Citing data from Morningstar, Aon pointed out that smart beta ETFs had $797bn (€724bn) of assets at the end of 2018, having grown at a compound annual growth rate of 29% between 2012 and 2018. However, they still represented 20% of the total ETF market, which stood at $5bn at the end of 2018.By comparison, passive funds at large, including ETFs and mutual funds, went from 14% of the US market in 2005 to 37% by the end of 2018.In terms of valuations, since 2012 the momentum factor has become increasingly expensive compared with the MSCI World, while low volatility and quality have not risen to the same extent, as measured on a price to earnings basis.Given the strong performance of the equity markets, these movements are to be expected, according to Aon, and are not explained by the growth of fund flows into factor strategies.The paper said: “Overall, the evidence for overcrowding is weak. From a flows standpoint, factor-based funds have certainly been popular, but this popularity has been dwarfed by the wider trend towards passive investing and away from active investing.” Despite the significant flows into factor investing strategies, fears about overcrowding are not justified, according to Aon.In a paper titled Factor Investing – Standing out from the Crowd, the consultancy makes the case that the evidence of overcrowding in factor strategies is not strong enough to support the idea that flows into the sector are eroding factor premiums on a permanent basis.Andrew Peach, principal consultant and one of the authors of the paper, said: “Given the growing popularity of factor strategies, clients often ask us, if everyone is doing this, does the benefit go away?“Our principal stance is that these are separately identifiable rewarded risks that exist for structural reasons. Therefore, even if everyone piles in, these risks should not be arbitraged away.” He added: “Each of the individual factors can operate its own cycle. They can be relatively more or less attractive than their peers over the market cap index at any given time. But these premia exist because there are risks that not everyone wants to take.“As a result, these premia for allocating to a risk factor ought to remain on a long-term basis.”It is unrealistic to foresee a situation where factor premiums are wiped out completely, owing to the majority investors allocating to factors, said Peach.“There is always a role for active management in price discovery. At the same time, it is highly unlikely that investors would allocate to factors defined in the same way.”The consultancy used trends in investor flows and relative valuations as a proxy for overcrowding. The growing popularity of factor strategies has to be put into context with the remarkable growth of passive strategies, according to Aon’s paper. “Likewise, from a valuation standpoint, the evidence suggests variability and certainly some periods when a particular factor has become more expensive relative to history and the market cap index. But it does not suggest anything permanent or particularly concerning.”However, the consultancy noted that on a long-term basis, the premiums for the value and momentum factors have fallen. Possible explanations for the erosion of the value premium are the strong weight of financials within value portfolios and the strong performance of the technology sector within market cap indices.The erosion of the momentum factor is linked with the behaviour of the whole market cap index, which has been increasingly momentum-driven, according to the paper.While overcrowding should be a concern, Aon said that the erosion of certain factor premiums must be watched closely.The spread and variability of relative valuations support the case for a multi-factor approach, added Aon.