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Factor-Based Investing: Q&A With Director of Research at Buckingham Asset Management
Susan Ayodele Nov 08, 2016
We recently had a chance to speak with Larry Swedroe, Director of Research at Buckingham Asset Management and author of “Your Complete Guide To Factor-Based Investing.” We discussed the theory behind factor investing, its potential benefits, and how investors can achieve their risk and return objectives through this strategy.
Theory Behind Factor Investing
MutualFunds: Factor investing has gained a considerable amount of attention as of late, what is the theory behind it?
L.S.: If a poll was taken asking investors to name the greatest investor of all time, it’s safe to say the vast majority would likely respond, “Warren Buffett.” Thus, we could say that a major goal of investors the world over is to find Buffett’s “secret sauce.” If we could identify it, we could invest like him – assuming we also had his ability to ignore the noise of the market and avoid the panicked selling that causes so many investors to incur the higher risk of stocks while ending up with lower, bond-like returns.
“Your Complete Guide To Factor-Based Investing” is in part about the academic community’s search for that secret sauce – specifically the characteristics of stocks and other securities that both explain performance and provide premiums (above market returns). Such characteristics can also be called factors, which are simply properties or a set of properties common across a broad set of securities. Thus, a factor is a quantitative way of expressing a qualitative theme. For example, value factor can be measured by a number of different metrics, such as price-to-book, price-to-cash flow, price-to-earnings and price-to-sales. But this book is also about how practitioners use that academic research to build portfolios, and how you as an investor can benefit from that knowledge.
Therefore, it’s helpful to think about a factor as a unique, independent source of risk and return. At its most basic level, factor-based investing is simply about defining and then systematically following a set of rules that produce diversified portfolios whose components each have an expected premium return and whose returns have low correlation with the returns of the other components, providing diversification benefits.