RESEARCH

Building an Inflation Portfolio Using Stocks

• An inflation portfolio can be created by systematically selecting stocks correlated to inflation
• This would have resulted in a portfolio with strong sector and factor biases
• However, the correlation to inflation would not have been significantly higher than for stocks overall

Building a Long Volatility Strategy without Using Options – II

• Long volatility strategies can be built without using options
• Portfolios would have primarily consisted of certain currency pairs and treasury bonds
• They lack explosive returns when volatility spikes, but they also lack the bleed

Digital Asset ETFs: Not Crypto Enough?

• Digital asset ETFs have outperformed tech stocks in recent years
• However, they provide no exposure to cryptocurrencies
• Their returns are explained by market beta and equity factors

Myth Busting: Equities are an Inflation Hedge

• Equities generated attractive nominal returns across all inflation regimes
• However, real returns were zero when inflation was above 10% 
• Energy and materials performed best, consumer-facing sectors worst

Building a Long Volatility Strategy without Using Options

• Long volatility strategies can be built without using options
• Our systematic approach has used exclusively currencies and bonds
• Investors can achieve attractive diversification benefits with such strategies

Building a Long Volatility Strategy without Using Options

• Long volatility strategies can be built without using options
• Our systematic approach has used exclusively currencies and bonds
• Investors can achieve attractive diversification benefits with such strategies

Factor Olympics Q2 2021

• The Q1 2021 factor rotation into Value and Size has reversed
• Value is the only factor with positive performance in 1H 2021
• Momentum has generated the most negative returns

Factor Exposure Analysis: Exploring Residualization

• Regression analysis is frequently subject to multicollinearity
• Independent variables can be residualized
• Using residualized variables in a factor exposure analysis identifies different drivers

Avoiding Disasters with Catastrophe Bonds

• Catastrophe bonds offered exceptionally high risk-adjusted returns since 2005
• These were uncorrelated to equities, making cat bonds attractive for diversification
• However, cat bonds might have underpriced risk historically, raising concerns going forward

Mid-Caps: The Hidden Champions?

• Mid-cap stocks are less popular than small or large caps
• In the US, they only outperformed in one out of 10 decades
• Globally, they have done better, creating a conundrum for investors

Liquid Alt Juggernauts: Worth their Salt?

• Liquid alternative mutual funds only captured 10% of the market share from hedge funds
• The alpha generated since 2013 was essentially zero
• Long-short equity funds can be replicated simply via market beta + cash

The Case Against EM Equities

• EM equities are highly correlated to US stocks & high yield bonds, limiting diversification benefits
• They outperform primarily when the USD is depreciating, making it a currency play
• The largest MSCI EM index members will experience 50% population declines

Portfolio Construction in Venture Capital

• A few winners generate most of the venture capital returns
• Given this asymmetrical return distribution, portfolios should be constructed equally
• Missing the winners is simply too risky

Managed Futures: Fast & Furious vs Slow & Steady

• Managed futures strategies aim to exploit short- or long-term trends
• Short-term trend followers are often seen as offering better stock market crash protection characteristics
• Our analysis highlights that the differences are marginal

60/40 Portfolios without Bonds

• Bonds have become less useful in asset allocation given low to negative expected returns
• Liquid alternative strategies can be used to replace bonds
• From a historic perspective, long volatility strategies would have been especially attractive

Factor Investing: The Truth Has Many Shades

• The data from Professor French has laid the foundation for factor investing
• However, over time factor portfolio construction grew complex and with many nuances
• Returns may look more or less attractive, which makes a weak foundation

MYTH-BUSTING: MONEY PRINTING MUST CREATE INFLATION

• The link between central bank policy, money supply, and inflation seems to have changed
• QE money printing had no substantial impact on inflation, aside from asset price inflation
• More direct stimuli might change that

TIME MACHINES FOR INVESTORS

• Investors are challenged when evaluating investment opportunities with limited track records
• Factor exposure analysis can be used to create replication portfolios
• These empower investors to walk backward and forward in time, enhancing the investment decision process

FACTOR OLYMPICS Q1 2021

• Q1 2021 featured a major factor rotation
• Value & Size, the losers of previous years, are leading the scoreboard
• In contrast, Momentum, Quality, and Low Volatility have generated negative returns

MYTH-BUSTING: EARNINGS DON’T MATTER MUCH FOR STOCK RETURNS

• There is no strong relationship between stock returns and earnings
• This is regardless of current or expected earnings
• High earnings growth does not lead to high P/E ratios

MULTI-STRATEGY HEDGE FUNDS: EQUITY IN A DIFFERENT SHADE?

• Investors can outsource the hedge fund selection process to multi-strategy hedge funds
• These have outperformed broad hedge fund indices since 2005
• However, most of the returns can be attributed to simple equity exposure

DOES FINANCIAL LEVERAGE MAKE STOCKS RISKIER? PART II

• The most leveraged stocks were not riskier than the least leveraged ones on a cross-sector basis
• However, this changes when portfolios are created sector-neutral
• In this case, the least leveraged stocks also generated higher returns and risk-return ratios

GOOD VERSUS BAD VALUE STOCKS

• Value stocks can be easily filtered by applying quality metrics in order to sort out value traps
• Value & High Quality generated higher returns than Value in Europe and Japan, but not in the US
• However, from a risk perspective, metrics improved across all markets

ALPHA GENERATION: THE SEARCH FOR THE UNEXPLAINABLE

• The performance of equity market neutral hedge funds, both discretionary and systematic, can be fully explained by market beta and equity factors
• At their peak, systematic managers brought in twice as much unexplained returns  versus their discretionary counterparts, however, their factor loadings explain this difference
• Given that we understand their performance drivers, these can be replicated efficiently

MYTH-BUSTING: LOW RATES DON’T JUSTIFY HIGH VALUATIONS

• High equity valuations are frequently justified by low interest rates
• There is no long-term evidence in the US to support this theory
• P/E ratios in Japan and Europe have remained low, despite zero or negative yields

MARKET TIMING VIA THE VRP?

• Stock market returns were highly positive when the variance risk premium (VRP) was negative
• Returns were slightly negative across markets when the VRP was positive
• This relationship can not be exploited for market timing

OH, QUALITY, WHERE ART THOU?

• Quality and quality income ETFs have underperformed the S&P 500 since 2005
• The most recent underperformance is explained by an underweight to technology stocks
• However, more importantly, quality ETFs have not reduced drawdowns during stock market crashes

MUSINGS ABOUT FACTOR EXPOSURE ANALYSIS

• There are few alternatives to regression analysis when explaining investment performance
• Too few as well as too many independent variables can be problematic
• The results are often not intuitive, but also encourage asking further questions that may prove insightful

FACTOR OLYMPICS 2020

• Momentum has been the clear winner across markets in 2020
• Value has been the laggard like in recent years
• Low Volatility ended a 10-year fantastic run

RESEARCH COMPENDIUM 2020

• Contains more than 50 research papers that we published on FactorResearch.com and other media in 2020
• Focus on factor investing and quantitative strategies from an investor’s perspective
• They are kept brief, as simple as possible, and will hopefully stimulate debate

THE VALUE FACTOR’S PAIN: ARE INTANGIBLES TO BLAME?

• The rise of intangibles has been increasingly used as an argument for the poor performance of the value factor
• However, this idea is not supported by data
• The type of market environment is marginally more useful for explaining the value factor performance 

MINIMUM CORRELATION FACTOR PORTFOLIOS

• Minimizing factor correlations is a common approach to creating multi-factor portfolios
• However, the diversification benefits from minimizing the correlations of long-only two-factor portfolios were marginal
• This suggests that investors should not focus too much on correlations when combining smart beta strategies

ESG DATA: DAZED AND CONFUSED

• Case study of one ESG data set from a well-known provider
• Highly ranked ESG stocks do not have better fundamentals 
• Stocks with the worst rating outperformed over the past 12 months 

HEDGE FUND BATTLE: DISCRETIONARY VS SYSTEMATIC INVESTING

• Given alternative data, machine learning, and AI advances, systematic should beat discretionary investing
• However, the performance of systematic and discretionary equity market neutral hedge funds has largely been the same since 2009
• Both were also correlated to the stock market, offered low returns, and featured no performance consistency

EXPLORING DEFINED OUTCOME ETFS

• Defined outcome ETFs have quickly gathered almost $5 billion in assets
• Not unexpected given their much lower drawdowns when the market crashed in March 2020
• However, they are complex and expensive products and there are viable alternatives

MARKET NEUTRAL FUNDS: POWERED BY BETA?

• The long-term track record of equity market neutral hedge funds is attractive, but should be viewed with scepticism due to Madoff and survivorship bias
• Only one index from HFRX seems sound, but his highlights negative alpha since the GFC and positive returns primarily from market beta
• A factor exposure analysis reveals unusual factor loadings

THE DEAD VERSUS THE LIVING STOCKS

• Zombie stocks are a diverse group, both from a country and sector perspective
• Zombie stocks were fundamentally riskier, yet outperformed non-zombie stocks over the last year
• Oddly, investors need to pay up as they are also more expensive

DON’T GET CARRIED AWAY BY CARRY

• Carry across asset classes has not performed strongly over the most recent decade
• Currency carry and Value & Size equity factors exhibited the same trends in performance since 1999
• All three factors are likely driven by risk sentiment, essentially offering the same risk exposure

FACTOR EXPOSURE ANALYSIS 101

• Linear regression is widely used for factor exposure analysis
• However, a high R2 and low p-value can be misleading
• Unsurprisingly the data quality matters

FACTOR OLYMPICS Q3 2020

• Momentum & Quality are leading the performance scoreboard in Q1-3 2020
• Value & Size generated negative returns, like in recent years, and Low Volatility ended a 10-year fantastic run 
• 2020 is shaping up as a year of highly dispersed factor returns

DOES FINANCIAL LEVERAGE MAKE STOCKS RISKIER?

• The leverage of US stocks has been increasing over the last four decades
• The most leveraged stocks did not generate higher returns than the least leverages ones
• However, they were also not riskier

AGING & EQUITIES: SELLING STOCKS FOR THE LONG-TERM

• There is a negative relationship between aging populations and stock valuations
• Given that most developed markets are aging, this creates structural headwinds for equities
• The massive future population declines require investors to rethink traditional asset allocation

CROIC, CFROI, CROCI & CROCS

• Cash-return-on-invested-capital (CROIC) has been proposed by some as a superior Value metric
• Since the GFC in 2009, CROIC generated consistently positive compared to flat (or negative) returns from traditional valuation metrics
• However, CROIC turns out to be just a simple combination of Value & Quality factors

VOLATILITY HEDGE FUNDS: THE GOOD, THE BAD, AND THE UGLY 

• Volatility hedge funds provided attractive diversification benefits for equity portfolios
• However, long were preferable over short volatility strategies
• Some scepticism is required for the hedge fund index performance

PICKING PROFITABLE BUSINESSES CAN BE HIGHLY UNPROFITABLE

• There seems to be a relationship between the Profitability factor and interest rates
• The most profitable stocks outperformed the least profitable ones when market cap-weighted
• However, when equal-weighted, the least profitable stocks outperformed

HOW RISKY ARE VALUE STOCKS?

• The Value factor is often explained as representing a risk premium or a behavioral bias
• However, financial analysts regard cheap stocks as less risky than expensive ones
• Data shows that expensive stocks were riskier than cheap ones, which challenges the risk premium theory

BANK RISK PREMIA INDICES: UNBANKABLE?

• Factor investing can be pursued across asset classes
• Risk premia products sold by investment banks have generated mostly unattractive returns since 2006
• The idea of risk premia indices is great, but the implementation has been poor

FACTOR INVESTING IN SINGAPORE

• Singapore’s stock market has unique features given its strong sector biases
• However, despite these, there were no structural factor exposures over time
• Like in other markets, investors can pursue factor investing to generate outperformance

CREATING ANTI-FRAGILE PORTFOLIOS

• Most asset classes are bets on economic growth
• Diversified endowment-style portfolios are essentially short volatility 
• Long volatility strategies can be used to create anti-fragile portfolios

GLOBAL MACRO: MASTERS OF THE UNIVERSE?

• The alpha of global macro funds has been shrinking consistently over time
• However, correlations to equities & bonds were low on average, offering diversification benefits
• Capital allocators have been cautious on the strategy in recent years

EM EQUITIES VS DEBT: SAME, SAME, BUT DIFFERENT?

• Some EM asset classes are highly correlated, to the point they can almost be considered interchangeable
• EM equities and hard-currency government debt are highly correlated to US equities and bonds
• In crisis times, all EM exposure is sold off and fails to provide meaningful diversification benefits

CAP-WEIGHTED BENCHMARKS: GOOD MOMENTUM BETS?

• After strong momentum rallies, investors frequently ask if cap-weighted benchmarks are good Momentum bets
• Factor exposure analysis shows this is not the case
• Investors should seek smart beta and long-short products if they want Momentum exposure

FACTOR OLYMPICS 1H 2020

• Momentum & Quality are leading the performance scoreboard in 1H 2020
• Value & Size generated negative returns, like in recent years
• Low Volatility failed to preserve capital during the COVID-19 crisis

THE VARIANCE RISK PREMIUM: WHAT PREMIUM?

• Harvesting the variance risk premium has a sound theoretical foundation
• However, actual investment products have generated poor returns
• Furthermore, they are correlated to equities, providing few diversification benefits

NO LONGER SUPERHEROES? TWILIGHT OF THE BONDS

• Bonds had superhero qualities over the last few decades
• The case for bonds in asset allocation is not clear when yields are low or negative
• Japan can be used as a roadmap for the outlook of a 60/40 portfolio in the US or Europe

MUSINGS ON LOW VOLATILITY

• The Low Volatility strategy failed to protect investors in March and April 2020
• Industrials & materials generated positive and technology & real estate negative relative performance
• Low Vol strategies do not deliver ESG benefits

DEFENSIVE & DIVERSIFYING STRATEGIES: WHAT WORKED IN 2020?

• Defensive smart beta strategies like Low Volatility did not offer much capital protection in 2020
• Long-short multi-factor investing generated negative returns, but still offered diversification benefits
• Managed futures finally found their redemption given positive & uncorrelated returns

BONDS & THE INVISIBLE THIEF

• US bonds generated positive total returns in most inflation regimes
• Returns were mixed when inflation was above 4%
• Real returns were strongly negative when inflation was high

TACTICAL ETFS: TACTFULLY NO, THANK YOU?

• Tactical investing aims to deliver better risk-adjusted returns and/or reduced drawdowns
• Tactical ETFs have not achieved either objective in recent years
• It is challenging to explain the consistent underperformance across different types of tactical ETFs

CHEAP VS EXPENSIVE FACTORS

• Factors can be valued like stocks
• Factor valuations have not changed structurally over the last 30 years
• Cheap factors outperformed expensive ones on average

THE CASE AGAINST FACTOR INVESTING

• Factor investing is likely the best option for investors seeking to outperform the market
• However, the cyclicality of factors makes factor investing challenging when it underperforms
• Investors that do not understand this cyclicality are likely better served by plain, rather than smart beta

MERGER ARBITRAGE: ARBITRAGED AWAY?

• As AUM in merger arbitrage has increased, alpha decreased
• Investors can access merger arbitrage via hedge funds, bank indices, and ETFs
• The strategy is not as uncorrelated from equities as likely perceived by allocators

TAIL RISK HEDGE FUNDS

• Tail risk funds tend to be most in demand when they are least attractive
• Short-term bonds provided similar benefits to tail risk funds
• The TAIL ETF closely replicates the performance of tail risk funds

TAIL RISK HEDGE FUNDS

• Tail risk funds tend to be most in demand when they are least attractive
• Short-term bonds provided similar benefits to tail risk funds
• The TAIL ETF closely replicates the performance of tail risk funds

SMART BETA FIXED INCOME ETFS

• Factor investing in fixed income has been heralded as the next frontier in asset management
• Smart beta fixed income ETFs in the US manage only slightly more than $2 billion of assets
• Defensive strategies reduced drawdowns during the ongoing coronavirus crisis

LOW VOL-MOMENTUM VS VALUE-MOMENTUM PORTFOLIOS

• Low Vol-Momentum & Value-Momentum portfolios outperformed stock markets since 1989
• Low factor correlations contributed to the attractive risk-return profiles
• Excess returns have been lower in the most recent than in previous decades

FACTOR OLYMPICS Q1 2020

• Beta-neutral long-short factors were largely negative during Q1 2020
• Momentum & Quality are leading the performance leaderboard
• Investors were most negative on small cap and cheap stocks

THOU SHALL NOT SHORT THE VIX

• The VIX has not remained at high levels for long in recent times, theoretically making a mean-reversion strategy attractive
• However, there were periods historically where volatility stayed elevated for years
• Furthermore, the VIX is not a tradeable index and related products should be viewed with caution

THEMATIC INVESTING: THEMATICALLY WRONG?

• Thematic investing can be viewed as performance chasing with a narrative
• A systematic approach to thematic investing would have underperformed the stock market
• Thematic hedge fund managers have not generated attractive returns

EM DEBT: TO HOLD, OR NOT TO HOLD?

• Hard currency emerging market debt outperformed local currency EM debt since 2013
• EM government and corporate debt traded comparably
• Adding EM debt to a traditional US equity-bond portfolio would have generated only marginal benefits

LOVM PORTFOLIOS AROUND THE WORLD

• Low Volatility-Momentum portfolios outperformed markets across regions over the last 30 years
• The combination model generated consistently the highest excess returns
• Low correlation between the two factors provided significant diversification benefits

ESG VS LOW CARBON INVESTING

• ESG and Low Carbon portfolios feature significant, but different sector & country biases
• Investors should expect large tracking errors in some ETFs
• Some products contain stocks that are likely unexpected and undesired 

LOVM: LOW VOLATILITY-MOMENTUM PORTFOLIOS

• Low Volatility-Momentum portfolios in the US outperformed the stock market since 1989
• Investors can use various multi-factor models for combining the two factors, which results in different portfolios
• Valuations have increased and the multiple expansion is mainly explained by Momentum, not Low Volatility 

VENTURE CAPITAL: WORTH VENTURING INTO?

• Venture capital returns are likely to be overstated
• Top-performing VC funds generated attractive returns, but are difficult to access
• Average venture capital returns can be replicated efficiently with public equities 

TIMING LOW VOLATILITY WITH FACTOR VALUATIONS

• Factors can be valued like stocks or markets
• The Low Volatility factor in the US had the best subsequent returns when cheapest and worst when most expensive
• However, the perspective is less clear when analyzing European and Japanese stock markets

SENTIMENT & FACTOR PERFORMANCE

• Stock sentiment can be aggregated from public sources using a big data approach
• Results indicate that sentiment has some predictability for short-term factor performance
• Positive sentiment resulted in higher subsequent returns than negative sentiment 

LIQUIDITY & FACTOR PERFORMANCE

• Most institutional investors can only trade the largest, most liquid stocks
• Introducing minimum liquidity requirements impacts factors differently
• Factor portfolio construction with liquidity constraints is especially challenging in small stock markets

PRIVATE EQUITY: FOOLING SOME PEOPLE ALL THE TIME?

• Private equity return data should be viewed with caution
• Returns are likely overstated while volatility is understated
• Private equity returns are highly correlated to public equities

HOW EXPENSIVE ARE ESG STOCKS?

• Highly ranked ESG stocks trade at higher valuation multiples than the stock market
• However, the difference in multiples is minor and far less than extreme than for Growth stocks
• ESG ETFs generated lower returns than the stock market, but were also less volatile

FACTOR SCORING SMART BETA ETFS

• The difference between the cheapest and most expensive smart beta ETF in the US is 59 bps on average
• Some smart beta ETFs offer negative factor exposure, which requires explanation
• Factor scores can be used to identify which smart beta ETFs offer the best ratio of factor exposure per dollar in fees

FACTOR OLYMPICS 2019

• As in 2018, Low Volatility produced the best and Value the worst performance
• Value did not recover significantly further after a short rally in Q3 2019
• However, Momentum broke its upward trajectory since then

RESEARCH COMPENDIUM 2019

• Contains more than 50 research papers that we published on FactorResearch.com and other media in 2019
• Focus on factor investing and quantitative strategies from an investor’s perspective
• They are kept brief, as simple as possible, and will hopefully stimulate debate

GLOBAL PENSION FUNDS: THE COMING STORM

• The outlook for US equity and bond returns is low based on historical data
• The return assumptions of US public pension funds are difficult to achieve
• Only an extreme allocation to alternatives would meet the expected rate of return

HOW TO EVALUATE SMART BETA ETFS

• Smart beta ETFs can be compared via a factor score, which relates fees to the factor exposure
• Value-focused ETFs in the US show a wide range of factor scores
• Large firms offer more attractive factor scores, but largely due to lower fees   

WHY PENSION FUNDS & MILLENNIALS SHOULD AVOID ESG

• ESG ETFs underperformed the stock market since 2005
• Likely explained by higher fees, a constrained stock universe, and sector bets
• Financially-impaired investors like public pension funds and Millennials should avoid ESG investing   

DO ACTIVIST INVESTORS CREATE VALUE?

• Shareholder activism has not grown from a campaign or AUM perspective recently
• Activist funds have not generated attractive returns
• The lack of outperformance is challenging to explain   

EQUITY VS BOND INDICES

• Bond indices are frequently portrayed as featuring a lower quality composition than equity indices
• Analysing equity and bond indices in the US and emerging markets confirms this view
• Perhaps this explains why there is some alpha generation in fixed income   

THE CASE AGAINST REITS

• Real estate stocks featured moderate correlations to stock markets over the last 30 years
• However, diversification benefits for equity portfolios were only marginal
• Other strategies provide similar yield and downside protection characteristics

FACTOR INVESTING IN EMERGING MARKETS

• The trends in factor performance are similar in emerging and developed markets
• Factor returns were higher in emerging than in developed markets
• However, higher transaction costs need to be considered carefully 

THE COMPLEXITY OF FACTOR EXPOSURE ANALYSIS

• Factor exposure analysis is essential for performance and risk contribution
• However, the results vary depending on methodologies, factor definitions, and other assumptions
• A holdings-based approach is preferable over regression analysis

THE CASE AGAINST EQUITY INCOME FUNDS

• Equity income mutual funds have underperformed the S&P 500 since 1988
• Especially on a post-tax basis
• Investors can create tax-efficient equity portfolios, but it does not represent a free lunch

AI, WHAT HAVE YOU DONE FOR ME LATELY?

• AI-focused companies have underperformed markets
• AI-powered ETFs have generated unimpressive returns
• In contrast, AI-powered hedge funds easily beat their benchmark, but the performance can be challenged

LOW VOLATILITY VS OPTION-BASED STRATEGIES

• Option-based strategies have similar characteristics to Low Volatility portfolios
• Combining these reduces idiosyncratic strategy risks
• The combinations feature higher risk-adjusted returns and lower drawdowns than the S&P 500

FACTOR OLYMPICS Q3 2019

• Most factors generated positive returns in Q1-3 2019
• Low Volatility produced the best and Value the worst performance year-to-date
• The factor rotation from Momentum into Value in Q3 was short-lived

SMART BETA VS ALPHA + BETA

• Investment portfolios can be simplified by separating alpha from beta
• Alpha + beta portfolios offer higher risk-adjusted returns than smart beta
• The main hurdle for better portfolios is investor behaviour, not a lack of products

IS LOW VOL THE NEW VALUE?

• The Low Volatility factor exhibited significant exposure to Value since 1989
• The factors were highly correlated in the 1990s, but less after the financial crisis
• Quantitative easing was positive for Low Volatility, but negative for Value

HEDGING VIA MANAGED FUTURES LIQUID ALTS

• Managed futures strategies provided attractive diversification benefits during the financial crisis
• The strategies have become available as mutual funds and ETFs
• Mutual funds provide the same exposure as private vehicles, ETFs do not

IMPROVING THE ODDS OF VALUE: II

• Value investors earn a premium for holding undesirable stocks
• The yield curve may identify periods where the premium is more attractive
• Since 1971, the performance of the Value factor was negative when the yield curve was flattening

FACTOR INVESTING ON COUNTRY LEVEL

• Investors can harvest returns from common equity factors on country level
• Returns are consistent when combined into a multi-factor portfolio
• Performance of some factors is comparable to those on single stock level, indicating common drivers

HOW PAINFUL CAN FACTOR INVESTING GET?

• A classic long-short, multi-factor portfolio has lost close to 20% since 2018
• The drawdown is within expectations, but the recovery period is abnormally long
• However, it’s difficult to argue for structural changes that make factor investing unattractive 

QUANT STRATEGIES: THEORY VS REALITY

• The live performance of quant strategies is significantly worse than in backtesting
• Factor investing returns from research are frequently challenged as being overstated
• However, the performance of smart beta and long-short multi-factor funds match theoretical returns

LOW VOL FACTOR: FROM OBSCURITY TO STARDOM

• Given the popularity of Low Volatility, investors might expect structural shifts in the factor characteristics
• Betas, valuations, sector biases, interest rate sensitivity, and factor exposures are highly time-varying
• Although these are worth monitoring from a risk perspective, none seem particularly concerning currently

GROWTH: FACTOR INVESTING SINNING?

• Growth stocks outperformed the US stock market since 1992
• However, the higher returns are explained by higher betas
• The long-short factor performance was negative, even if adjusted for other factor exposure

PMI & EQUITY FACTOR PERFORMANCE

• Value and Size have a positive relationship with the PMI, similar to the S&P 500
• Indicates that risk sentiment is a core driver of factor performance
• Investors can consider incorporating variables like the PMI in a risk management framework

ESG: WHAT’S UNDER THE HOOD?

• The ESG factor generated positive returns since 2011
• Strong sector biases (long tech & short discretionary) explain the performance
• Residual returns from ESG investing are essentially zero

INDEXING: OUT WITH TRADITION?

• Equal and fundamentally weighted equity indices outperformed market cap weighted in the US since 1990
• The higher returns are explained by exposure to Value and Size factors
• The outperformance is not consistent across time given factor cyclicality

FACTOR OLYMPICS 1H 2019

• Most factors generated positive returns in 1H 2019
• Low Volatility produced the best and Value the worst performance
• Factor performance is comparable in the US & Europe, but markedly different in Japan

MAPPING MY MIND: VALUE FACTOR

• There is consistency in the performance of the Value factor across markets and asset classes
• Allows to create a coherent framework of how to think about Value
• Suggests a global driver of factor performance

A HORSE RACE OF LIQUID ALTERNATIVES

• Investors can access alternative strategies via mutual funds and ETFs
• Most of these show moderate to high correlations to equities, which is concerning
• Bonds would have been a better diversifier in recent years

THE CASE AGAINST SMALL CAPS

• The performance of the Size factor in the US was positive since 1926, but not particularly attractive
• Returns in Europe were more favorable, but not in Japan
• Alternative metrics to market capitalization would not have resulted in better performance

HOW TO ALLOCATE SMARTLY TO SMART BETA

• Single factor excess returns are attractive over the long-term, less in the short-term
• Comparing popular asset allocation models does not highlight one superior methodology
• Multi-factor portfolios generated excess returns in two out of three regions since 2008

CHEAP VERSUS EXPENSIVE COUNTRIES

• A global value portfolio on country level features structural country biases
• Returns were positive since 1990, but lacked consistency
• Value on country and single stock level exhibit the same trends, highlighting common performance drivers

IMPROVING THE MOMENTUM FACTOR

• The performance of the Momentum factor in the US has been poor since 2000
• Fundamental valuation spreads were ineffective for improving the performance
• Combinations with other factors and factor volatility filters would have yielded better results

HEDGE FUND ETFS

• Core hedge fund strategies are available as low-cost and transparent ETFs
• The performance of hedge fund ETFs has been comparable to that of their benchmarks
• ETFs have only captured 1% of hedge fund assets

OPTION-BASED STRATEGIES: OPT IN OR OPT OUT?

• Option-based strategies generated better risk-adjusted returns than the S&P 500 over the last 30 years
• Investors should be wary of buying options and focus on harvesting the volatility risk premium by writing options
• Option-based strategies are an interesting alternative to long-short equity hedge funds for reducing risk

EQUITY FACTORS & THE MIGHTY US DOLLAR

• The US dollar had a slightly negative relationship with the stock market since 1996
• Some equity factors are more sensitive to changes in the US dollar than others
• On average the sensitivity is zero, but as often averages are misleading

REPLICATING FAMOUS HEDGE FUNDS

• Diverse hedge fund strategies can be replicated via factor-mimicking portfolios
• The analysis highlights that most returns are explained by factors, not alpha
• However, hedge funds can create value by harvesting factor returns efficiently via portfolio construction

WARREN BUFFETT: THE GREATEST FACTOR INVESTOR OF ALL TIME?

• A factor exposure of Berkshire Hathaway reveals structural factor tilts
• Long Value, Size, Quality, and Low Volatility factors and short Growth and Dividend Yield
• Warren Buffet generated little alpha, but is highly skilled at harvesting factor returns

MULTI-FACTOR SMART BETA ETFS

• Investors have leaned towards multi-factor over single-factor products in recent years
• The factor selection and portfolio construction of multi-factor ETFs can be challenged
• Multi-factor ETFs often feature factors, such as growth, which are not supported by academic research while lacking exposure to established ones such as quality and momentum

FACTOR OLYMPICS Q1 2019

• 2019 has started favorable for factor investors, compared to 2018
• Low Volatility generated the best and Value the worst performance
• Factor performance is comparable in the US & Europe, but different in Japan

BLACK SWANS, MAJOR EVENTS & FACTOR RETURNS

• It is questionable if investors should prepare for catastrophic events
• Factor returns are almost random after black swan and major events
• Simple diversification is likely the best option for the expected and unexpected

SMART BETA ASSET ALLOCATION MODELS 

• Most smart beta strategies outperformed the market since 1990, but few have in recent years
• Diversifying across strategies mitigates the risk of underperformance
• Various asset allocation models for creating multi-factor portfolios highlight similar results

GARP INVESTING: GOLDEN OR GARBAGE?   

• GARP aims to combine Growth and Value investing
• GARP stocks have outperformed the market since 1989
• It is somewhat perplexing how well the strategy worked

BENCHMARKING SMART BETA ETFS

• Long-only factor portfolios can be used for benchmarking smart beta ETFs
• Results highlight minor tracking errors
• Likely explained by relatively homogenous factor definitions by ETF issuers

MINIMUM VARIANCE VERSUS LOW VOLATILITY

• The largest smart beta Low Volatility ETF is technically a Minimum Variance strategy
• Low Volatility and Minimum Variance have comparable and attractive characteristics
• However, both currently feature a high sensitivity to interest rates

FACTOR INVESTING IN FINANCIALS, REITS & MLPS

• Beating benchmarks is challenging for fund managers, even in unique sectors
• Factor performance in financials, REITs, and MLPs is comparable to the cross-sector factor returns
• Classic factor investing strategies are likely more attractive than industry expertise

SMART BETA: BROKEN BY DESIGN?

• Smart beta excess returns are different from factor returns
• The Low Volatility factor shows the highest discrepancy between theoretical and realized returns
• Investors might be better served by embracing long-short factor products

CAN VALUE INVESTORS DO GOOD?

• ESG factors underperformed the Value factor and market since 2009
• Integrating ESG in Value investing decreased returns, but increased risk-return ratios
• Residual ESG factors are likely to generate negative returns given the focus on stakeholders, not shareholders

VALUE, MOMENTUM & CARRY ACROSS ASSET-CLASSES

• Cross-asset multi-factor exposure might be an attractive diversifier for an equity portfolio
• Factors share trends across asset classes, indicating common drivers
• However, relationships are time-varying, increasing complexity and risks

CORPORATE DEBT IN THE CHINESE STOCK MARKET

• China exhibits the world’s highest corporate debt as % of GDP
• However, Chinese stocks are not significantly more levered than U.S. stocks
• Asset and debt growth has stalled in 2018, likely indicating an economic slowdown

ESG INVESTING: TOO GOOD TO BE TRUE?

• ESG factors generated positive excess returns since 2009
• Show positive exposure to Low Volatility & Quality and negative exposure to Value & Size
• Factor exposure is likely structural and not temporary

AN ANATOMY OF SMART BETA VALUE ETFS

• Smart beta Value ETFs are relatively homogenous
• Some show high exposures to other equity factors, which may represent risk
• Excess returns from smart beta are significantly lower than long-short factor returns

FACTOR OLYMPICS 2018

• 2018 was negative for classic multi-factor portfolios
• Low Volatility generated the best and Value the worst performance
• Factor performance was homogenous across global markets

FACTOR INVESTING MADE IN CHINA

• Common equity factors generated attractive risk-adjusted returns in the Chinese stock market
• Factor performance in China often mirrors global factor performance
• Indicates common factor drivers that permeate even emerging and isolated markets

PRIVATE EQUITY: THE EMPEROR HAS NO CLOTHES

• Private equity returns can be replicated with small cap equities
• Small, cheap and levered stocks would have achieved higher returns since 1988
• Valuation and debt multiples are at all-time-highs, lowering expected returns

TACTICAL STATISTICAL ARBITRAGE

• Statistical arbitrage behaves similarly across markets
• Volatility is the main performance driver
• Attractive strategy for diversifying an equity portfolio

THE RISE OF ZOMBIE STOCKS

• Zombie firms, where interest payments exceed operating profits, are on the rise
• Zombie stocks perform surprisingly well
• They are expensive, volatile stocks from diverse sectors

EQUITY FACTORS: REDUCING PORTFOLIO TURNOVER

• Portfolio turnover of equity factors can be reduced significantly by trading more conservatively
• However, reducing turnover does not necessarily increase risk-return ratios
• It all depends on transaction costs

THE ODD FACTORS: PROFITABILITY & INVESTMENT

• The Profitability factor generated attractive returns in the US and Europe since 1990
• It is difficult to explain why investors should be compensated for holding highly profitable companies
• The Investment factor was less attractive and is unusual from a financial analyst’s perspective

THE DARK SIDE OF LOW VOLATILITY-STOCKS

• Low-volatility stocks have outperformed the market over the last 25 years
• The strategy has reduced equity drawdowns in the US, Europe, and Japan
• However, low-volatility stocks have been bond-proxies, which poses risk when rates rise

THE DARK SIDE OF LOW VOLATILITY-STOCKS

• Low-volatility stocks have outperformed the market over the last 25 years
• The strategy has reduced equity drawdowns in the US, Europe, and Japan
• However, low-volatility stocks have been bond-proxies, which poses risk when rates rise

STATISTICAL ARBITRAGE IN THE US

• Statistical arbitrage has attractive strategy characteristics
• However, the returns are highly dependent on transaction costs
• Best used as a tactical strategy when volatility is high

IMPROVING THE ODDS OF VALUE

• Value investors earn a premium for holding undesirable stocks
• Market skewness may identify periods where the premium is more attractive
• The returns from the Value factor since 1926 were zero when market skewness was negative

FACTOR INVESTING IN MICRO & SMALL CAPS

• Micro caps are commonly perceived as highly risky, but potentially also highly rewarding
• Smalls caps generate more attractive risk-return ratios than micro caps on index level
• Focusing on factors improves risk-adjusted returns across market cap segments

FACTOR OLYMPICS Q3 2018

• Global factor performance in the first three quarters of 2018 is comparable to 2017
• However, regional factor performance diverges, reflecting changes in monetary and trade policies
• Low Volatility leads and Value lags

LIQUID ALTERNATIVES: ALTERNATIVE ENOUGH?

• Liquid alternatives offer hedge fund strategies in mutual fund format
• The correlations to the S&P 500 have been high, even of market neutral funds
• Diversification benefits have therefore been limited

SHORT-TERM MOMENTUM IN EQUITY FACTORS

• Short-term momentum persists in common equity factors
• The persistence is strong in Value and Dividend Yield
• However, these results conflict with short-term mean-reversion on equity index level

VOLATILITY, DISPERSION & CORRELATION – FRIENDS OR FOES?

• Higher volatility & dispersion imply higher stock market risks
• The relationship between correlation and risk is not linear
• However, these market technicals do not behave consistently across time

CHASING MUTUAL FUND PERFORMANCE

• Mutual funds exhibit momentum when measured by their one-year performance
• Momentum disappears when more reasonable fund selection criteria are applied
• Performance does not seem effective for fund selection for a full market cycle

FACTOR MOMENTUM

• The Momentum strategy can be applied to stocks, sectors, countries and factors
• Factor momentum shows positive excess returns across regions
• However, single-stock Momentum performance is comparable and less complex to implement

HOW CROWDED ARE TECH STOCKS?

• Equity crowding models can be applied to factors and sectors
• Crowding leads to more frequent drawdowns
• Tech sector was crowded over the last 12 months

LOW VOLATILITY, LOW BETA & LOW CORRELATION

• The Low Volatility, Low Beta and Low Correlation factors are interrelated
• Low-risk factors generate attractive risk-adjusted returns, but require beta-neutrality
• Currently they feature moderate to high interest-rate sensitivity

FACTOR EXPOSURE: SMART BETA ETFS VS MUTUAL FUNDS

• Investors can express factor views via smart beta ETFs or mutual funds
• Some mutual funds offer higher factor exposure than smart beta ETFs
• Given higher fees, strong views on expected factor performance are required

MOMENTUM VARIATIONS

• The simplicity of the Momentum factor can be intellectually challenging
• Various alternative Momentum versions highlight remarkable similar return profiles
• The robustness is an attractive characteristic of the investment strategy

FACTORS: SHORTING STOCKS VS THE INDEX 

• Most factor investing research is based on long-short stock portfolios
• Investible risk premia strategies often feature a short index position
• Trade-off between theoretical alpha and implementation costs & efficiency

ETFS, SMART BETA & FACTOR EXPOSURE

• Factor exposure analysis can be used to derive factor themes
• Smart beta ETFs offer relatively low factor exposure
• It is all about how factors are defined

STOCK PORTFOLIO OPTIMISATION

• Portfolios frequently contain stocks representing duplicate factor risks or insignificant weights
• An optimisation process focused on factor exposure can increase the portfolio efficiency
• Increasing or decreasing factor exposure requires a view on expected factor performance and risks

IMPACT OF SINGLE STOCKS ON FACTOR RETURNS

• Factor portfolios are typically created by equal weighting stocks
• The impact of single stocks is therefore reduced compared to market-cap weighted indices
• The FAANG stocks impacted factors differently

FACTOR OLYMPICS 1H 2018

• Factor performance in 1H 2018 is comparable to 2017
• The Size factor has taken the lead, likely reflecting the threat of global trade wars
• Value has generated the most negative returns across regions

FACTOR CROWDING VIA VALUATIONS

• Fundamental factor valuations can be used to identify factor crowding
• However, the approach does not improve risk metrics
• A multi-metric approach for identifying factor crowding is likely more successful

SECTOR VERSUS COUNTRY MOMENTUM

• The Momentum strategy can be applied to stocks, sectors and countries
• Sector and country Momentum portfolios generate positive excess returns
• However, cross sector & country and single stock Momentum portfolios generate higher risk-return ratios

SKEWNESS AS A FACTOR

• Skewness is a feature of stocks with high firm-risks
• Stocks with positive or negative skewness outperform the market
• Can partially be explained by the Size factor

MARKET TIMING WITH MULTIPLES, MOMENTUM & VOLATILITY

• Equity multiples have been elevated in recent years
• Using valuation multiples for allocation decisions is a challenging strategy
• Momentum and volatility-based strategies are more attractive

TACTICAL MEAN-REVERSION

• The Mean-Reversion factor is driven by volatility
• Allocating tactically when volatility is high generates an attractive payoff profile
• The strategy can be considered as a tail risk hedge for equity portfolios

MEAN-REVERSION ACROSS MARKETS

• The Mean-Reversion factor shows the same trends across markets
• The strategy differentiates itself from other factors by exhibiting strong positive skewness
• Mean-Reversion is an attractive diversifier for an equity-centric portfolio

ALPHA MOMENTUM

• Stocks can be ranked by alpha instead of stock returns
• Alpha Momentum generates a higher and more consistent performance than Price Momentum
• Momentum crashes are reduced significantly and risk-return ratios increase

VALUE FACTOR: COMPARISON OF VALUATION METRICS

• Price-to-book is not an effective valuation metric
• There is not one valuation metric that is superior across markets
• Combining multiple metrics generates the highest risk-adjusted returns

EQUITY FACTORS & INFLATION

• Factor performance is impacted by inflation and deflation
• An inflationary environment is more attractive for most factors
• The change in inflation has been most meaningful for the Size factor

VALUE FACTOR: IMPROVING THE TAX EFFICIENCY

• The tax efficiency of the Value factor can be improved by reducing exposure to dividend-yielding stocks
• Improving the tax efficiency reduces the performance in Europe and Japan, but not in the US
• Reducing turnover can be considered for minimising capital gains and stamp duty taxes

LOW VOLATILITY FACTOR: INTEREST RATE-SENSITIVITY & SECTOR-NEUTRALITY

• The interest rate-sensitivity of the Low Volatility factor has increased in recent years
• Mainly due to the sectoral biases from the long portfolio
• Sector-neutrality reduces the interest rate-sensitivity, albeit at the cost of performance

SMART BETA OR SMART MARKETING?

• Smart beta ETF investors seem to ignore empirical evidence
• Excess returns from smart beta are substantially different from factor returns
• Smart beta ETFs offer little diversification for an equity-centric portfolio

FACTOR OLYMPICS Q1 2018

• 2018 started negative for the majority of factors
• Momentum, Quality and Growth showed the strongest performance
• Low Volatility, Dividend Yield and Value generated negative returns

FACTOR EXPOSURE ANALYSIS: DOW JONES

• Factor exposure should be considered a source of returns as well as of risk
• Factor biases can be measured top-down or bottom-up
• The results of the two approaches do not necessarily reconcile

FACTOR PORTFOLIOS: TURNOVER ANALYSIS

• Factor portfolios have an annual turnover over more than 100%
• The turnover rate varies substantially across factors
• Decreasing the rebalancing frequency reduces turnover, but also risk-return ratios

EQUITY FACTORS & GDP GROWTH

• Economic cycles have a clear impact on factor performance
• Some factors show pro-cyclical while others highlight anti-cyclical characteristics
• Given that real GDP is not published in real-time, it is unlikely effective for factor selection

DIVIDEND YIELD COMBINATIONS

• Buying high yielding and selling low yielding stocks is not an attractive strategy
• Combining Dividend Yield with Quality & Growth factors improves the performance
• Interestingly Dividend Growth adds relatively little value

FACTOR CONSTRUCTION: PORTFOLIO REBALANCING

• Factor portfolios do not benefit significantly from intra-month rebalancing
• However, too infrequent rebalancing leads to lower risk-return ratios
• The robustness of factor performance at different rebalancing periods is one of the advantages of factor investing

SEQUENTIAL MODEL: SORTING BY 5 FACTORS

• The sequential model ranks stocks by factors sequentially
• Allows investors to prioritise factors and results in concentrated portfolios
• However, the factor sequence matters and only a few factors can be considered

VALUE FACTOR: INTRA VS CROSS-SECTOR

• Intra versus cross-sector Value portfolios share the major trends
• Neutralising the sector exposure increases the risk-return ratio of the Value factor
• However, the benefits are marginal and come with higher operational complexity

WHAT’S IN A FACTOR? BREAKDOWN BY SECTORS

• Some factors show structural sector exposure while others rotate sectors frequently
• Sector concentrations explain factor performance and may represent concentration risks
• Value is currently long Financials, Low Volatility is short Health Care, and Growth is short Energy

FACTOR ETFS & FUTURES

• Investors can directly access factor returns via ETFs in the US & futures in Europe
• However, neither of these come without some investor concerns
• Realised returns differ substantially from theoretical returns

VALUE & MOMENTUM FACTOR PORTFOLIOS

• Value and Momentum compliment each other given a low or negative correlation
• Investors have different options for combining these two factors
• The multi-factor model selection will be determined by investor preferences

FACTOR INVESTING: GROSS TO NET RETURNS

• Long-short multi-factor portfolios generate attractive returns before fees
• Returns are much less attractive post fees charged historically
• However, some fees in the long-short space are likely justified given higher complexity

FACTOR OLYMPICS 2017

• 2017 was a positive year for most factors
• Quality, Growth and Momentum showed the strongest performance
• Value, Dividend Yield and Size generated negative returns

FACTOR-RETURNS: YEAR-END CALENDAR EFFECTS

• Value & Size generate abnormally large positive returns in January, Momentum negative returns
• Abnormal returns are limited to the last week of December and first week of January
• Difficult to harvest these returns efficiently due to illiquidity of markets at these times

MEAN-REVERSION ON EQUITY INDEX LEVEL

• Mean-Reversion on index level became profitable post the 1970s, before that Momentum dominated
• The structural shift from Momentum to Mean-Reversion is consistent across markets
• Likely explained by the evolution of financial markets

INTERSECTIONAL MODEL: SORTING BY 7 FACTORS

• Focusing purely on Value is a difficult strategy
• Sorting by multiple factors improves performance and risk-metrics
• However, factor selection and allocation remain challenging topics

FACTOR CONSTRUCTION: PORTFOLIO SCENARIOS

• Most researchers create factor portfolios by taking the top & bottom 30% of stocks, which results in large portfolios
• Portfolios can be reduced, but firm risks start influencing factor returns with too few stocks
• Most investors are likely better of buying factor products then building factor portfolios themselves

QUANT STRATEGIES IN THE CRYPTOCURRENCY SPACE

• Cryptocurrencies have reached a market capitalisation of > $150 billion
• Backtesting quantitative strategies is difficult given a limited trading history & universe
• Short-term Momentum works very well, classic factor investing strategies less so

HEDGE FUND FACTOR EXPOSURE & ALTERNATIVES

• Equity hedge fund returns have been disappointing over the last 14 years
• An exposure analysis shows no structural factor exposure, but frequent factor rotation
• Multi-factor long-short products are an interesting alternative, depending on the fee level

INTEGRATED VALUE, GROWTH, & QUALITY PORTFOLIOS

• Integrated Value, Growth & Quality portfolios generated attractive returns year-to-date 2017
• Sorting stocks on several characteristics results in relatively smooth performance
• Mitigates the issue of factor timing, but not of factor selection

RESIST THE SIREN CALL OF HIGH DIVIDENDS

• Buying high yielding and selling low yielding stocks has been an attractive strategy since 2000
• However, it has been a highly unattractive strategy over the last century
• Investors should resist the Siren call of high yielding stocks and focus on other factors

FACTOR RETURNS: SMALL VS LARGE CAPS

• A frequent criticism of factor investing is that factor returns are stronger in small caps
• Our research highlights that this is not uniformly true across factors
• Value and Size benefit most from including small caps

HEDGING MARKET CRASHES WITH FACTOR EXPOSURE

• None of the factors consistently generated positive performance during recent market crashes
• However, almost any factor exposure would have increased the risk-return ratio of an equity-centric portfolio
• Low Volatility and Mean-Reversion would have been most beneficial, Momentum least

DEATH, TAXES, AND MEAN-REVERSION?

• Mean-reversion has not performed well over the last few years
• Highly sensitive to model assumptions
• The strategy is an attractive addition for an equity-centric portfolio

FACTOR OLYMPICS Q3 2017

• 2017 is on track for a good year for factor exposure as most factors are positive
• Quality, Growth, and Momentum are headed for the winners podium
• Value is negative across regions, giving up all of last year’s gains

QUALITY FACTOR: ZERO ALPHA FOR MOST INVESTORS?

• It’s difficult to rationalise why there should be excess returns from high quality stocks
• The Quality factor needs to be constructed beta-neutral to achieve positive returns
• Exposure to the Quality factor is an attractive hedge for an equity-centric portfolio

QUALITY FACTOR: ZERO ALPHA FOR MOST INVESTORS?

• It’s difficult to rationalise why there should be excess returns from high quality stocks
• The Quality factor needs to be constructed beta-neutral to achieve positive returns
• Exposure to the Quality factor is an attractive hedge for an equity-centric portfolio

QUALITY FACTOR: ZERO ALPHA FOR MOST INVESTORS?

• It’s difficult to rationalise why there should be excess returns from high quality stocks
• The Quality factor needs to be constructed beta-neutral to achieve positive returns
• Exposure to the Quality factor is an attractive hedge for an equity-centric portfolio

FACTOR ALLOCATION 101: EQUAL VS VOLATILITY-WEIGHTED

• Equal-weight and volatility-weighted allocations are two common factor allocation frameworks
• Risk-return ratios are not higher with volatility-weighted allocations
• Different reasons can explain the superiority of equal-weight allocations

THERE IS VALUE IN THE VALUE FACTOR

• Equity factors can be valued using fundamental metrics
• Value and Size are cheap while Low Volatility and Growth are expensive
• Likely more meaningful for medium- to long-term than short-term investors

FACTORS: CORRELATION CHECK

• Correlations between Quality and Growth factors are currently elevated
• Value is more negatively correlated than usual to Quality, Growth and Low Volatility
• Monitoring correlations is important for maximising diversification benefits

FACTORS: CORRELATION CHECK

• Correlations between Quality and Growth factors are currently elevated
• Value is more negatively correlated than usual to Quality, Growth and Low Volatility
• Monitoring correlations is important for maximising diversification benefits

VALUE + QUALITY OR HIGH QUALITY VALUE STOCKS?

• Investors can either combine single-factors into a portfolio or sort stocks for several factor characteristics
• Double-sorting seems to work better for Value & Quality than Value & Momentum
• The combination portfolios show the highest risk-return profiles, albeit at lower returns

SMART BETA & FACTOR CORRELATIONS TO THE S&P 500

• Most smart beta products exhibit correlations of > 0.9 to the S&P 500
• Factors show correlations of zero on average
• However, factor correlations are highly volatile across the market cycle

SMART BETA VS FACTORS IN PORTFOLIO CONSTRUCTION

• Investors seek smart beta products for risk reduction
• However, smart beta products are effectively long-only products with full equity risk
• Only factor products, i.e. long-short portfolios, offer true diversification benefits and downside protection

SMART BETA VS FACTOR RETURNS

• Smart beta ETFs are based on factor investing research
• Excess returns from smart beta ETFs are different from factor returns
• Investors need to be aware that smart beta ETFs offer little diversification for an equity-centric portfolio

EQUITY FACTORS IN JAPAN

• Japan has unique characteristics from an economic perspective
• Factor performance in Japan mirrors global factor performance
• Debt & demographics seem to matter less than underlying factor drivers

FACTORS & VOLATILITY-BASED RISK MANAGEMENT 

• A common approach to factor allocation is to scale exposure by factor volatility
• This approach improves the risk-return ratios of Momentum, but lowers them for Value and Size
• Factors have different underlying drivers, which require different risk management systems

QUALITY FACTOR: HOW TO DEFINE IT? 

• Different Quality definitions result in dramatically different return profiles
• Questionable if there is structural alpha in the Quality factor
• Investors would not have benefited significantly from exposure to Quality in the GFC

LOW VOLATILITY FACTOR: HIGH VALUATION 

• The Low Volatility factor has generated stellar abnormal returns over the last decades
• Current factor valuations are expensive compared to historical valuations
• Factor volatility is at record lows and will likely surprise investors going forward

FACTORS & INTEREST RATES

• There are no consistent relationships between Value, Size, Momentum and interest rates
• Applies to high and low and increasing and decreasing rate environments
• Investors shouldn’t be too concerned about factor exposure and rising rates, more about very low rates

FACTOR OLYMPICS: 1H 2017

• 2017 seems to be a good year for factor exposure as most factors are positive
• Growth, Quality, and Low Volatility are headed for the winners podium
• Value is negative across regions

MOMENTUM FACTOR: INTRA VS CROSS-SECTOR 

• Intra vs cross-sector Momentum factor profiles look remarkable similar
• Momentum is like a force that permeates sectors and countries
• Sector analysts need to pay attention to cross-sector Momentum

FACTOR CONSTRUCTION: BETA VS $-NEUTRALITY 

• Factors constructed $-neutral didn’t benefit much from beta-exposure from 2000 to 2017
• Beta-neutrality is only a must for Low Volatility
• However, beta-neutral factors offer lower correlation to long-only indices

MARKET & FACTOR VOLATILITY 

• Factor volatility mirrors market volatility
• Market volatility is higher than factor volatility
• Momentum has a higher volatility than Value or Size

VALUE & QUALITY FACTOR VALUATIONS 

• Value and Quality stocks are typically polar opposites from a valuation perspective
• The Value factor can be considered cheap across developed markets
• The Quality factor is cheap in some and expensive in other markets

VALUE US SECTORAL ANALYSIS

• Using price-to-book (PB) or price-to-earnings (PE) results in similar Value factor performance
• Some sectors are perpetually expensive while others are always cheap
• Sector rotation is higher with PE than with PB

MARKET TIMING VS RISK MANAGEMENT

• Behavioural biases cause the average human to make sub-optimal investment decisions
• Market timing should not be attempted
• Simple and robust risk management systems may help overcome some of our issues

SIZE FACTOR

• Size as a factor shows little consistency in generating positive returns over time
• Investors do not seem to get compensated for the higher risks of holding small caps
• If small cap exposure is still desired, best to implement via a small cap ETF

FACTORS & BEHAVIOURAL BIASES

• Investors are humans and not the homo economicus
• Investing is influenced by a wide variety of behavioural biases
• Factors can be explained by a single or multiple biases