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Friday, September 17, 2021

Commentary: Paul Ebeling on Wall Street


Investing in this market successfully requires the creation of an investing strategy that outperforms the broader market.

Consider, Factor Investing, it is not new, dating to the mid-1970’s, and has been boosted over the past few years from the acceptance of ETFs.

Now, there is over $900-B invested in about 820 ETFs that take this Factor approach, according to FactSet data, meaning they use a rules-based approach to achieve better returns than the broader market, when adjusted for risk.

Note: Funds constructed around Factor-driven strategies are often called smart beta.

A Y 2016 study led by Campbell Harvey, a professor of finance at Duke University’s Fuqua School of Business and a senior fellow with Research Affiliates, surveyed the academic research into specific factors around which investment strategies are constructed and counted 316 distinct Factors, some say more…

But when thinking about Factors the focus is around the 4 Key ones and there is a 5th too.

The 4 Key factors are:

Value is familiar to most investors as describing Warren Buffet’s approach: “buy low, sell high.” If you can find a way to find assets at a lower price, they tend to be better investments over the longer term. Good value for money spent makes sense in investing.

We have observed, momentum is described as “buy high, sell higher.” If that sounds expensive, then consider this: If there is a “stock that everyone’s talking about at the cocktail party,” it is likely not a great value play, but if the big players in the market are buying it, it’s going to go up.

Value and momentum may be the Yin & Yang of investment strategies: Value is a long-term trade, it is cheap to put on, but expensive from an emotionally. On the other hand Momentum is expensive because requires a lot of trading, ongoing repositioning of your positions, last month’s hot stocks to this month’s.

Factors are concepts that ring true, but are also quantifiable.

The value and momentum factors are market-based, and the Big Q is: Have enough investors piled into a stock to give it momentum?

In contrast, the 2 other big Key Factors are fundamental, and about the company.

The low-volatility factor is easy to understand, but mysterious to account for. Long and deep research show that less-volatile stocks outperform the broader market. It may simply be that if investors buy into higher-flying stocks, then less-risky ones may become value plays.

Quality refers not just to a company’s management and governance but also to its results, as in does it reliably produce strong earnings and maintain a healthy balance sheet?

Among other notable things, “being highly profitable is both a blessing and a curse. Company management may not be fully aligned with shareholders and may make disappointing decisions,” such as enriching themselves, expanding too fast or going into riskier ventures, or not.

Many analysts place a 5th factor, and that is sizeamong the primary themes, but, thanks to the recent research and advocacy among market leaders, it is being ignored. While there is an obvious logic to the narrative that smaller companies are more likely to be undervalued, some of the initial research that supported the idea has been disproved. We are size skeptics, and remembering that small/er companies are likely to be more volatile.

It is important for investors to understand the narrative behind each Factor. As you have to come up with a rationale or a belief that you have to adhere to that a particular Factor is big enough to trust.

It is a strategy that is almost impossible for most investors to do casually, and not really appropriate for applying to 1 securities, hence the application to ETF.

For a deeper understanding of Factor Investing go here.

Remember, it is your money, so your responsibility.

Have a terrific week.

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