Factors: Systematically Advantage Your Portfolio

Doug Walters, CFA

We continue our series on our guiding principles, focusing on one of the most important… Factors. In addition, we take this opportunity on the holiday weekend to highlight what investors should be thankful for in 2023.

Contributed by Doug Walters, David Lemire, Max Berkovich,

As we continue our series on our guiding principles, we turn our attention to what may be the most important among them – Factors. This is one of our favorite topics; we could gush for pages on their benefits. But today, we’ll focus on the two main advantages: Performance and Diversification.

So, what are these “Factors” we are referring to? Research shows that certain segments of equity markets display a proven persistent tendency to outperform the broader market over time. We call these Factors. If you have heard of “value investing,” you know factors (or at least one). Value is a factor. But there are others. We introduce you to them here and then talk about their advantages.

Value: Arguably the most recognizable factor. Value seeks stocks that have low prices relative to their fundamental value… i.e., they are cheap!
Quality: The Quality factor identifies companies with low debt, stable growth, and high profitability… e.g., big technology companies.
Momentum: The Momentum factor is all about recent price performance. The more, the better. Data shows a stock in motion tends to stay in motion.
Size: The Size factor refers to a company’s market cap (or size). Smaller companies have tended to outperform larger ones over time.
Minimum Volatility: ”Min Vol” captures stocks with less market sensitivity (i.e., more downside protection) yet provide market-like returns.

While each of these factors is unique, they all share two advantages that lead us to put them at the core of our strategies.

Advantage 1 – Long-Term Performance

The chart below shows the performance of a multifactor index versus the broad market over time. This multifactor index overweights stocks with attractive Value, Quality Momentum, and Size characteristics. Over time, the factor index has outperformed the broad market by about 1.5% annually. That is a significant advantage!

Advantage 2 – Natural Diversification

Last week, we touted the importance of diversification in a well-managed portfolio. Factors are unique in that they provide natural diversification within equities. While each of these factors has historically outperformed over time, they tend to work well at different points in the economic cycle. The chart below shows historically when each factor has performed well versus others.

Each of our guiding principles is designed to incrementally advantage portfolios over time. Factors is a shining example. By simply redefining what is held at the core of our equity strategies (factors rather than the broad market), we believe the evidence shows an opportunity to systematically advantage portfolio performance in the long run.

What Investors Should be Thankful for in 2023

Thanksgiving weekend is upon us, and as we do each year, we take a moment to highlight what investors have to be thankful for. The year has been a difficult one for many around the world, and our hearts go out to all of those impacted directly or indirectly by the all-too-numerous tragedies that 2023 witnessed. For those in need of some good news, you likely need only look to your investment portfolio.

So, let’s get to it…

Thank you, “Magnificent Seven”… we see concentration and valuation risk in the market because of you, but you dragged the US equity market ever higher, leading to a nice rebound from 2022.
Thank you, gold… near double-digit returns in a year when equities are ripping is a nice one-two punch for diversified portfolios.
Thank you, inflation… you’ve come down well off your peak and are approaching the low single-digit range we have come to expect.
Thank you, Fed… even though you’ve not yet signaled rate declines, your hints of peak rates have helped buoy equity markets.
Thank you, American consumer… you’ve kept the US economy out of recession despite many nay-sayers.
Thank you, elevated Treasury yields… it’s been a while since we’ve seen positive real yields available on bonds (although those seeking mortgages don’t thank you).
Thank you, SBF and FTX (two years running)… investors now know better the importance of a trusted custodian (and you inspired my Halloween costume!).
Thank you, generative artificial intelligence… some are concerned your descendants may wreak havoc on the human race, but for now, you are enabling massive productivity gains for workers.

But most of all…

Thank you to our clients and readers of Insights… we are so thankful to have you as part of our cherished growing community!

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on total client assets of over $2 billion.

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