Academic Research Insight: Facts About Factors

Academic Research Insight: Facts About Factors
  • Publication: THE JOURNAL OF PORTFOLIO MANAGEMENT, SPRING 2017  (version here)

Get The Full Warren Buffett Series in PDF

Get the entire 10-part series on Warren Buffett in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Goldman: These Sectors Won't Be Able To Resist Online Disruption For Long

What are the research questions?

  1. Do factors offer superior diversification benefits relative to assets because factors are less correlated with each other?
  2. Does consolidating a larger set of assets into a smaller set of factors reduce noise?
  3. Are investors more skilled at relating current information to future factor behavior than to future asset behavior?
  4. Are factors and assets prone to the same types of errors that contribute to covariance instability?
  5. In summary, is it correct to use factors as building blocks for forming portfolios?

What are the Academic Insights?

  1. NO-this claim is only true because factors include short exposure to the assets.
  2. NO-The authors find no evidence that factor groupings reduce noise more effectively than asset class groupings. In fact, they find the opposite.
  3. NO-Investors who favor predicting factors face the additional challenge of mapping these factor predictions onto asset predictions, and they must also incur incremental trading costs to the extent that factor-mimicking portfolios change over time.
  4. YES-Factors are less stable than assets mainly because, unlike assets, they are subject to mapping error.
  5. NO-Investors should not replace assets with factors as the building blocks for forming portfolios.

Why does it matter?

While the authors acknowledge that factors may offer risk premia, which are an important component to portfolio’s returns, they advise against using factors instead of asset classes when defying the asset allocation of a portfolio. In fact, after reviewing a series of claims that back this idea in the scientific community, they find no strong evidence that it adds value compared to traditional asset allocation approaches.

The Most Important Chart from the Paper:

Oakmark’s Nygren faces off with Morgan Stanley’s Lynch on disruption

activist short selling Investing investThere has been much talk in recent years about disruption and trying to pick companies that will disrupt their industries. The debate continued at the Morningstar Investment Conference as Bill Nygren of Oakmark Funds faced off with Morgan Stanley's Dennis Lynch. Q2 2021 hedge fund letters, conferences and more Persistence Morningstar's Katie Reichart moderated the Read More

Note: This site provides NO information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.

Join thousands of other readers and subscribe to our blog.

Please remember that past performance is not an indicator of future results. Please read our full disclosures. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.

Definitions of common statistics used in our analysis are available here (towards the bottom)

Article by Elisabetta Basilico, PhD, CFA - Alpha Architect


Updated on

No posts to display