Your Complete Guide to Factor-Based Investing – Review

What are factors for investing? How are they determined? Why are they useful?

Your Complete Guide to Factor-Based Investing: The Way Smart Money Invests Today Paperback – October 7, 2016 by Andrew L Berkin and Larry E Swedroe discusses this.

What are factors? “A numerical characteristic or set of characteristics common across a broad set of securities. The authors explain there are a “zoo of factors” out there. The book condenses key factors based on criteria:

  • Persistent: factor holds across long periods of time and different economic regimes.
  • Pervasive: factor holds across countries, regions, sectors and asset classes.
  • Robust: Factor holds for various definitions.
  • Investable: Factor holds up not just on paper but also after trading costs for example.
  • Intuitive: Factor has explanations that are risk-based or behavioral-based as to why it should continue to exist.

The book then discusses each of the follow factor, given its’ own chapter, against the above criteria point by point:

  • Size Factor
  • Value Factor
  • Momentum Factor
  • Profitability and Quality Factor
  • The Term Factor
  • The Carry Factor

The chapters scatter behavioral considerations and biases throughout as well. Understanding the influence of behavior on yourself and the markets is as, if not more, important than the act of investing alone. The authors also include a chapter on whether publication – making the investment factor a broader known, rather than some proprietary trading strategy, affects the premium expected from the factor. They also then discuss putting into place a portfolio based on these factors.

Chapter 9, “Implementing a Diversified Factor Portfolio,” discusses thinking differently about diversification goals; rather than focusing on increasing expected returns, instead focus on reducing risk while holding expected returns the same. This can be done by reducing “exposure to market beta” while increasing exposure to size and value factors. Market beta is reduced by owning less in stocks and more in bonds. I have more discussion on the differences between diversification and allocation, Black Swan portfolio construction,  It’s Not Just About Returns, and Is All your Portfolio at Risk of Loss?

Their conclusion chapter discusses each appendix in brief. The valuable 10 appendices are also written about tracking error regret, smart beta (just smart marketing), dividends (not a factor), default, and other interesting topics around what are, or are not, factors.

Rather than explain this all here, instead I’d refer readers to the author’s very good and concise glossary as well as the references for the very interested reader to dive deeper into the research that supports the concepts discussed in the book. Evidence-Based research is important to the concepts discussed throughout this book.

If you’re a reader and are looking for a book that explains how to approach investing that removes speculation and prediction addictions, this is one that would do you no harm.

The concepts discussed in this book form the foundation that I have applied since the late 1990’s for client implementation using Dimensional.

  1. In the interest of disclosure: I do use Dimensional sub-managed SA Funds with most clients (not a fund requirement, but a business standardization decision I’ve made).

Analogies that explain the difference between investing and planning (Yes, they are different)! :

This blog is not a solicitation; simply an explanation of the basic philosophy and approach.

Photo from book cover on Amazon book page (first link above).

, ,

No comments yet.

Leave a Reply