Ever heard of factor-based investing? This is new to me too, which arouse my curiosity to attend the seminar Profit Mastery Seminar 2 on 23 October 2016, to find out more.
Profit Mastery Seminar 2
Factor-based investing is based on the concepts of investing by focusing on certain criteria called factors. Alvin Chow of BigFatPurse shared that five of the factors used are value, size, momentum, volatility and quality.
He mentioned that research shows that what gives better returns for each factor:
- Value: Low P/B ratio
- Size: Small capitalisation
- Momentum: 52 weeks high (buy/long) ; 52 weeks low (sell/short)
- Volatility: low volatility/beta
- Quality: High gross profitability / high dividend
Do note that not all factors would work all the time. Some factors work better at certain time, so we should diversify. He gave an example of having 20% in each factor.
Jake Damien Chow from CIMB Research shared that during the weak macro-environment that we are experiencing now, we should focus on high dividend, quality and minimum volatility.
I decided that I need to find out more about “factor-based investing” and what it is all about.
Why factor-based investing?
Some research into factor investing on the internet that one of the reason for factor investing is that portfolio diversification based on stocks and bonds seemed not to be working anymore in the current market condition. It used to be that stock and bond prices generally move in opposite directions which allows investors to choose a part stocks and part bonds portfolio. However, after the financial crisis in 2007 and the low interest rates environment, it causes both stocks and bonds to move in the same direction. So, different asset classes could be having the same positive (which is great news) or negative (that’s bad) in the same market conditions.
What is factor-based Investing?
I found this article, an interview with Eugene Podkaminer who spoke about “What Is Factor-Based Investing?” There are several points that jumped out to me. “Any portfolio, whether it’s constructed with asset classes or risk factors or some other system, needs to be based on ex-ante, forward-looking assumptions.” – I feel this is one of the most challenging part about investment. We need to have our own crystal ball and see what is the future. In investment, they always say past performance is not indicative of future performance. However, many analysis of ratios and performance are based on historical data and the belief that the company will continue to perform based on good track records. In recent times, this has become more difficult due to technological disruptions.
The other point he mentioned is that for factor-based investing that he set up, he does both long and short. It’s not just buy and hold, and the long-short component need to be rebalanced continuously.
Although factor investing means there would be many factors that we would need to consider, he mentioned that we could make use a simple matrix framework. It is a two-by-two matrix of looking to see what happens in rising and falling inflation and economic growth environment.
