Real estate factor-based investing is an investment methodology aimed at focusing on specific drivers of return and risk across markets and sectors. Factor-based strategies can support portfolio returns and improve diversification.
INTRODUCTION TO FACTOR INVESTING
Factor Investing aims at improving the trade-off between risk and return by investing in assets related to specific factors, so-called investment factors. These are defined as measureable features of an asset with information about risk and return.
While most of the research on the subject has been performed for the stock market, investment factors seem to be relevant for other asset classes such as bonds, currencies and commodities. Furthermore, our analysis demonstrates that investment factors can affect real estate returns as well.
Factor Investing is an intuitive, albeit rigorous and data-driven methodology that can be applied to the reality of day-to-day investment. In short, the beauty of this methodology is that it creates the link between behavioral finance and quantitative analysis.
- Laurent Ternisien, Global CCO BNP Paribas REIM
THE CENTRAL ROLE OF THE INVESTOR
At its heart, the idea behind Factor Investing is not to impose to investors what is best in theory but to provide them with a tailor-made advice.
This factor-based approach stresses the central role of the investor: investors can spell out their preferences in terms of risk and rewards, therefore enabling the manager to create ’tailor-made’ solutions that cater to their precise needs.
In short, Factor Investing brings a quantitative discipline element to the choices active managers make.
FACTOR INVESTING TO IMPROVE DIVERSIFICATION
Factor Investing is designed to enhance diversification, generate above-market returns and manage risk. For example, geographical portfolio diversification has long been popular with managers. However, the gains of diversification are lost if the chosen markets move in lockstep with a broader trend. So an investor may choose a mixture of cities that all decline in value when certain market conditions arise. Factor Investing can offset potential risks by targeting recognized and persistent drivers of returns.
HOW DOES IT WORK?
Classical strategies allocate in terms of countries (and sometimes cities) and sectors. We, on the other hand, aim at allocating in terms of investment factors. These factors and their combination will then provide us with an indication of where and what to buy.
Our analysis (based on both historic data and forecasts) has highlighted six investments factors that are relevant for real estate investment: growth, yield, low volatility, liquidity, quality and value. Each of these factors is characterized by a specific investment rationale.
Investment factors behave in a dynamic way. Some factors can generate extra returns in specific regimes such as an economic recovery, while other factors can outperform in other regimes, i.e. an economic contraction.
WHY BNPP REIM?
BNPP REIM is leading research in the application of style investing to real estate and can leverage on an extensive database, including robust historical data and state-of-the-art forecasts, to test our investment assumptions.
Moreover, BNPP REIM has the ability to access suitable stock in different geographies and sectors, compatibly with the diversification required by a style-driven strategy.