Animal Spirits Podcast - Talk Your Book: Global Factor Investing

Episode Date: July 1, 2019

On this week's Talk Your Book, Michael & Ben sat down with Vincent De Martel of Invesco to discuss how institutional investors are using factor investment strategies and what this means for the space going forward. Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Like us on Facebook And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits is brought to you by Invesco. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Battenick and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holt's Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. of Ritthold's wealth management may maintain positions in the securities discussed in this podcast.

So Ben and I sat down with Vincent DeMartel, who is the senior strategist of investment solutions for Invesco, to talk about, now listen, we get us out of the way early. We are on the record. We're an anti-survey podcast. However, this is not just any survey. This is real. They didn't just say, do you like factors? Do you like this? Where are you investing? What they did was they sat with over, how many investors, Ben? 300 face-to-face interviews across Europe, North America, and Asia. How long do these interviews last? He said they lasted quite a long time, right? At least an hour apiece. Yes. So they have, and they've been doing this for, I think this is their, I don't know how many years, but they've been doing this for a few years. Three years.

So the data here, the data is good. Let's just get that out of the way. The data is good. We have to admit, sometimes surveys are useful. And the great thing about this one was so much of factor investing these days is in the theoretical. And here's how we should think about it. And here's how investors should use optimized factors to create portfolios that blah, blah, blah. But Vincent and his team looked at what investors are actually doing with factors and how institutions are actually using them. And so I thought that was very helpful in terms of looking at things, taking it out of the textbook or out of the theory and putting it into reality. Like, here's how people actually think about these things. And these are

institutions that control a lot of money. And so they're going to have a big say in what happens with a lot of these things in terms of how they succeed or fail. A lot of the debate over the last years in factor investing, or one of the debates, is whether or not people should time factors. And people have done exhaustive, intensive research. And it's funny that people just looking at the data could come to two very different conclusions. Sort of funny how that works. But he said, you know what? Who cares what the data says, whether you should, whether you shouldn't, when you should, when you shouldn't? The fact of the matter is people are timing factors. So maybe let's look at how and when they're timing them, as opposed to the theoretical should they

or should have they? Because they are. Ben, I know that you've been timing factors left and right. Last week, you wouldn't shut up about momentum. Yes. I'm a momentum trader with momentum factors. So they looked at five big themes that came about from their study of all these investors. And I thought the biggest one for me and the one that we spent the most time talking with Vincent about were the fact that implementation barriers are falling away. And so it's just much easier to adopt factor investing for institutional or individual investors, and it's also easier for fund firms to come in and create these funds and what that means. What does that mean? What exactly are you talking about? Just the fact that

it's so much easier and how that changes the potential historical premiums that people use in their back tests. Easier how? Well, it's just easier to create these things. Back in the day, it just wasn't cost effective to create a momentum portfolio where you had to turn the portfolio over, say, even once a month because it would have been far too, you know, costly to do it. Now you can do it where you have free trades or really low-cost trades and it's easier to do it much more efficiently. So there's that side of things. But then there's also the fact that there's just more competition. And back in the day, when we run all these back tests on this stuff, people weren't actually implementing these portfolios using quantitative solutions and doing them in a systematic

way like they are now. So now we like people have looked back in time to deconstruct what Buffett was doing or what Sequoia was doing or whoever. Yes. And they're, they're ascribing factors to what was done previously. One question that I don't know that you can necessarily answer is how do flows affect prices and how do they affect factors? I mean, do you have an opinion here? I think it's probably got to affect valuations and at least short to intermediate term performance a lot, depending, especially if we're talking institutional money. It's interesting because we talked in here, we looked at all their different factors that they have. And so they have, we put these six different factors that Invesco has in funds. So they have, they have a value

and equal weight, which is kind of more like a smaller midcap, if you really think about it. Momentum, low-val, quality, and then dividend, and compared it against the S&P. And going back five years, the only ones that have beat the S&P are momentum and low-val. And I made the point with Vincent that it's kind of funny that these ones that are outperforming are the ones that haven't been adopted as far and widely as the other ones. And they're also the ones that are probably the most misunderstood. But at this point, like value is the easiest one to understand, right? You buy 50 cents on the dollar.

Yes. Yes. And momentum in terms of assets is a drop in the bucket compared to value. Do you think that it's outperforming because there's not as much money going into it? I don't, I mean, I don't think, is that what you're saying? No, I'm just saying it's kind of ironic that I just made this point a lot recently that it seems like 10, 15, 20 years ago, all the quants really at this, you know, kind of figured out, okay, this is how markets generally work. And then over the next 10 or 15 years, markets proceeded to not follow that playbook at all. I guess you could say momentum is one, but I think it's just, especially when you look at it in terms of assets, it's one that hasn't done as well. And so I don't think that the flows have a lot to do that here because like you said, momentum is still a drop in the bucket in terms of fun flows and all that stuff. But it's just kind of interesting that things just don't go to plan even when you have these perfect back tests in place. So why don't we get started with this interview? Again, Ben and I spoke to Vincent D. Martel. We will be back on the other side.

We are sitting here with Vincent D. Martel, senior strategist for Investment Solutions and Investco. Vincent, thank you for joining us today. My pleasure. We've been paying attention to the factor space for a while now. I think a lot of investors that are listening have to. So we wanted to start off kind of reverse engineering factor investing. So we wanted to start off with so who should not invest in factors and who should stay away from these strategies because it seems like there's a lot of people that are talking about

the benefits of them, but who should stay away and then maybe you can use that as a springboard for talking about who, you know, what factor investing is and who should be in the space? Well, I think you should stay away if, in general, you're not trying to outperform the market. If really your goal is to track an index, then factor investing is not the right place to go. One thing that we've learned, and I have learned certainly over the past 10 years, working on factors, is that I think anyone who invest in factors should take the time to learn and educate themselves. In other words, this is not a product-led conversation. You need to have a deep understanding.

from the studies we've made of actual factor investors, there's a time to learn because it's an investment philosophy. Once you've adopted it, then maybe several investment strategy will come out of it. But I wouldn't recommend anyone going into it before taking the time to learn. So I'm delighted we have this session today. So when you say learn, are you talking about the advisor who's bringing them to the client? Does the advisor need to educate the client? How much does the end user need to know about these factors because they do tend to ebb and flow in terms of their performance, underperformance, outperformance, and it does take a decent amount of education to stick with it during the bouts and underperformance. So who should know about factors and how much should they

know? Well, usually you expect the advisor to know more, but as a simple rule, something that I think is very effective, is that advisors and their clients can use single factor strategies for outcome orientation. And I'm sure we'll talk more about that. But if you're trying to achieve a specific investment result like low risk or income, then single factor is the way to go. Multi-factor is a way to enhance performance, taking into account the diversification between factors between themselves, so leading to high risk-adjusted return portfolios. So that would be effectively the basis for the conversation with a decline for an advisor. Of course, an advisor should have an idea and understanding of why and what is the source of

the return. And once they understand that, they'll feel more confident explaining it to their own clients in simple but not simplistic terms. So what is factor investing? If somebody asked you, you know, an alien came down today and they said, what is factor investing? What would you say? So I'd say factor investing is a strategy that consists in selecting securities on the basis of certain characteristics or attributes to achieve a particular investment goal. So you heard me say attributes and characteristics, and we'll talk more about this today, I'm sure. It's going to be, for instance, what is the price to earnings, what is the performance of any particular stock over the past 12 months, three years. And so these are characteristics that you can now apply

across a wide range of securities to achieve a certain goal. And that seems to be one of the themes that we've seen in recent years as more products have come to four and more indexes and more strategies. It kind of went from this single application or this single signal, if you will, a ratio. And now multifactor investing seems to be the thing that is sort of taking off. Was that sort of a natural progression that it made sense to not just look at a single variable? Do you think that single variable malice still has some room to run these days? So there are two different things. I would say single variable would be, for instance, that you measure value only as price to earnings or price to book. And clearly there's a benefit in applying

multiple variable at the security level. That's for sure. In terms of the strategy themselves, they still a lot of value in having single-factor strategy, like momentum, quality, value. This is still very worthwhile using in portfolios. The multi-factor approach is potentially great for investors who look for more an old-weather type strategy, where you'd have various factors performing differently at different times. And then the combination of that leads to a more stable result over a long period. So you spoke about characteristics. And I think what's interesting about this is there can be business characteristics. So you're looking at valuations of the underlying businesses. And then there's also characteristics on the actual stock.

So you're talking about momentum and low vol. Talk about the differences between characteristics of a stock price versus characteristics of the underlying business. So these are just different ways to evaluate a security. So one of the roots of factor investing is really security analysis. And so on the business side, you could have, for instance, sales, what's the volume of sales, or what has been the buybacks, for instance, or it could be the time series of a security itself. So how is it performed over the past few months and years? These two can be used indifferently. I think the idea is to try and capture the premium. And the premium is really linked to an anomaly in the market. It should not exist. If you take the strict application of CAPM, all stocks, price

variations should be based on their beta to the market. We observe that it's not the case. And factor investing is about capturing these anomalies to earn an extra return compared to the market. So what do you think, you spoke about security analysis, what do you think Ben Graham would think of factor investing today? Well, so, yeah, the Graham and Dodd book security analysis that it was back to 1939, and I think he would recognize. I have a confession.

Okay. I skinned it. I never read the whole thing. Vincent, did you read the whole thing? I read some good summaries of it. But I think what's important, I mean, you know, if you train as a financial analyst, which I know you two have and I have, you learn a lot of the content that goes into gram and dot security analysis.

If you become a chartered financial analyst, these are the basis of what started the profession. It's about analyzing the balance sheet, the statement, the P&L, the cash flow statement, to get to a certain characteristic. So, yes, Graham would definitely recognize factor investing today because his point was you could find value in companies and earn higher returns. What's fascinating about Graham is that not only did he wrote the book, but he was teaching for many years, others, how to take advantage of what he had found in analyzing securities. And you find the same thing today with factory investing. A lot of these recipes are public and you can find them. anyone can use them. So it's a source of return that can be replicated across multiple portfolios.

So why do you think it took so long for this stuff to really take off? Obviously, people have been doing a form of this investing for a long time, whether it's small caps or value or momentum and they just didn't really quantify it. Was it the technology? Well, the pharma French paper was 91, I think. Yeah. Or was it, I mean, was it technology or was it the fact that people had to catch up with understanding that you could actually make this rules-based instead of just using your discretion? Thinking about Graham, to start there. At the time, it wasn't compulsory to have an auditor to sign off on the accounts. So imagine the same principles now can be applied across thousands of securities and multiple markets. One name I would like to mention is Barra, so Barr Rosenberg, that was created in 1975. And that came around the same period when the critique of Cap M was made, an arbitrage pricing theory came to light. That was around the same time. Ross and Roll, you're looking at this. the end of the 70s. So what Barra did as a company and Barr Rosenberg did is to find ways to analyze securities returns and decompose them across multiple dimensions. Barr himself created a

company to manage money along those dimensions in 1985. 1985 was the creation of the IBM PS2 computer and that was really when you started having possibilities of replicating these series of analysis across many more securities in a very systematic matter, just feeding stock information to a system in order to systematically capture a source of return. And I think that was really a key driver. And then what happened is in the last 15 years, of course, the emergence of ETFs. That by itself has been, I think, really a huge advantage for the growth of factor investing. So that's kind of the other side of this. In your Invesco Global Factor Investing study, you give five main themes. And one of them is,

implementation barriers are falling away, which is kind of a double-edged sword because it's a good thing that investors now have access to these strategies that were once not available to them, especially in a liquid wrapper at a low cost and a sort of tax-efficient way. The other side of that, I thought this was kind of apropos for you because one of my favorite authors, William Bernstein, wrote a piece in his book, Rational Expectations, about how him and his wife 30 years ago would go to this umbrella shop in Paris, and it was a little expensive, but no one, you know, no one would go there. And he said, each time they would return, more and more people showed up and it finally got found out a little bit. And he was kind of

using that as sort of the small value factor investing thing where eventually people are going to understand that this good umbrella shop is going to be found and more people come in. So do those barriers make it harder to have a premium going forward? And if so, how do we know what that compression looks like? There's obviously your shelf life for any investment ideas. Well, good thing. There's 400 academic factors. A lot to choose from. So there's a lot of choice, but I would say this is the case for all factor investment strategies. So there are anomalies, and it's no surprise that they were first found by active managers trying to capture alpha. And so that's what happens.

And so potentially the returns, the outsized returns that exist may not be as large as they used to be. However, however, I think that's what really is the benefit, the attraction of factor investing, is that they exist because, there are anomalies in the market due to either investor behavior or market structures. And they continue existing. I mean, we know that investors tend to overpay for growth stocks because they like the glamour stories and they like to buy winners. And so that shows no sign of disappearing. Structural impediments also continue existing.

We know that many investors cannot use leverage. We know that investors are not driven by profit, not all of them. if you think about central banks or commodity hedgers. So as long as you have these type of actors and types of behaviors in the market, there will be space for factor investing for the existence of a premium. Our friend Wes Gray often talks about this paper, not his paper, called The Limits to Arbitrash, which goes to what you're talking about, that some of these things just cannot be arbited away entirely.

So you refer to these as anomalies. But if some of these are just straight plain vanilla factors and they, can be explained very clearly. Are potential excess returns, are they alpha or is it something else? So you've heard of factor investing sometimes portray as a third way. It is a form of beta in a way. And I think what's really appealing is that it can be captured by a large number of investors. So I have seen personally large institutional investors in Europe, in Asia, in the US, use factor investing because they can deploy large amounts of capital in that space. And also we'll talk about some of the details of implementation. At the end of the day, it's like capturing

the equity premium. If you buy small cap stocks, if you buy major A, B, or C, you're still going to capture the equity risk premium. There'll be variations around that, but the theme, the main driver of return is going to be the same, and it's going to be there for everyone to be able to capture. So we talk about this a little bit in our prep with you, and we said, you know, what are your thoughts on timing these factors and jumping in and out? And you said, well, it doesn't really matter to debate the point. It's happening. People are jumping in and out of these things. Yeah, I thought that was really interesting because it's so obvious. Like, this gets lost in the noise. It's like, well, should you, shouldn't you? It doesn't matter if you should or shouldn't because people are. Yeah. And obviously, that's another sort of downside for these ETFs. It's a great thing, but people can jump in and out. And so how much harder does that make it for investors to understand how to be disciplined with these things and which ones to use and diversify with and how to stick with it. Because that's obviously the hardest thing for most people in terms of any type of its strategy.

And just piggybacking on that, like, how do we know when a factor's time is up? Like, okay, we've been waiting for value for a decade plus. Is it over? And how long should we wait and recognizing that we're human beings and that 10 years of underperformance can feel like a century? Like, how do we go about checking ourselves and checking these factors? So that's where you need to gain a good understanding and learn. And so I was looking at these results actually recently.

you look at when value underperforms. So we're in this right now. Value historically always tends to underperform when the market is rallying. So there's a bull market. Investors are feeling ecstatic. They're feeling positive. That's going to be a bad time for value. And I think you would recognize that some of the excitement around the market, around

tech stocks, around growth is here right now. And so would it make sense for value to outperform today? No, absolutely not. So as a value investor, you are a contrarian investor by design. So does it hurt right now to be a value investor? Yes, it does. But it's what you'd expect. In fact, we saw it from the survey, by the way, it's an interesting point.

So we surveyed 300 institutions face to face asking them about how they use factors and why. And the number one factor that they use is value. And they tend to use multiple ones. But you could argue that value has had not a really strong, long periods of, outperformance since 2009, but these investors believe in it because they want to hold it for the long term. So we actually looked at Investco's different lineup of factor strategies. So you have the value, equal weight, momentum, low volatile quality.

And it's kind of interesting because over the last, call it five or ten years, momentum and low vol are the ones that have outperformed. Do you think there's still something to the fact that those are almost contrary in strategies because they're not as well understood? And it seems like, obviously, value is the contrarian strategy. But it's almost easier to wrap your head around that, at least for me personally. When I started reading Graham, that made sense. The momentum stuff took me a lot longer to actually grasp and low-valve-the-same thing to actually wrap my head around.

So is there something to that that maybe investors still haven't come around to those factors? And that's part of the reason they're doing so well lately. It's partially that not that many investors get it. In fact, momentum is an interesting example. And thank you for being so honest about this. You're not alone. There are some large institutions, large sovereign wealth fund that still don't believe in momentum. Well, because it's like, wait a minute, you're telling me to buy a basket of stocks

at a 52-week high list. Like, I don't want to be a bagholder. Isn't that the exact opposite? Aren't you supposed to buy low and sell high? Well, you're writing the trend. And there are many investors who do that and you can ride the trend on the way up and you can write the trend on the way down. And you could argue that there is some information maybe that the market is not seen for these

stocks. And that may be one explanation for momentum. the other is the herd behavior that we see in the investors. So it's typically behavioral bias. But if I think about what you achieve with these factors, so loval is a clear outcome. You can retain some participation to the equity market, but with less downside. It's pretty clear what you're getting. Quality is interesting because quality gets you, potentially of all factors, the most consistency through time. Quality is such a squishy word. So what do we even mean here? Are we talking about quality of the balance sheet? what quality where?

So that's a great question, and it means that's one of the factors where it's worth looking under the hood, how it's done. Typical factors that you find, or typical characteristics of quality stocks, you find low debt level, you find pretty stable earnings, you find companies that don't play with their accruals too much, so their gap earnings or close to their cash flows, or they have they pay high dividends, so you have all consistency through time. So there's a variety of ways, return on equities. These are all the financial statements, the income statement, the balance sheet, and the statement of cash flows.

Correct, yes. Just to get back to the momentum for a second, which has been by far the best performer, momentum is still a tiny drop in the bulk of in terms of assets, especially relative to value. So to Ben's point, it is taking a long time for people to jump on the momentum train bandwagon. So actually, that connects well to the point we talked about earlier about all these flows so large that the opportunity has gone away. And when you look at the actual AUM or the assets that you find in smart beta or factor strategies, it's still a tiny slither of the whole market. I was trying to do that

actually on my own. I found that it's about 5% maximum of the total mutual fund plus ETF that's currently in smart beta. And the other thing to bear in mind is you need to also look at how much active risk in the market is being taken. What do you mean by that? So I mean that effectively as a factor investment, you're taking some tracking error against the benchmark. similar to an active mutual fund or a hedge fund. And so what I try to do is to compare how much, on average, all the factor of funds have of tracking error comparing that to the AUM in hedge funds and active mutual funds. And I found typically maybe a factor strategy has maybe 3% tracking error against benchmark.

So in total, you're looking at less than 5% of the total active pie that's in the market, which is mainly occupied by hedge funds and active mutual funds. The other thing to bear in mind, final point, a lot of the money that is currently in factor investment is coming from active strategies. So you find some money that was actively managed moving to factors. So it's not really changing the overall amount of alpha strategies in the market. And so from that perspective, I would say, yes, there's a lot of talk about factors, but there's not that much flows when you think about the active position versus benchmark.

So one of the things that we like to avoid as investors, maybe it's because we're just chicken, but it's just taking an extreme view. And so there's no reason an investor has to go on on value or all on momentum. And so how do you sort of teach people to understand that you can use these in concert with one another and diversify through them? And unfortunately, diversifying means you're always going to have to say you're sorry, but that these factors can complement each other, right? So, yes, as you know, diversification is always challenging. I think one way, not challenging, but it means you cannot always buy the top performing assets.

I'm sure everyone would love their advisor to always recommend to them the best performing asset. Diversification is not a strategy that is going to be necessarily the highest performer in every year. But you also know the magic of compounding. The magic of compounding is that if you are diversified, you avoid losses. And so that means that you are more able to capture the upside in the market in the long run. That's a very powerful concept. especially for investors that have inflows and outflows into these strategies. So in this case, having a balanced mix of factors. And in this, I would put value, momentum, quality, all the

obvious ones. Lowval is a good one. So Lowval, you mentioned, Ben, that you weren't sure why lowval works. And I've seen it. So I've worked with institutional investors now for close to 20 years. And I've seen the aversion to leverage. The aversion to leverage means that many investors are looking for high returns, but they cannot use leverage. So they have to buy the highest risk stocks and highest risk strategies, which pushes down the sharp ratio of these strategies. If you are able to use leverage, you're able to take strategies that by themselves are lower risk, but where the risk-adjusted return is greater. And so that's one of the clear reasons why Lowell has been working so well, not just in terms of delivering an outcome of reduced risk, but also a high

sharp ratio compared to other factors. What you just described using these factors with one another and maybe applying some leverage basically sounds like something of a hedge fund strategy. In my time in the institutional world, it made it seem like, you know, call it 10 years ago, it was going to be a hard time to get them out of the hedge funds. In your experience with some of the studying, how have you found that these institutions are at accepting this type of strategy now and maybe moving from a hedge fund or even using factor strategies against the hedge fund almost as a way to compare.

contrast those different styles of investing. So I'm grateful that we have the study to tell us the truth about what factor investors actually do. And what we see from the study, it's really telling us some useful information because we're used to seeing investors moving from active strategies to factor strategies. But more and more, we see investors going from market cap strategies to factor. And for them, it means it's a small stretch. And you've seen many institutions, large and small move to market cap because it's a cheaper way to invest, more transparent, more liquid. But now they're realizing that maybe they can earn a few basis points more by changing the market gap dimension to factors where they can still retain the transparency and the liquidity,

but also hope for a premium in excess of the market. So we're seeing that a lot more in long-only space. And I'm really meeting with a lot of institutions right now that are looking exactly into that. They've allocated large amounts to index, and now they're looking at migrating to factors. So I just want to clarify something you said earlier about diversification across factors can help mitigate the downside. But just to be clear, you can have a portfolio of the best and sharpest and clearest factors and still get crushed in a bare market, right?

These are not going to protect you from a market decline. I would think twice about this because if you take low volatility, it's a pretty reliable factor when markets are tanking. So in general, and if you look at the study, you find that on average, low value is going to lose 2% less than the market. What do you mean by that? So I mean that if the market falls by X, say 10%. On average, low wall tends to lose 2% less than that. Okay, but say the market falls 30 and you fall 28, nobody feels good about that.

That's always been the case. But I think if you look at, if you're in equity, you've got to be prepared to accept equity risk. Did you just discover the stock market, Michael? Is that you're trying to tell us? All right. So let's make you great progress today. Let's hit on this low wall for a second, which has been one of the better performing factors over the last few years.

So in this survey, it goes from 2016 to 2017 to 2018. And the biggest percent change in interest has gone, not surprisingly, is in low vol. So 84% of investors are using low val. That's up from 62% in 2016. So how do you think about flows affecting the price of these stocks, affecting the factors? Is it possible that they don't or they do, but they get washed out? How do you think about flows and psychology and all that sort of stuff affecting the underlying factors?

So what we see is that there are more and more investors trying to time the factors. That's for sure. We talked about this earlier. But I remember 2013 and looking at Lowval and being very concerned about valuations. and at that time there was a big clamor around the fact it was the end of low volume. That was 2013. Yes. So it was because it was utilities and they were training at the most expensive valuations historically.

And there was a bazillion articles about that. Yeah, we always talk about that. One of the things, to get your point of having an understand this stuff, a lot of these strategies are rebalancing monthly or quarterly. And so those types of stocks can change. And I think people, when they look at valuations at a single date, don't realize that the composition of this fund could completely change in style. and type. And we've seen that with some momentum funds recently where they've gone completely

in and out of certain sectors of the market. It's very true. So it depends. That's one of the things you need to look at under the hood in terms of selecting which index and which strategy. But it is the case that there will be times when investors are worried about certain strategies not performing well. But I would say in the case of Lowval, you see five years later it's actually doing what investors were expecting. Again, to our earlier question, if you really are worried about equity risk, go into cash. But if you want some participation and potentially lower risk and more attractive characteristics, and the advisors can have, they should be able to have a conversation about outcomes with their clients. So it's very simple with factors. Low Val,

if you want to have lower risk, maybe you're getting close to retirement. If you're looking for a contrarian approach, yes, choose value. If you're looking for consistent performance through time, quality is a great way to do that. If you're very active and to your point earlier. And if you want to take some very big positions in the market and be prepared to change sectors very rapidly, momentum is the way to go. So these are the kind of conversations that can be had between a financial advisor and his own clients. So is the next logical step, if these factors are so wonderful and you're just trying to get pure factor exposure, why not have market neutral factor exposure where you go long and short and you just get rid of the

beta and you're just left with long short strategies? Is that? sort of the next step? So yes. However, two things. One is first, the ability to implement these strategies within mutual funds or public vehicles is a challenge. So you have legal requirements that make it difficult. And then number two, it's not clear that there is really high demand for this right now. Well, yeah, because stocks are doing well. And I think a lot of the problem is, and this is where I actually give hedge funds some credit is a strategy like that is a cash plus strategy. And cash hasn't yielded anything. So one of the things I want to ask you before we go is how much do institutions care about getting under the hood and understanding these? So are they taking their time to get into

these? Do they get down to the nitty-gritty where they care about what type of value factors are using or what kind of momentum are they using certain indicators? Do they want to get down to that granular level? Are they still at the, you know, 10,000 foot view on these factors? So that's a great question. There are two schools of thought here. The first one is relax. And that's something I tell people around me when you think about the equity market, chill, because the equity market, you look, if you hold, if you're a holder of equity markets for 10, 20, 30 years, you're going to win. It's everybody wins. It's more than a zero-sum game. So the same would happen with factors. So relax. You know, you can take value this way, that way it's going to deliver because that behavioral bias is still there. And so these factors have been proven. to work over long periods. So that's the first school of thought. The second one is for people who really want to fine-tune,

enhance their performance at the margin, there is really worth looking at what you're getting. So how do you calculate the factors? How do you rank them? Is it by quintiles? Is it normal distribution? For momentum, is it risk-adjusted momentum or is it just simple price series?

How constrained are the factor, the sector exposures? how frequently do they change, et cetera. So what are the fees? That's another, of course, dimension. That's pretty obvious. So when do you rebalance as well? You know, is your allocation public? You know, do you disclose it to the marketplace or no?

All of these things will have an impact on at the margin on performance. So they should, some investors should pay attention. But for others, it's pretty comfortable. You either choose an outcome you like and you're trying to achieve that or you're picking a multi-factor approach, in which case you're looking at the diversification. And you're looking for a more stable return profile through time. But you could have, you could be outcome oriented and still, and be severely disappointed. Like, you could say that quality is the most consistent and value is contrarian.

And you could just, you could, you could write it down and say, this is why I'm doing this. And still not have the temerity to stay the course when, when times get tough. So that's, that's the world we live in. I mean, you know, if an R squared of 50% is considered high in finance. So there's going to be some fluctuations, but I think what it is is that if you hold the asset for long enough, you have great confidence that despite the basis risk, the outcome you're expecting will materialize. I think that's, if you think about those factors, plus if you've learned about them, the ones we talked about today, there's a lot of academic literature around them. You could find times when they seem to not work, but they tend to revert over longer periods. So I would say, yes, be prepared for some fluctuations, but the long-term direction is pretty clear.

So is value going to turn around? Is that what you're trying to say? Blink twice. Well, so not to put your crystal ball in front of you a little bit here. Let's say you, 10 years from now, you do the same study. What do you think is shown? I mean, are we going to see an explosion in this stuff, especially with institutions? What would you say things could potentially look like if you had to think about that a little bit?

So that's going to be pretty easy. I think fixed income will be a big area. I think we're going to, we're just starting to see that fixed income markets are becoming more and more transparent. There's more and more information and we're starting to see more and more managers putting funds out there. Certainly we have. We have ETFs that are now live using factors in fixed income, but I expect it's going to be more. Because the assets on the management, especially in areas outside the US, actually, in Europe, most insurance companies are tend to be more fixed income heavy as opposed to the US. So when these markets open up for fixed income factor investing, it's going to be a revolution. Okay. So that's kind of one of the next growth areas in ETS probably. Absolutely. Yes.

Vincent, thank you so much for coming on. Investco, thank you for sending him. This is a fun conversation. And we will link to the study and the show notes. Thank you. So the other thing that we talked with Vincent about, and we talked a little bit off recording on this, especially since I've had some background in the institutional nonprofit world, is that he still sees a lot of those institutions looking at this stuff from a 10,000-foot view where they haven't really got their hands dirty and really dug deep into what these factors are doing. It's more, you know, from a 10,000-foot view, they're just looking at it from a macro perspective. Like, we need to have some more exposure to value or small caps or even momentum or something.

And they haven't gone the quant route yet of figuring out, okay, we need to really optimize within the value factor or within the momentum factor and understand what the best way to implement these things are. And so I guess that's probably the next step, but it just kind of reinforces the idea how important education is in all this stuff. And it doesn't really matter how well a fund firm optimizes this stuff and how great their back test is if they can't explain it or educate their clients on it and help them understand because a lot of the clients that are using these

and pushing big trades around and have a lot of money, they still need a lot of education in a lot of ways. So let me ask you a question. Let's assume that there is pretty decent education. And one of the benefits, in theory, to using these factors is that you can do microscopic attribution bias, figure out exactly what's going on. You don't have to wonder whether or not a discretionary manager was lucky, whether or not they lost their touch, or anything like that.

that, you can say, okay, this fund is not working because this right here, this is what's driving the underperformance. Do you think having that information makes it any easier to know when a strategy is going to outperform or underperformer, whether it's broken versus, say, a discussionary manager? Not really, because you still don't know if that is sort of a one-off thing or if it's going to persist. But I think the interesting thing about this is that it's going to make it easier for people to tinker with this stuff. And they'll say, oh, man, I should have known we should have had X energy in our value factor. So next time around, we're going to take energy stocks out. Or, oh, man, I knew we should have taken out all the banks that have above a hundred billion

dollar value, or whatever it is. I feel like there's going to be a lot more tinkering and pulling of levers because it's now easier to do that than it was in the past. And that's what people are going to do. They're going to use these back tests down to the micro level and continue to make changes and probably make changes at the wrong time. So they're going to change, they're not only going to try to time factors. They're going to try to time the minutia within the factors, which probably is another recipe for disaster. Yeah, I think I'm with you.

I mean, in certain ways, it's easier, but you're only, it's like a step or two easier. It doesn't make it easy. Yeah. And to our point with him, again, I think a lot of the money going into this space has really been helpful because it's come out of closet index funds that were charging higher fees for this stuff and now it's more efficient. the taxes and trading are probably more efficient and then the fees are lower, but that doesn't make it easier for the investor if they're constantly hopping it out of this stuff.

Yep. So, all right. I think that does it for us. Thank you very much, Investco for coming on. Thank you, Vincent. Email us at Animal Spiritspot at gmail.com and we'll talk to you next time.