As the equity markets shatter one new record after the other, investing is undergoing a "seismic shift" in strategic approach, according to  Bank of America Merrill Lynch, a division of Bank of America Corp. (BAC), in the company's 26th annual Institutional Factor Survey. In this client survey, the most striking shift is from fundamental to systematic approaches that focus on smart beta strategies, which are weighting schemes that are not strictly based on market capitalization, BofA says.

Smart Beta Drawing Big Money

ETF assets, for example, that are managed under smart beta strategies have exploded, growing at a 26% annualized rate since 2009, from under $100 billion then to under $500 billion today, according to Bloomberg Intelligence data cited by BofA. This is faster than the 19% growth rate enjoyed by all ETFs over the same period.

Value is the Next Smart Beta Theme

As part of this major shift to systematic strategies, smart beta ETFs​ focusing on value are now the leading category, covering 26% of assets under management (AUM), eclipsing both yield and growth in popularity. The factor, or screen, most frequently used in value-oriented smart beta strategies is low price-earnings (P/E) ratios, BofA adds.

Investopedia's May 9 article on the 123rd birthday of value investing oracle Benjamin Graham, cites a new study pointing out that many value investors make the mistake of using a "formulaic" approach and end up buying assets with inflated values. (See also: Value Investing: Why You're Doing it Wrong.)

Factor and Risk Premium ETFs

​Smart beta, as mentioned, generally applies to weighting schemes that are not strictly based on market capitalization. Now BofA sees a "massive influx" of ETFs based on factors or risk premiums. A word of caution: BofA notes that bubble-like valuations in low beta stocks arose after low volatility ETFs grew in popularity, from about $5 billion in AUM in 2012 to almost $40 billion in 2016. In tandem with this development, valuation multiples (P/E ratios) on low beta stocks rose to their highest level relative to the market as whole in 30 years.

More Complex Models

The use of factors also has grown more complex. The average number of factors used by survey respondents to screen investments now is 17, a sharp increase from 7 or 8, which was typical in the early 1990s, BofA says. Two-thirds of respondents use a mix of fundamental and quantitative signals, and BofA believes that this is the optimal approach. However, only 7% of respondents are using artificial intelligence (AI). Nonetheless, text-based algorithms are showing the biggest increase in usage from last year's survey, BofA indicates.

Stock Buybacks and Leverage

The factor that's seen the largest decline in popularity versus the 2016 survey is share repurchases, or stock buybacks, BofA reports. By contrast, respondents are putting greater weight on balance sheet strength and balance sheet leverage. (For more, see also: Goldman Says Stock Buybacks Are no Longer a Sure Winner.)

Forward P/E Dominates

Forward P/E ratios are the most-used factor by survey respondents, utilized by 80% of them, BofA reports. This is the 11th consecutive year in which this factor led the field. The other most-used factors, in order, are: EV/EBITDA, net debt/EBITDA, size, price/free cash flow (P/FCF), beta, ROE, relative strength and EPS momentum. All these are utilized by at least 50% of respondents. Dividend yield, debt/equity and price to book (P/B) ratio are the next three, all used by just under 50% of respondents, per BofA.

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