Description
Combining multiple investment factors may be a “smarter” approach to smart beta. For investors seeking stock
exposure, without a specific need for any single factor, blending investment factors could make sense. When
identifying drivers of long-term stock returns, two factors with a lot of academic support for outperformance
are value and momentum (Reference: Fama-French Research, University of Chicago Booth School of Business).
Value strategies attempt to identify stocks that seem underpriced relative to their actual financial characteristics.
Whereas, momentum strategies try to identify stocks exhibiting the strongest positive price movement with little
regard to company valuations. It’s easy to understand why these two factors may complement one another.
One approach tries to find diamonds in the rough while the other focuses on the high fliers. Of course there is also the question of quality. Value factors have an element of quality screening, but may have difficulty in determining undervalued stocks from stocks that are low for reasons other than the balance sheet. Momentum factors are somewhat quality agnostic in that they have little regard for the quality of a company, favoring the stock’s price movement instead. Again, this explains why these two factors complement one another.
But perhaps an even “smarter beta” approach would be to apply a quality screen to the entire universe of stocks while also assessing the value and momentum characteristics. Quality can be subjective and determining a good company from a great one can be difficult—but identifying the bad ones may be easier. As an analogy, the illustration to the right shows several apples. It would be hard to say which of the apples would make the best pie.
Many of the apples have similar traits such a rich color, smooth texture and a bright shine. But before selecting the ones to use in a pie, it would at least make sense to throw out the bad ones. There is no guarantee that the remaining apples will always give the best result, but having basic quality standards is at least a logical starting point. A similar philosophy can be used for stock selection.
Quality stocks tend to have certain traits in common, such as earnings consistency and a good track record of dividend payments. Of course there is no way to tell how well a seemingly good company’s stock will perform, but looking for an indication of quality and corporate stability may provide some initial benefit. If single factor strategies are called smart beta, then perhaps combining multiple factors with a quality screen may be considered smarter beta? A blended approach may lead to the exclusion of the deepest value stocks or some of the fastest moving momentum stocks, but it may also help to avoid a few bad apples along the way. Past performance is no indication of future returns. All investment methodologies have risks, both general and product-specific, including the risk of loss of principal.
No investment strategy can guarantee superior performance in all market environments. Always read the prospectus or offering memorandum before making any investment.The information provided is intended to be general in nature, not specific to any product or investor profile, and should not be construed as investment advice. This information is subject to change at anytime, based on market volatility and other conditions, and should not be considered as a recommendation of any specific security. AD-041015 .
One approach tries to find diamonds in the rough while the other focuses on the high fliers. Of course there is also the question of quality. Value factors have an element of quality screening, but may have difficulty in determining undervalued stocks from stocks that are low for reasons other than the balance sheet. Momentum factors are somewhat quality agnostic in that they have little regard for the quality of a company, favoring the stock’s price movement instead. Again, this explains why these two factors complement one another.
But perhaps an even “smarter beta” approach would be to apply a quality screen to the entire universe of stocks while also assessing the value and momentum characteristics. Quality can be subjective and determining a good company from a great one can be difficult—but identifying the bad ones may be easier. As an analogy, the illustration to the right shows several apples. It would be hard to say which of the apples would make the best pie.
Many of the apples have similar traits such a rich color, smooth texture and a bright shine. But before selecting the ones to use in a pie, it would at least make sense to throw out the bad ones. There is no guarantee that the remaining apples will always give the best result, but having basic quality standards is at least a logical starting point. A similar philosophy can be used for stock selection.
Quality stocks tend to have certain traits in common, such as earnings consistency and a good track record of dividend payments. Of course there is no way to tell how well a seemingly good company’s stock will perform, but looking for an indication of quality and corporate stability may provide some initial benefit. If single factor strategies are called smart beta, then perhaps combining multiple factors with a quality screen may be considered smarter beta? A blended approach may lead to the exclusion of the deepest value stocks or some of the fastest moving momentum stocks, but it may also help to avoid a few bad apples along the way. Past performance is no indication of future returns. All investment methodologies have risks, both general and product-specific, including the risk of loss of principal.
No investment strategy can guarantee superior performance in all market environments. Always read the prospectus or offering memorandum before making any investment.The information provided is intended to be general in nature, not specific to any product or investor profile, and should not be construed as investment advice. This information is subject to change at anytime, based on market volatility and other conditions, and should not be considered as a recommendation of any specific security. AD-041015 .
