Institutional investment know-how isn’t just for institutions anymore

Key takeaways:

• Institutional investment strategies can seek to enhance returns while maintaining tight risk controls, offering a disciplined “core-plus” approach to portfolio construction.
• These strategies can also include climate and responsible investment goals, helping investors align their portfolios with responsible investment objectives.
• By using an ETF, investors can access institutional-level investment expertise in a transparent, liquid and cost-effective way.

Institutional investors have long enjoyed access to sophisticated investment strategies targeting enhanced returns. These strategies have been able to combine their performance uplift targets with other features required in the institutional space, such as responsible investment commitments and climate transition pathways.

We believe a well-designed investment strategy can help meet these requirements within a strict risk framework that keeps overall portfolio characteristics in line with core asset allocation targets, such as a global sleeve that can be benchmarked with the MSCI ACWI Index.

Today, access to these types of strategies isn’t restricted to institutions. ETFs mean sophisticated investment strategies can be wrapped in a transparent, low-cost and potentially tax^[1] efficient vehicle available to all investors.

The factor edge in portfolios

One way that “core-plus” strategies aim to provide enhanced returns versus vanilla indices is by implementing factors.

Put simply, factor investing refers to allocating to certain investment factors that have historically generated excess returns^[2] over the long term. These returns can be attributed to a combination of structural, behavioural and risk-based explanations, and are subject to extensive investigation by academics. Some of the most established factors include:

• Value: Stocks that are undervalued relative to the market or peers based on company fundamentals.
• Quality: Stocks with higher profitability and more sustainable asset growth relative to the market or peers.
•  Momentum: Stocks with a positive share-price trend.

[1] Tax treatment is dependent on individual circumstances and is subject to change.
[2] Past performance is not a guide to the future.

One interesting feature of factors is that each of them can be expected to perform best during particular phases of the business or economic cycle. For example, in the current environment Momentum has performed well, while Quality has suffered in comparison.

While some investors seek to express tactical views through single-factor allocations and factor rotation, others prefer a strategic, long-term approach. Multi-factor strategies are designed to combine factors with differing performance characteristics, aiming to smooth outcomes across market environments and reducing the risk associated with being concentrated in a single factor at the wrong point in the cycle.

Responsible investment considerations

Beyond familiar responsible investment exclusions such as the UN Global Compact and limiting exposure to thermal coal, oil sands and controversial weapons, institutional-style strategies often incorporate decarbonisation targets, forward estimates of financial risks and responsible investment scores.

Greenhouse gas emissions targets can be applied to reduce emissions versus an index such as the MSCI ACWI by a predefined percentage within a particular time horizon, alongside a defined reduction at each index review.

Even more sophisticated, forward-looking estimates of climate risk can also be incorporated via a Climate Transition Value at Risk (CT VaR) framework, which estimates how much a company's value could be affected by the transition to a low-carbon economy.

Risk management

Crucially, the ideal scenario is not choosing between factors and responsible investment objectives, but harnessing both simultaneously – capturing rewarded factor exposures and aligning with sustainability objectives – while maintaining risk controls that limit deviation from standard benchmarks.

This risk management can be achieved through optimisation constraints that include:

• Stock and issuer constraints
• Sector and country constraints
• Currency constraints
• Factor and responsible investment constraints

Together, these constraints aim to create a portfolio with very similar characteristics to the parent index, but with the incorporation of the previously mentioned enhancements.

Access for all

These sophisticated “core-plus” strategies are nothing new, having been tried and tested in the institutional space for many years.

But placing these strategies within an ETF wrapper can provide easier access, higher transparency and additional liquidity. Ultimately, this brings institutional-grade investment expertise within reach of a broader range of investors.