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In this article, the author discusses current structural research and investment trends that are shaping the future of factor investing. Specifically, the author focuses on three emerging trends: the ongoing evolution of traditional factor models and strategies, recent innovation in data sources and modeling techniques, and the potential disruption from integrating factor strategies into the asset allocation process. Key Findings ▪ Factor models and strategies evolve gradually over time, reflecting the evolution of capital markets and advances in academic theory, data availability, empirical research, and investment practice. ▪ Current innovation efforts in factor investing focus on exploiting new unstructured data sources, applying new data science modeling techniques, and integrating sustainability and climate factors. ▪ Innovation in factor investing is reshaping the traditional asset allocation paradigm by creating new opportunities for investors to express active investment views through a factor allocation process.

This study presents an updated assessment of the projected climate change over Greece in the near future (2021–2050) and at the end of the 21st century (2071–2100) (EOC), relative to the reference period 1971–2000, and focusing on seasonal crop-specific climatic indices. The indices include days (d) with: a maximum daily near-surface temperature (TASMAX) > 30 °C in Spring, a TASMAX > 35 °C in Summer (hot days), a minimum daily near-surface temperature (TASMIN) < 0 °C (frost days) in Spring, a TASMIN > 20 °C (tropical nights) in Spring–Summer and the daily precipitation (PR) > 1 mm (wet days) in Spring and Summer covering the critical periods in which wheat, tomatoes, cotton, potato, grapes, rice and olive are more sensitive to water and/or temperature stress. The analysis is based on an ensemble of 11 EURO-CORDEX regional climate model simulations under the influence of a strong, a moderate, and a no mitigation Representative Concentration Pathway (RCP2.6, RCP4.5 and RCP8.5, respectively). The indices related to TASMAX are expected to increase by up to 11 days in Spring and 40 days in Summer, tropical nights to rise by up to 50 days, frost days to decrease by up to 20 days, and wet days to decline by up to 9 days in Spring and Summer, at the EOC with an RCP8.5. The increased heat stress and water deficit are expected to have negative crop impacts, in contrast to the positive effects anticipated by the decrease in frost days. This study constitutes a further step towards identifying the commodities and/or regions in Greece which, under climate change, are or will be significantly impacted.

Factors are the underlying forces that drive portfolio risk and performance over different investment horizons. In this article, first the author reviews the theoretical foundations and practical applications of factor models. The author then discusses the integration of factors into different types of investment strategies. He concludes with a discussion of how factor models and strategies enable investors to manage total portfolio risk and capture risk premiums through the asset allocation process. TOPICS:Factor-based models, portfolio construction, risk management, performance measurement Key Findings ▪ Factor models empower investors to understand and manage the sources of portfolio risk. ▪ Factor strategies reflect factors, offering investors the ability to capture factor premiums. ▪ In factor allocation, factors replace asset classes as the drivers of asset allocation decisions.

Here, we present an updated assessment of projected climate change over Greece in the near future and at the end of the 21st century. The analysis is based on an ensemble of 11 high-resolution EURO-CORDEX simulations based on historical emission data and three different greenhouse gas concentration scenarios, namely, RCP2.6, RCP4.5, and RCP8.5. Our results strongly point towards a warmer future under all the examined RCPs. Under the extreme RCP8.5 scenario, temperature is expected to increase on average by 1.6 oC (12%) in the near future and 4.3 oC (33%) at the end of the century. The number of hot days and tropical nights per year is expected to increase significantly and the number of frost days to decrease. Also, the future will be possibly drier, with statistically robust results for the end-of-the-century period under RCP8.5 only. On average, precipitation is expected to decrease under RCP8.5 by -0.4 mm day-1 (-16%) and the number of consecutive dry days per year to increase by 15.4 days (30%) at the end of the century.The authors acknowledge funding from the Action titled "National Νetwork on Climate Change and its Impacts - CLIMPACT" which is implemented under the sub-project 3 of the project "Infrastructure of national research networks in the fields of Precision Medicine, Quantum Technology and Climate Change", funded by the Public Investment Program of Greece, General Secretary of Research and Technology/Ministry of Development and Investments.

BACKGROUND AND AIM: In the LIFE ASTI project a forecasting system for estimating the urban heat island intensity (UHI) and defining high resolution heat health watch warning systems was developed i...

In this article, the authors review factor performance in global equity markets using coherent data and methodology and apply a new template to evaluate their backtests for potential selection bias under multiple testing. They then propose a systematic process for integrating factor information into different investment strategies. The authors show that this process is consistent with the Black–Litterman framework and test it on a sample of market indexes and active equity portfolios. Integrating factors in indexes improved risk-adjusted performance while retaining high liquidity and capacity. Adding factors to active strategies enhanced information ratios while maintaining the portfolio characteristics and stock selection alpha of the original strategies. The authors’ analysis may have important implications for different types of investors. Asset owners may be able to tilt reference indexes toward rewarded factors without sacrificing market coverage and diversification. Index managers can track factor-tilted indexes because they remain investable and replicable. Finally, active managers may be able to incorporate factor information into their strategies to harvest factor premiums while preserving their core investment process and the added value from fundamental security selection. TOPICS:Factor-based models, portfolio management/multi-asset allocation, style investing

Many studies have focused on the relationship between companies with strong environmental, social, and governance (ESG) characteristics and corporate financial performance. However, these have often struggled to show that positive correlations—when produced—can in fact explain the behavior. The authors of this article provide a link between ESG information and the valuation and performance of companies, by examining three transmission channels within a standard discounted cash flow model—which they call the cash-flow channel, the idiosyncratic risk channel, and the valuation channel. They tested each of these transmission channels using Morgan Stanley Capital International ESG Ratings data and financial variables. This showed that companies’ ESG information was transmitted to their valuation and performance, both through their systematic risk profile (lower costs of capital and higher valuations) and their idiosyncratic risk profile (higher profitability and lower exposures to tail risk). The research suggests that changes in a company’s ESG characteristics may be a useful financial indicator. ESG ratings may also be suitable for integration into policy benchmarks and financial analyses. TOPICS: ESG investing, security analysis and valuation, risk management

There has been a wide range of research in academia and the asset management industry about the financial benefits of ESG investing. However, the question of how to achieve consistency when integrating ESG has not obtained the same level of attention. As a result, ESG integration currently is often applied inconsistently and incompletely across asset owners’ portfolios. The authors of this article focus on how asset owners can implement ESG integration through index-based allocations to portfolios that seek to replicate ESG indexes. Index-based approaches offer consistency, transparency, and replicability and are generally cost-effective. Over a seven-year study period, global and regional versions of the MSCI ESG Leaders Indexes (as proxies for regional allocations) resulted in significant variations in their respective ESG profiles and performance, but in all instances, there was a clear reduction in all key risk measures.

The spatial distribution, radiative forcing, and climatic effects of tropospheric ozone in China during summer were investigated by using the regional climate model RegCM4. The results revealed that the tropospheric ozone column concentration was high in East China, Central China, North China, and the Sichuan basin during summer. The increase in tropospheric ozone levels since the industrialization era produced clear-sky shortwave and clear-sky longwave radiative forcing of 0.18 and 0.71 W m–2, respectively, which increased the average surface air temperature by 0.06 K and the average precipitation by 0.22 mm day–1 over eastern China during summer. In addition, tropospheric ozone increased the land–sea thermal contrast, leading to an enhancement of East Asian summer monsoon circulation over southern China and a weakening over northern China. The notable increase in surface air temperature in northwestern China, East China, and North China could be attributed to the absorption of longwave radiation by ozone, negative cloud amount anomaly, and corresponding positive shortwave radiation anomaly. There was a substantial increase in precipitation in the middle and lower reaches of the Yangtze River. It was related to the enhanced upward motion and the increased water vapor brought by strengthened southerly winds in the lower troposphere.

The authors examine how a factor allocation can be integrated into an asset owner’s existing roster of active managers. Using a risk-budgeting framework, they have several findings. (1) Asset owners who wish to maintain their existing roster of active managers and incorporate factor views may consider a top-down factor implementation, funded entirely from the core passive allocation. This approach distributed most of the active risk to active managers. (2) Asset owners who wish to preserve their existing roster of active managers and incorporate high-conviction factor views may consider an allocation between active management and a bottom-up factor implementation. This approach more evenly distributed the risk budget to active management and factors and partially funded the factor allocation from active management. (3) Asset owners who pursue a barbell strategy between core passive allocations and concentrated active managers could implement a low-volatility factor allocation, which may lower the total risk of the equity program, releasing active risk budget that can be deployed to active managers.

Minimum volatility strategies enjoy broad support in the academic literature and have been applied extensively by institutional investors to reduce portfolio volatility. In this article, the authors discuss how such strategies can adapt to address risks beyond price volatility. Specifically, concentration, sustainability, and crowding risks could be mitigated using appropriate but simple optimization constraints. However, adding a diversification constraint increased exposure to residual volatility and had a negative impact on risk reduction and risk-adjusted performance. In contrast, to help manage environmental, social, and governance (ESG) risks, adding a significant sustainability constraint had only a small effect on the risk reduction properties. Finally, introducing constraints on the value exposure ensured the market-relative valuations of the strategy remained attractive for only a small increase in realized volatility. The authors show that simple constraints could be used effectively in minimum volatility strategies to manage risks beyond volatility.

This study aims at assessing the differences induced in the Global Horizontal Irradiance (GHI) predictions by the mesoscale atmospheric Weather Research and Forecasting (WRF) model when using different shortwave radiation. Model predictions are compared with GHI measurements at 12 stations of the Hellenic Network of Solar Energy (HNSE) for January, April, July and October 2013. The shortwave radiation schemes that were evaluated are: the Dudhia, the updated Rapid Radiative Transfer Model (RRTMG), the updated Goddard and the Goddard Fluid Dynamics Laboratory (GFDL) schemes. All schemes perform better under cloudless conditions due to limited ability of the WRF model to simulate cloudy conditions. The Dudhia scheme performs best with mean relative difference of 2.2 ± 15% for clear-skies, while the differences for the other schemes range between 5 and 12% with similar standard deviations. For all-skies, the model-derived hourly GHI is overestimated for all schemes (∼40–70%). For the daily averages, the model predictions are in better agreement with the measurements, mainly under all-sky conditions, with deviations of about half those of the hourly data and smaller standard deviations. There are strong indications that the differences of the model predictions from the measurements depend on the solar zenith angle and the amount of aerosols at each station.

Stratosphere-to-troposphere transport (STT) is an important natural source of tropospheric ozone, which can occasionally influence ground-level ozone concentrations relevant for air quality. Here, we analyse and evaluate the Copernicus Atmosphere Monitoring Service (CAMS) global and regional forecast systems during a deep STT event over Europe for the time period from 4 to 9 January 2017. The predominant synoptic condition is described by a deep upper level trough over eastern and central Europe, favouring the formation of tropopause folding events along the jet stream axis and therefore the intrusion of stratospheric ozone into the troposphere. Both global and regional CAMS forecast products reproduce the “hook-shaped” streamer of ozone-rich and dry air in the middle troposphere depicted from the observed satellite images of water vapour. The CAMS global model successfully reproduces the folding of the tropopause at various European sites, such as Trapani (Italy), where a deep folding down to 550 hPa is seen. The stratospheric ozone intrusions into the troposphere observed by WOUDC ozonesonde and IAGOS aircraft measurements are satisfactorily forecasted up to 3 days in advance by the CAMS global model in terms of both temporal and vertical features of ozone. The fractional gross error (FGE) of CAMS ozone day 1 forecast between 300 and 500 hPa is 0.13 over Prague, while over Frankfurt it is 0.04 and 0.19, highlighting the contribution of data assimilation, which in most cases improves the model performance. Finally, the meteorological and chemical forcing of CAMS global forecast system in the CAMS regional forecast systems is found to be beneficial for predicting the enhanced ozone concentrations in the middle troposphere during a deep STT event.

Practical Applications Summary In Bridging the Gap: Adding Factors to Passive and Active Allocations, which appeared in the 2018 Quantitative Special Issue of The Journal of Portfolio Management, Anil Rao, Raman Aylur Subramanian, and Dimtiris Melas (all of MSCI, Inc.) argue that asset owners should use risk budgeting to determine the optimal mix of active and passive investments. To support this assertion, the authors examine the effects of different possible active, passive, and factor (top-down or bottom-up) allocations when the active managers have high tracking errors. The authors also examine the effects of using a minimum-volatility strategy to de-risk the equity program. Ultimately, they found that the optimal allocations were around 40% passive, 30-40% active, and 20-30% factor allocation, with differences in funding source and risk allocation.

The annual and diurnal behavior of the temperature differences in urban areas is important to predict the possible impacts of the future land-use development on climate change and air pollution in heavily populated areas. The behavior of the temperature as well as wind spatio-temporal differences in turn is strongly interconnected with the turbulent and radiative fluxes variability. A 3-year dataset from three automated micrometeorological stations run by the Regional Agency for Environment Protection of Lazio and located in and around the city of Rome is used. The distribution of the urban heat island intensity for the whole period of measurements peaks at 1 °C, but higher values are frequently registered especially referring to differences with the coastal site also due to the sea-breeze cooling effects. The city is generally drier and characterized by winds of lower intensity reaching their maximum 1 h later with the respect to the sub-urban/coastal sites during the afternoon. The micrometeorological data are also analyzed to estimate some key parameter characteristic of the terrain, which represents the main forcing in the numerical models for UHI estimates, such as the albedo, aerodynamics and atmospheric turbulence parameters.

Practical Applications Summary In Managing Risks Beyond Volatility, from the Fall 2017 issue of the Journal of Index Investing, authors Mehdi Alighanbari, Stuart Doole, and Dimitris Melas, all of MSCI, discuss how well investment strategies that minimize price-volatility risk address other risks not directly targeted by a traditional minimum-volatility strategy, such as concentration, sustainability, and crowding. By applying factor models, the authors examine whether minimum-volatility strategies guard against these other risks, or if they do not, how such strategies could be modified to do so without compromising their fundamental mission of minimizing overall portfolio volatility. Minimum-volatility strategies, by selecting for low-volatility and weakly correlated assets, innately promote diversification. The authors demonstrate that adding a diversification constraint to portfolio management may in fact be counterproductive to a minimum-volatility investment approach. In contrast, mitigation of crowding risk, and, to some extent, sustainability risk, can be enhanced through portfolio-construction constraints without compromising a minimum-volatility strategys fundamental objective. Therefore, a minimum-volatility strategy properly incorporating some methodological constraints into portfolio design can effectively mitigate some risks other than volatility, especially from overvalued assets that may increasingly take over a minimum-volatility portfolio’s composition over time.

1. Dimitris Melas 1. is a managing director and global head of Equity Research at MSCI in London, U.K . (dimitris.melas{at}msci.com) In this editorial, I argue that factor investing, also known as smart beta, is having a profound and lasting impact on the way long-term investors construct

In the past 10 years, ESG considerations have increasingly become integrated into mainstream portfolio management. A large number of long-term institutions such as pension funds, sovereign wealth funds, insurance companies, endowments and foundations have signed up to the UN Principles for Responsible Investment. Many of these institutions either make allocations to segregated ESG mandates or incorporate ESG criteria across their entire portfolio. Asset managers have responded to this increasing demand from asset owners and have started to integrate ESG into their strategies using mechanisms ranging from exclusions based on screening to full integration into the security selection and portfolio construction process.

Bender et al . discussed six factors – value , low size , low volatility , high yield , quality and momentum – that historically have earned a premium over long periods, represent exposure to systematic sources of risk and have strong theoretical foundations. They also discussed how these factors could be captured through indexation. In this chapter, we turn to the question of how institutional investors interested in factor investing may allocate to and across factors.