By |Published On: June 12th, 2017|Categories: Basilico and Johnsen|
  • Title: A WEALTH MANAGEMENT PERSPECTIVE ON FACTOR PREMIA AND THE VALUE OF DOWNSIDE PROTECTION
  • Authors:        LOUIS SCOTT AND STEFANO CAVAGLIA
  • Publication: THE JOURNAL OF PORTFOLIO MANAGEMENT, SPRING 2017  (version here)

What are the research questions?
The article links two current hot topics: goal based investing and factor premia.

  1. Can factor premia (value, size, momentum and quality) help the aspiring retiree achieve the goal of accumulating enough to meet his retirement spending needs?

What are the Academic Insights?
By using the circular block bootstrap ( Politis and Romano (1992)), the authors study the impact of six different strategies to the terminal wealth of the retiree: the core portfolio, the core portfolio plus an overlay in one risk premium at a time and the core portfolio with an overlay of an equally weighted allocation to each factor premia. They find that positive sentiment (defined as the BULLISH percentage) on stocks is associated with positive returns

  1.  YES- Factor premia (except for size) can enhance the distribution of terminal wealth compared to the core portfolio of global equities. The authors simulate two robustness checks where they hypothesize lower future mean returns of factor premia and skill based market timing of the global equity manager. Results of the factor premia enhancement properties seem to hold up.

The authors simulate two robustness checks where they hypothesize lower future mean returns of factor premia and skill based market timing of the global equity manager. Results of the factor premia enhancement properties seem to hold up.

Finally, the authors analyze the drawdown properties of the stand-alone core portfolio and those of the overlays. They find that a strategy which overlays an equal weighted portfolio of factor premia on top of the global equity portfolio is superior in terms of drawdown protection.

Why does it matter?
This paper confirms the importance for investors to be exposed to certain factor premia (value, size, momentum, quality). In fact, it shows that an equal allocation to these four premia on top of a global equity portfolio: 1) enhances the probability to reach retirement goals, 2) mitigates drawdowns in the journey to retirement.

The Most Important Chart from the Paper:

Elisabetta Basilico, Ph.D., CFA, (@ebasilico) is an independent investment consultant. With co-author Tommi Johnsen, PhD, she is writing an upcoming book on research backed  investing. You can learn more at http://academicinsightsoninvesting.com/

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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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