I recently attended the Inside Smart Beta & Active ETFs conference in Boston, MA and here are five of the most pertinent takeaways:
1. For single factors, timing (and time-frame) is everything – Is the Value factor working? Is Growth? It is impossible to answer this question without referencing a timeframe. The below Value vs Growth graph from the St. Louis Fed illustrates this point (an increase on the graph indicates Value outperformance, and decline indicates Growth outperformance). The chart is titled “Growth Trumps Value” – presumably noting the strong and consistent growth outperformance from 2006 through 2018, but despite that decade of robust outperformance – Value has still performed better for the total time period going back to 1980. Dave Nadig underscored the cyclical nature of factors with this great stat – single factor ETFs have a “bad three years” ~ 33% of the time and a “bad five years” ~ 25% of the time. To the extent that success in timing “factor performance” is spurious at best, if you believe in a factor it should always be part of your portfolio as conviction and patience are required to reap the benefits.
2. What are Fixed Income “Factors”? – Mark Landis, Co-Founder of Wavelength Asset Management made an interesting point while on a panel in response to that question. His view was that “true factors” are asset class agnostic and therefore are the same as equity factors. The definition of what qualifies an issuance to be “Value” or “Quality” will be different (for equity vs credit), but the behavior of those assets and the environments in which they excel will be similar. Further, he noted that a big challenge for fixed income factor investing is the difficulty of compiling and mapping that data – as it doesn’t trade on a central exchange and a single company can have many issuances with different qualities.
3. Constructing Multi-Factor portfolios: Portfolio Blending vs Signal Blending – Kal Ghayur, Managing Director of Active Beta Strategies at Goldman Sachs Asset Management discussed different methods of constructing Multi-Factor Portfolios. Portfolio Blending is the process of building single factors portfolios and then combining those portfolios. This method has the added benefit of being tactically efficient, as it’s easy to adjust any single factor exposure by tweaking that individual factor bucket. However, despite their intentions, single factor portfolios often have exposure to other factors as well and as the portfolios are constructed independent of each other – there is the possibility of security overlap (I.e. Apple can be in both value and growth portfolios, depending on the parameters). Signal blending is the process of combining desired factor inputs to generate a signal and then building a single portfolio of stocks meeting those combined criteria. This provides investment efficiencies but is more difficult to tweak the inputs/weights without generating more turnover.
4. The Style Box gets an upgrade –In 1992, Morningstar introduced its style box (seen below) which plots where a portfolio sits in terms of “Size” and “Value” factors – which along with Beta, were the only accepted factors of the time.
Blackrock has recently given this tool a facelift in unveiling its Factor Box (available here). This tool incorporates our evolved understanding of factors to include Size, Value, Momentum, Quality, Yield and Volatility.
5. Where are we in the cycle? – While there was no consensus here (not surprising), there was a spectrum of opinions on how close the US economy is to a recession. One interesting take that I had not considered was discussed by Rob Lutts, President and CIO of Cabot Wealth Management. Part of the reason he does not see a recession on the horizon is a lack of outsized retail investor flows into the market that have traditionally accompanied a market top. This position is supported by recent Bank of America Merrill Lynch and Goldman Sachs notes which point to this effect. BAML (in the chart below), noted that 2019 has been the worst year for stock outflows since 2008. Goldman strategist Alessio Rizzi wrote that “historically fund flows tend to be closely correlated with equity performance, but the recent divergence is one of the largest since the GFC.” It’s possible this could point to additional slack in the retail investment community despite having recently hit all-time highs.
Posted by: Josh Blechman 06/06/2019