Factor investing
Posted: Mon Aug 31, 2020 7:23 pm
I know that there have been discussions in various topics regarding Factor investing. It seems like it's be most appropriate in the context of a Variable Portfolio? But it seems like there have also been discussion regarding it in terms of enhancing the Permanent Portfolio, e.g., Tyler's Golden Butterfly.
Vinny
What’s Driving The Factor Frenzy?
https://www.fa-mag.com/news/what-s-driv ... 50623.html
For many advisors, examining the investment landscape through a factor lens produces a more granular picture of the choices and exposures they can create for clients. Some see it as an advanced, second-generation version of the traditional style-box perspective used by giant fund research concerns like Morningstar. Most academics in finance believe there are five genuine factors—value, quality, momentum, small cap or size and minimum volatility—that create more targeted options than capitalization size and growth versus value.
Twice in recent months, Peter Lazaroff, co-chief investment officer of Plancorp, has found himself at an event where AQR Capital Management founder and CEO Cliff Asness, a thought leader in the field, was delivering the same address. His message: Essentially, nothing is working.
It wasn’t supposed to be that way. Many expected that increased computing power and data availability should be spawning more opportunities for index designers and both rules-based and active managers alike. As Lazaroff sees it, while traditional indexers view security selection as a zero-sum game, factor investing presumes that markets and prices contain vast quantities of information that can be harnessed to construct portfolios that deliver superior returns.
Academic research still indicates he is right. However, the consensus ends when it comes to product design and implementation.
A landscape dominated by disruptive technology giants growing earnings at rates of 20% or more provided the investing theme of the decade. When set against a backdrop of near-zero interest rates, those earnings are perceived as even more valuable.
There is only one problem for investors who want to isolate this kind of unbridled euphoria. Momentum has an uncanny habit of turning on a dime.
Critics argue that momentum is really just a form of performance-chasing that can get you into hot stocks late in the cycle. In early November, Jim Cramer, co-founder of TheStreet.com, raged in public that the liquidation in momentum ETFs was vaporizing the value of his Visa and Mastercard holdings. Other stocks favored by momentum funds, most notably the FANG stocks, also got slammed, but many of the latter group had specific problems of their own (such as regulatory issues).
Few believe that U.S. equities are near 1999 levels, though there are some similarities. Fully 95% of the price of Amazon, probably the leading momentum stock, is “based on future earnings,” Hunstad maintains. “They are going to have to grow to 10% of GDP over the next 10 years to justify that.”
Value
Long before factors were discovered, value investing was rewarding investors with excess returns. Benjamin Graham shared the concept with readers of his books Security Analysis and The Intelligent Investor. Warren Buffett put it into practice for the public to see.
It may be the first and oldest factor, but value is experiencing an extended bout of underperformance. “A lot of people are wondering if value is dead,” Plancorp’s Lazaroff says.
Recent history also shows that when value shines it can be powerful and offer protection. Rarely was this more obvious than in the years 2000 to 2004, when the tech bubble popped and the market punished profitable high-growth companies with almost the same vengeance it did bogus dot-com stocks.
“When value outperforms, it outperforms by a wide margin,” Invesco’s Nguyen says. “It’s hard [for people] to see that today.”
ensive and lose Ben Graham’s prized margin of safety. Just recall the shellacking that energy, materials and financial sectors suffered in 2008.
The Small-Cap Premium
Academic research indicates that small-cap stocks outperform the market over time. Yet once again, that research is being questioned now for a host of different reasons.
Skeptics point to the dramatic shrinkage in the universe of public equities over the past couple of decades: The number of public U.S. companies is about 50% smaller than it was in 1999.
Some believe that many of the best investment opportunities are no longer available in public markets. An investor who bought onetime small-cap Amazon after its 1997 IPO earned a return of about 800 or 900 times the IPO price. Contrast that to a 20-fold increase in Google since it went public in 2004 or the quintupling of Facebook since its 2012 IPO.
The trend of keeping start-ups private longer is only accelerating—there were recently believed to be about 260 so-called unicorn start-ups valued at more than $1 billion, according to CB Insights. At last year’s Inside Alternatives conference hosted by Financial Advisor in Las Vegas, iCapital managing partner Nick Veronis told attendees that today’s VC firms and private investors seem eager to “extract most of the value out of their portfolio companies” before bringing them public.
Much ink has been spilled on how the indexing boom drives up the prices of mega-cap growth companies, but some believe its influence on small-cap equities is even greater. That’s because they are less liquid and fund flows can drive even more extreme price swings in this sector.
Can multifactor investing be timed in the same fashion that some professional investors deploy sector rotation? Balasa says most of the serious research on this subject isn’t encouraging. It strongly suggests the best alternative is to select a factor weighting appropriate for the client and leave it in place.
State Street’s Bartolini goes further. “If you are timing factors, you are playing with fire,” he warns. If the goal is timing, he goes so far as to advise that it be executed at the single stock level, not with ETFs.
Logical though it sounds, broad multifactor diversification begs another question. Why not just buy the total market index?
The answer will likely emerge after the next major bear market when advisors will find out if factor investing really lives up to its billing and delivers excess returns with a lower beta.
Vinny
What’s Driving The Factor Frenzy?
https://www.fa-mag.com/news/what-s-driv ... 50623.html
For many advisors, examining the investment landscape through a factor lens produces a more granular picture of the choices and exposures they can create for clients. Some see it as an advanced, second-generation version of the traditional style-box perspective used by giant fund research concerns like Morningstar. Most academics in finance believe there are five genuine factors—value, quality, momentum, small cap or size and minimum volatility—that create more targeted options than capitalization size and growth versus value.
Twice in recent months, Peter Lazaroff, co-chief investment officer of Plancorp, has found himself at an event where AQR Capital Management founder and CEO Cliff Asness, a thought leader in the field, was delivering the same address. His message: Essentially, nothing is working.
It wasn’t supposed to be that way. Many expected that increased computing power and data availability should be spawning more opportunities for index designers and both rules-based and active managers alike. As Lazaroff sees it, while traditional indexers view security selection as a zero-sum game, factor investing presumes that markets and prices contain vast quantities of information that can be harnessed to construct portfolios that deliver superior returns.
Academic research still indicates he is right. However, the consensus ends when it comes to product design and implementation.
A landscape dominated by disruptive technology giants growing earnings at rates of 20% or more provided the investing theme of the decade. When set against a backdrop of near-zero interest rates, those earnings are perceived as even more valuable.
There is only one problem for investors who want to isolate this kind of unbridled euphoria. Momentum has an uncanny habit of turning on a dime.
Critics argue that momentum is really just a form of performance-chasing that can get you into hot stocks late in the cycle. In early November, Jim Cramer, co-founder of TheStreet.com, raged in public that the liquidation in momentum ETFs was vaporizing the value of his Visa and Mastercard holdings. Other stocks favored by momentum funds, most notably the FANG stocks, also got slammed, but many of the latter group had specific problems of their own (such as regulatory issues).
Few believe that U.S. equities are near 1999 levels, though there are some similarities. Fully 95% of the price of Amazon, probably the leading momentum stock, is “based on future earnings,” Hunstad maintains. “They are going to have to grow to 10% of GDP over the next 10 years to justify that.”
Value
Long before factors were discovered, value investing was rewarding investors with excess returns. Benjamin Graham shared the concept with readers of his books Security Analysis and The Intelligent Investor. Warren Buffett put it into practice for the public to see.
It may be the first and oldest factor, but value is experiencing an extended bout of underperformance. “A lot of people are wondering if value is dead,” Plancorp’s Lazaroff says.
Recent history also shows that when value shines it can be powerful and offer protection. Rarely was this more obvious than in the years 2000 to 2004, when the tech bubble popped and the market punished profitable high-growth companies with almost the same vengeance it did bogus dot-com stocks.
“When value outperforms, it outperforms by a wide margin,” Invesco’s Nguyen says. “It’s hard [for people] to see that today.”
ensive and lose Ben Graham’s prized margin of safety. Just recall the shellacking that energy, materials and financial sectors suffered in 2008.
The Small-Cap Premium
Academic research indicates that small-cap stocks outperform the market over time. Yet once again, that research is being questioned now for a host of different reasons.
Skeptics point to the dramatic shrinkage in the universe of public equities over the past couple of decades: The number of public U.S. companies is about 50% smaller than it was in 1999.
Some believe that many of the best investment opportunities are no longer available in public markets. An investor who bought onetime small-cap Amazon after its 1997 IPO earned a return of about 800 or 900 times the IPO price. Contrast that to a 20-fold increase in Google since it went public in 2004 or the quintupling of Facebook since its 2012 IPO.
The trend of keeping start-ups private longer is only accelerating—there were recently believed to be about 260 so-called unicorn start-ups valued at more than $1 billion, according to CB Insights. At last year’s Inside Alternatives conference hosted by Financial Advisor in Las Vegas, iCapital managing partner Nick Veronis told attendees that today’s VC firms and private investors seem eager to “extract most of the value out of their portfolio companies” before bringing them public.
Much ink has been spilled on how the indexing boom drives up the prices of mega-cap growth companies, but some believe its influence on small-cap equities is even greater. That’s because they are less liquid and fund flows can drive even more extreme price swings in this sector.
Can multifactor investing be timed in the same fashion that some professional investors deploy sector rotation? Balasa says most of the serious research on this subject isn’t encouraging. It strongly suggests the best alternative is to select a factor weighting appropriate for the client and leave it in place.
State Street’s Bartolini goes further. “If you are timing factors, you are playing with fire,” he warns. If the goal is timing, he goes so far as to advise that it be executed at the single stock level, not with ETFs.
Logical though it sounds, broad multifactor diversification begs another question. Why not just buy the total market index?
The answer will likely emerge after the next major bear market when advisors will find out if factor investing really lives up to its billing and delivers excess returns with a lower beta.