factors could create enhanced risk-adjusted returns with reduced costs.
Using historical return data, the MIS team was able to show how the actively managed core option was a more costly solution without clear advantages compared to the rules-based portfolio with factor tilts and regular rebalancing. By tilting the portfolio towards historically rewarded risk factors while controlling tracking error risk and turnover, the overall portfolio characteristics and risk adjusted returns were improved.
Moreover, the MIS team demonstrated how the new rules-based factor portfolio interacted with their existing lineup of large-cap growth and large-cap value active managers. The MIS team was able to fine-tune the factors in the rules-based portfolio to help the consultant achieve their stated long-term risk and reward characteristics.
The MIS team’s analytical capabilities were key in determining how to incorporate multiple factors into the rules-based large-cap core portfolio. The team was able to offer detailed analysis that was not easily replicable from other sources and went beyond the consultant’s in-house capabilities. The MIS team demonstrated different scenarios that showed the impact of shifting assets from a risk-return perspective, showing how factor intensity scores could be improved compared to the current management structure, highlighting how factor tilts could affect potential investment outcomes.
The MIS team provided the consultant with the capability to implement the new, rules-based factor portfolio in its investment lineup, alongside the existing actively managed large-cap growth and value strategies, when it determined the timing was appropriate. The new portfolio solution was able to reduce the plan’s overall costs while bringing risk characteristics into line with the consultant’s goals. This was a more nimble, practical investment solution compared to existing portfolio options.
The MIS approach positioned the consultant to more effectively meet the needs of the defined contribution plan participants it served. This investment solution provides an example of how MIS can offer meaningfully unique solutions that stand out in today’s investment marketplace. Plan providers can leverage those solutions to implement distinctive, analysis-based solutions that will help differentiate their offerings.
Investment solutions that work for you
Your needs and objectives are specific. You deserve an investment solution that is best suited to accomplish your goals. The experienced professionals of Westwood’s MIS team take the time to work with you, understand the challenges you face, and design a customized approach that specifically aligns with your unique goals, beliefs and objectives. Our MIS team is in a unique position to choose the tools and data sources required to achieve your desired outcomes.