By |Published On: February 1st, 2017|Categories: Factor Investing, Research Insights, Book Reviews|

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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About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

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Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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