Resources/Weekly Insights

Volume 13, Edition 30 | November 16 - November 22, 2024

Factor Investing: Focusing Your Portfolio

Doug Walters, CFA

This week we continue our focus on our Guiding Principles and focus in on Factor Investing. We view these as the heart of our evidence-based portfolio strategies.

Contributed by Doug Walters, David Lemire, Max Berkovich

We continue our series on our Guiding Principles this week with a focus on Factor Investing. You may know it by other names such as Smart Beta, Strategic Beta, or Fundamental Indexing. Call it what you like; for us it is the beating heart of our evidence-based approach to investing, and for good reason.

You Probably Know Factors

You may not think you are familiar with Factor Investing, but I’d venture to say you are! If you have heard of investing in “Value” then, congratulations, you are familiar with at least one key investment factor. Investment factors are simply segments of the investment market that can be classified quantitatively based on some fundamental measure. Companies with cheap valuations exhibit the Value factor.

While Value is one of the oldest and widely known factors, there are others… many others. But factor investors like us are most interested in those factors that have tended to outperform the broader market over time. Passive investing (owning the whole market) is an effective approach to long-term investing, but why invest in the whole market if certain definable segments tend to outperform over time? Why indeed!

Be Selective in Your Factors

So, within our equity strategies we focus on the factors that both have a history of outperformance and are supported by sound academic reasoning. For us, that includes:

Good Value
High Quality
Strong Price Momentum
Small Company Size

It is not to say that these factors always work or are guaranteed to work in the future. But we are always looking for ways to tip the performance scales in our favor and we believe this to be one of them.

A Good Year for Factors

In 2024, a factor focus paid off for investors. Value has lagged, but Momentum has been very strong. In addition, “multi-factor” funds, that combine these factors into a single security, have been strong. For example, iShare’s US Equity Factor ETF (LRGF) is up over 29% this year, while the S&P 500 is up “just” 26%. Likewise, the small cap version (SMLF) is up 25% compared to the Russell 2000 which is up 20%. It is fair to say that factors are in favor in 2024.

As we work our way through our guiding principles, we are gradually building the case for our vision of evidence-based investing. As with factors, each step is designed to seek a small advantage for our clients and investors. We’ve discussed Patience, Diversification and now Factors. Next week we’ll continue the discussion, diving deep into the hidden benefits of Rebalancing.

Our Guiding Principles

PATIENCE: Focus on the long-term to fully benefit from market returns.
DIVERSIFICATION: Enjoy the best free lunch in finance.
FACTORS: Identify market segments with a propensity for outperformance.
REBALANCING: Systematically and opportunistically, buy low and sell high.
EXPENSES: Avoid the hidden costs that quietly erode performance.
TAXES: Manage the inevitable burden for successful investors.
BEHAVIOR: Learn to get out of the way of your own worst enemy.

-6.1%

Turkey deflation

According to the American Farm Bureau Federation, the average price for a Thanksgiving turkey is expected to decline 6.1% or $1.68 per pound. Other prices around the table, however, are not expected to fall.

Headline of the Week

AI’s Potential

Nvidia’s earnings was the latest example of the continuing Artificial Intelligence (AI) infrastructure build out, with the company beating lofty expectations. While numbers remain staggering and AI’s potential seems boundless, a healthy dash of skepticism is rarely a bad idea. Wall Street recently started to question the massive expenditures by Nvidia’s customers in relation to incremental revenue. For now, many companies seem to be employing a “Field of Dreams” strategy, where if they build it, the revenue (and profits) will come.

Going “all in” on a potentially game changing technology like AI seems like a no-brainer. We are not arguing against AI’s potential but rather question how much of the value is potential versus real and current. For those of us that spend an inordinate amount of time with spreadsheets, the value is real and current. Alt-Tab over to Word and ask for a summary of a meeting and things can be a bit off. In this case, it’s not unlike artificial sweeteners, yeah, they take the edge off your cup of coffee in the morning, but there is still a residual taste that doesn’t match the real deal. AI warrants continued experimentation matched with healthy doses of the original (intelligence and sweetener).

The Week Ahead

A holiday shortened week brings an inflation report as the only consequential news in the US. A Gross Domestic Product and minutes of the last federal reserve meeting are on the docket but are not expected to be market moving.

Over the Hump

On Wednesday, just in time for the holiday, the Personal Consumption Expenditures (PCE) price index, the preferred inflation measure for the federal reserve will be released.

Expectations are for a slight bump up in inflation, but nothing too alarming.
Analyst PCE estimates have been remarkably close to actual the last few months, so surprises seem unlikely.
The PCE headline number is expected to increase to 2.3% in October, a bit higher than the 2.1% in September, with the core inflation, which excludes food and energy at a 2.8% annual increase.
Inflation has already conquered a major hump and now small monthly moves in either direction seem to be the norm. However, surprising moves tend to alter the central bank rate path calculus.
The Federal Reserve meets again December 17th to 18th and the other major inflation report is on December 11th.
Currently there are 50-50 odds of a rate cut.

Turkey Time

Thursday is Thanksgiving in the US. Markets are closed, and we get an abbreviated session on Friday.

Happy Thanksgiving!

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