Well, I was midway through a formal book review on Larry and Andrew’s new book, “Your Complete Guide to Factor-Based Investing,” when I noticed that the team over at GestaltU already wrote the review I was going to write — great job and I encourage everyone to read it.

larry factor book

So we won’t rehash what has already been said about Larry and Andrew’s book, instead, I’ll bullet point our thoughts (with links to various research articles) on a variety of topics discussed in the book. Also, I want to encourage anyone interesting in factor investing to grab a copy of this book and take the content to heart. Larry and Andrew do an exceptional job exploring the factor zoo and summarizing which animals you should potentially visit.

factor zoo

Let’s begin.

A Framework for Identifying Investment Factors

First, I really like the framework the authors posit for the selection of “factors.” Here are the 5 elements which are described in the GestaltU review:

  • Be persistent over a long period of time, and across several market cycles;
  • Be pervasive across a wide variety of investment universes, geographies, and sometimes asset classes;
  • Be robust to various specifications;
  • Have intuitive explanations grounded in strong risk and/or behavioural arguments, with reasonable barriers to arbitrage; and,
  • Be implementable after accounting for market impacts and transaction costs.

Many of these concepts are described in detail by Antti Ilmanen in one of the most impressive and informative slide decks I’ve seen in a long time.

aqr slides

Note the 5 elements are essentially described in the deck: persistent, pervasive, robust, intuitive, and implementable

Bottomline? When Swedroe/Berkin and the AQR crew are aligned on something, we should probably consider it a good idea.

What Factors “Matter” According to Berkin/Swedroe?

  • Market beta
  • Size
  • Value
  • Momentum
  • Profitability & Quality
  • Term
  • Carry
  • Low-volatility
  • Default
  • Time series momentum (i.e., trend-following)

Our Thoughts on These Factors

Larry and Andrew do a wonderful job documenting a lot of the literature related to each of the factors discussed. In the section below we list all of their factors and articles we’ve done on these same subjects (some are discussed in the book). We also provide a high-level score based on our take on the evidence. In general, we pretty much agree with almost all of the sentiments expressed in the book (Warning. Warning. Warning. Group think alert, group think alert!).

Here is our ranking system:

  • Gold (top-tier factor)
  • Silver (solid factor)
  • Bronze (second-tier factor)

The list of Larry/Andrew’s favorite factors with our rough rank order of evidence and sustainability out of sample.

There you have it on the factors. But always remember: no pain, no gain. Financial markets — while perhaps not the greatest at setting perfect prices — are extraordinarily good at matching buyers and sellers. In the end, a factor can only work to the extent they earn a natural risk/mispricing premium that investors are willing to pay in order to offload the exposure. To the extent that the market determines that the risk/mispricing premium isn’t worth the costs, these factors can vanish in the blink of an eye.

Good luck!

PS. We have a monster factor investing post coming out tomorrow. Stay tuned.


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