Great interview with Andrew Ang on Factor investing.

Two key take outs from my perspective in relation to Factor Investing.

How to determine what factors to invest in?

1. Ensure the factor generates a return as a reward for bearing a specific set of risks. The risk return profile results from market structures, an economic value, or investors’ behavioural bias.
2. The excess return from the factor needs to be persistent and will be there over time.
3. The factor is a unique and a differentiated source of return, different to the risk return profile of the market (beta), and lowly correlated with other factors.
4. The factor is scalable, the factor can be delivered relatively cheaply and with scale.

As you know, there are lots of reported factors (the factor zoo). I tend to agree that there are a limited number, value, momentum, quality, size, and minimum volatility appear to have the greatest foundation of work in supporting their existence, economic rationale, and persistence over time.

How should factors be used?

1. To complement an existing portfolio of active managers, preferable active managers with genuine idiosyncratic risk exposures e.g. non-factors more company specific risks.
2.  Replace a traditional index exposure to get a more efficient market exposure, this could enhance your returns and/or reduce risk, see previous post on short comings of passive indexing.
3.  Express a view within a portfolio e.g. over or under weight certain factors that are attractive or unattractive at certain points in the business cycle.

Happy investing.

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Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.