The Jury Is (Still) Out:
This research paper looks at factor-based (factor-investing) mutual funds that extract anomalies in asset prices to earn higher returns than traditional active managers. However, the research finds the gains made by putting assets into factor funds are lower because investors actively reallocate their assets across factor funds. This paper contends that instead of trying to time factors by switching among funds, investors would be better off with a single multi-factor fund.
The paper raises the discussion on the point of factor investing returns and whether the “backtested” above-average returns can be attained. A substantial part of the analysis, in the end, recommends that these strategies can not capture “factor premiums.”
The paper also suggests that factor premiums or the extra return attained are possibly exploitable by professionals but, while intriguing, are not feasible in reality.
The authors also note:
1. The factor approach does produce higher returns compared to traditional active managers. Be that as it may, these returns are not as high as the hypothetical premiums detailed in academic studies.
2. Investors chase returns and would be better off implementing a buy and hold management approach with a multi-factor manager.
For what reason does it make a difference?
There is a significant discussion concerning the best way to approach active asset allocation. The debate comes down to whether an active stock-picker is more successful than a systematic stock-picker. The paper proposes a systematic factor-based approach rather than an active stock picker.
The most significant diagram from the paper below shows that a buy and hold approach utilizing a multi-factor fund could return as much as 110 bps more per year than a traditional active stock picker manager. Factor Investing has not been as promising as touted by asset management firms that have backtested different factors and launched mutual funds and exchange-traded funds supported by the factors.
Here is a link to the paper, Factor Investing from Concept to Implementation.