Factor Investing - Which Factor Outperforms The Market Best?

Factor Investing, also sometimes referred to as smart beta, is an attempt to beat the market by investing in the types of stocks that are associated with higher returns. In this video, I look at some of these factors to see which one does the best job of beating the market and I also discuss some problems with factor investing and why certain factors that seem to perform well may just not be right for you.
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#SmartBeta #FactorInvesting #PensionCraft

[@Pensioncraft]

If you like my videos then why not check out my weekly podcast “Many Happy Returns” many-happy-returns.captivate.fm/

[@Roman49837]

The interesting thing about investing is that these strategies create virtuous cycles. For example, the mere fact of watching this video will make more investors pile into quality and momentum, which in turn will make these strategies more successful and in turn will convince even more investors to put their money there and less into small value. There is a fundamental aspect, a technical aspect AND a mass psychology aspect to investing. I encourage people to pay more attention to the last, underrated one.

[@BillCarrIpswich]

It looks like a the periods of value stock underperformance correlate nicely with low interest rates.

[@masafelipe7033]

Beautiful video, pure value, easy to digest and deploy as a normal, retail investor. Not everyone of us can or is willing to buy depressed chinese stocks or russian value play oil giants. Where is regulatory risk? Where is the huge estate tax for non US investors? Ramin, along with Ben Felix has by far most reasonable approach to investing for normal people. At least that's what I think.

[@Pensioncraft]

That's very kind of you thanks masa felipe. Thanks, Ramin

[@gocoronago5853]

+1

[@johnristheanswer]

Add Sven Carlin to that list. Highly recommend.

[@masafelipe7033]

@@johnristheanswer I love my countryman Sven, he is truly great but I think his strategy meaning hard core value play, exotic stock picking etc isnt so suitable for average investor. As a trained lawyer i get instant white hair when I think about tax hassle, us estate tax, chinese regulatory risk etc. EU investors can invest in accumulating ETFs and virtually no tax if they hold for 2 yrs or more.

[@kvikende]

I've started to lean towards a multifactor fund on my "sin a little" allocation budget. Looking at the performance over the last 10 years it has trailed the index, but the annualised return is still above 10%. Given the long term return of the market historically lies in the 6-7 % range, I feel comfortable having a value tilt. My overall portfolio is still dominated by index funds, and this multifactor fund allocation is at 17% (was 15% originally but smallcap value has performed very well recently).

[@Ganok]

Thank you! I enjoyed the vid very much. :)

[@Pensioncraft]

Glad you enjoyed it!

[@narendersachdev2480]

Great content abt factor investing!!

[@TheSimArchitect]

Congratulations on 100k subscribers!!! 🎉

[@Pensioncraft]

Thank you!!

[@dogussahin]

Another great video without drowning us into too much data but using only key indicators to make his point

[@Pensioncraft]

Glad you enjoyed it

[@gyulasoos9865]

Great video as always, but I would agree with an earlier commenter that it would be interesting to see how a sector fund rotation would score here, like XLV, XLI, etc.

[@ba8898]

Exactly the topic I'm currently curious about.

[@ResilientFighter]

This is gold and very well said

[@Pensioncraft]

Thank you Gary! Ramin.

[@panagiotisanastasopoulos107]

Thank you for the interesting analysis Ramin!! I always take your advice seriously when thinking about market approaches and investing style! Have a nice weekend!

[@Pensioncraft]

I'm glad you found it helpful. You too

[@aks777777]

also, ulcer index comparison of quality and momentum factors with broad market etfs like spy, vti would have been amazing. I know I am asking too much for the free content but that comparison closes the loop for and helps make a decision on broad market index vs factors.

[@kevinu.k.7042]

Excellent. Thanks.

[@Pensioncraft]

You are welcome! @kevinu.k.7042

[@donkalzone6671]

Thanks for this well made lesson👍

[@Pensioncraft]

Glad you liked it!

[@jonb5135]

Funnily enough I had just come to the opposite conclusion from pretty much the same data :) Value has had such a bad run and is so cheap (while historically being the best performing strategy) that it seems it must be due a reversal. Also a satellite value fund holding, alongside a core global tracker, is a relative tilt away from large cap US tech which seems sensible from a risk management perspective given just how large a percentage of the world market they make up.

[@Pensioncraft]

Interesting Jon, the problem with factor investing is that it is at odds with human nature. Asking someone to underperform for a decade and stick with a strategy is simply unrealistic. That's why I think the ulcer index is so important for factor investing to be practical. I suppose if you're contrarian then value looks attractive, but it has for over ten years... Thanks, Ramin.

[@jonb5135]

@@Pensioncraft good point. I guess if it was easy there would be no premium! I think as a satellite fund, maybe less than 10% I can live with it but maybe I'll change my mind if we have a big drawdown.

[@Earth3077]

I'd say 10% is too little to be of use. You'll likely still have regrets if it drastically underperforms (loss aversion bias), but you'll barely have any upside if it outperforms. You might even have regrets there too, that you didn't put enough money. If you can't stomach 50%+, it might be best to avoid entirely.

[@cyclingphilosopher8798]

This highlights another point why the Golden Butterfly Portfolio is a good choice. Within the context of such a portfolio, in which you also rebalance, with growth and small cap you are basically using volatility as an asset.

[@jonandrews3528]

Excellent video very informative

[@Pensioncraft]

Glad it was helpful!

[@highonherbz]

Thanks for this. I like to buy value funds because I have more attractive 'buying in' points.

[@Pensioncraft]

Glad it was helpful!

[@nickdoyle-achievefinancial2464]

I think the most important part was being able to stick with the strategy you choose. These factors shift and have years or outperformance or underperformance. You need the conviction to stick with it to capture the possible marginal return. I'm still buying international in my portfolio after 10+ years of underperformance.

[@Earth3077]

Decades! You have to have deep conviction to stick to a factor if you see it underperform for almost 20 years, like with small cap value. Most people shouldn't try it, because they'll most likely give up on them and lock in the underperformance.

[@MultiformeIngegno]

Thank you to another great video Ramin! I am learning so much. Have you made a video on how to plot these graphs? In particular it would be interesting to see how you have done the volatility/returns plots!

[@Pensioncraft]

Hi @multoforme I should be making a video in a couple weeks that will cover how I make my graphs. Thanks for watching! Ramin

[@talbotsunbeamer]

Really good video Ramin. I bought in to Vanguard's Global Small Cap index fund at the start of August, so it wasn't all comfortable viewing! Enjoy the Bank Holiday weekend.

[@Pensioncraft]

Glad it was helpful!

[@mutton_man]

Stick with it small cap should outperform large cap over the long run. If your investment time horizon is long then small caps is a good choice.

[@thomascrew8268]

One of the best videos you have made. I frequently check the Morningstar style grid of cap size vs value and growth. The more I think about a factor tilt the more I just keep chosing the total market approach. I'm ulcer free.

[@Pensioncraft]

Thank you

[@thomaswegmann832]

Really always great insights. Wonderful summaries. You saw a good trend with quality shares which I find a good compromise in days of heated stocks. Unfortunately you mentioned no examples. Any examples you consider interesting?

[@Pensioncraft]

Hi Thomas you can find lots of quality funds in the US on ETFdb (just google "ETFdb quality fund") or for European investors on JustETF ("JustETF quality fund"). The lower the fee the better! Thanks, Ramin.

[@mechthildhaeussler5736]

Thank you so much, have been thinking for quite some time about these factors, which seem to increase not only return, but also volatility. Very interesting also the concept of UI ... (even though I think as "rational" investors we would like to forget about such a thing ;-). Nevertheless, I am still wondering whether there could not also be an impact on the "sequence of return risk": Even if in the long term, the factor index will more than recover (and I avoid looking at it in the meantime to spare me ulcers) - what if I need to sell some equity every month to obtain my regular, inflation ajusted income in $/€/etc.? How would a more volatile, hence factored portfolio then evolve over time?

[@MrHotrod79]

Thanks

[@Pensioncraft]

Hi @Rod McClair-Burgess Thank you for the supper thanks, very much appreciated! Ramin

[@jasonmountford]

Really interesting and in depth as always!

[@Pensioncraft]

Thank you! Ramin

[@MrMatisse22]

Once again, loads of actionable information. Thanks!

[@Pensioncraft]

My pleasure!

[@mattlm64]

The PE ratios between growth and value are at record highs suggesting a major reversal to come in favour of value. Growth has only done so well through massive inflows. Momentum is a strategy that has low correlation to value and research suggests may outperform the market long term unlike growth. Combining momentum with value is one strategy.

[@JamyOats]

I agree with you, but a divergence in PE could just mean we're expecting even more growth from the growth stocks.

[@mattiamartello4453]

Great content! Can you please make a video about the 5 factor tilted portfolio by fama and french? KZbinr "ben felix" is an adamant advocate of this and I would really like to hear your take on that.. also if you can somehow recreate this portfolio with UK ETFs I am sure you will gain broad interest and views because there is not a single video on KZbin recreating this portfolio for the UK market.

[@Faraz70]

Value has underperformed Growth for last 15 years (a considerable time period for an average investor). Saying that "over a very long time period, Value outperforms Growth", some one aptly said that "over a very long time period, we are all dead".

[@ImmuneGEORGE]

Great vid as always! I'd be interested to see how some factors are correlated. I wonder how a combination of 2 factors would perform over the long term, i.e. a 50/50 Momentum/Quality portfolio...

[@6toolbaseball]

They are mostly negatively correlated, which is why the original paper said that factors can be even better for diversification than asset class allocation.

[@danjuhl5134]

Hope you one day make a video about sector funds. When you might consider switching between different types of sector funds, which sectors might generally be better etc. Or clarify if this is a stupid line of thought. Btw. thanks for this great video as so often before on this brilliant channel.

[@Pensioncraft]

That's an interesting idea Dan. Sector plays might make sense after a market crash as the sectors that fell the most tend to recover the most. Other than that it's difficult to call individual sector performance during "normal" market conditions. Thanks for the positive feedback Dan, that's cheered me up! Thanks, Ramin.

[@Earth3077]

Don't try to outsmart the market. You don't get a risk premium for making sector bets like you do with factors. Best to be sector agnostic.

[@martindohnal55]

Could you share what factors you use in your portfolio? Thank you.

[@charlesgripp343]

What about the factor of insider ownership or “owner operator”?

[@LuisCabanzonGutierrez]

It's interesting that you mention in the very end quality as one of the winning factors in recent decades, but we are digging into it in the rest of the video. One of my main positions is IWQU (iShares World Quality) and... Well, it has not been performing badly lately, but I don't know how it may look like in the longer term 😕. I do like a low ulcer factor though, I'm still at a stage where I look at my investments a bit fanatically... 🕵️‍♂️💻 P.S. Keep the great work, I have hold your teachings in very high regard during the last couple years.

[@Pensioncraft]

Thanks for your comments, much appreciated

[@masafelipe7033]

I also have World Quality, it should be easiest to hold long term. It does seem that its at a discount compared to regular MSCI World considering the same P/E ratio and much higher earnings growth.

[@akshaykarni4001]

Hello, I am working on my dissertation based on factor investing strategies. I would appreciate a little help if you could please let me know what resources you have used to get most of the information in the video. I would cite this video and other resources as well. Many thanks for the detailed video full of knowledge.

[@coderider3022]

Etf finder is good. Played with koyfin but expensive. That said, money your saving with passive diy would be spent on the tooling.

[@binhvong5297]

I found most of your videos easy to follow except for this one. How would one differentiate growth from momentum? Quality and high dividend? They seem synonymous, how would we screen or find these qualities? Thank you for all your informative videos. Cheers.

[@Earth3077]

Growth is the opposite of value: high ratio of price to book. Momentum are stocks that have recently risen a lot in price. Some overlap, but growth stocks can be flat in price, and value stocks can appreciate rapidly (as long as book value increases along with it).

[@Earth3077]

Quality means strong profitability and steady cash flows, regardless of their dividend yields.

[@stulevin5066]

Very interesting.. could you help with clarifying what you meant by "US Quality" as a factor? In this context, how is quality defined, or were you referencing a specific fund or index? Thanks.

[@Earth3077]

The Quality factor is strong profitability and steady cash flows. Check the index methodology for the QUAL ETF if you want a deep dive into how they apply it in practice.

[@me-myself-i787]

My guess: Momentum and Quality

[@aks777777]

Also, why a market cap is not a factor? is there a certain market cap that gives better risk adjusted returns compared to other market cap. long time back I had done some research and analysis and I think summary was: small cap might outperform large cap but comes with way higher volatility that is it not worth to take more risk(in terms of volatility to generate alpha). mid-cap had way better risk adjusted return compared to small cap on longer term. based on that I invested in VTI and VO and stayed away from VB.

[@mk91-vz1oj]

What about globally? Do we see the same pattern?

[@cavildie]

How is it that in one slide value outperforms (long-term) vs index and then in the ulcer matrix value underperforms (also long term)? Fama-French and MSCI models also say there's a risk premium in value.

[@stevo728822]

You might notice the value stocks struggle during periods of war. The withdrawal from 20 years of military intervention in Afghanistan should be good for them. But let's also remember that value stocks pay dividends, unlike most growth stocks. Good point about momentum. Ultra low interest rates have helped momentum.

[@Pensioncraft]

Interesting point stevo728822. I think Afghanistan is less impactful than a global conflict so personally I doubt the withdrawal from Afghanistan will make a very large impact in value vs growth. Momentum could also work in a high rate environment e.g. if a particular sector which doesn't depend on leverage trends. Thanks, Ramin.

[@stevo728822]

@@Pensioncraft True but I hear it still cost 2-3 trillion USD. Money diverted from non-military purchases. As you described in this video, momentum would have to flip flop from low to high rate performers.

[@Ramdroid07]

What about GARP index. Does this index reduce drawdowns

[@aks777777]

Ramin, I was looking for a time to go over this video carefully, what an educational content. went through video couple of times. I was hoping you would show some momentum and quality etfs for US market at the end. I found that there is a momentum factor index and also different momentum etfs tracking russell 1000, 3000 to nasdaq100. MTUM is the biggest one. Would you put MTUM or VFMO in crisis list? buy some momentum factor instead of broad market like VTI? same for quality.

[@Earth3077]

I've looked into this myself, and MTUM and QUAL are likely the best funds. HOWEVER, most people can't stomach 10-15 years of underperformance. Unless you are very convinced in the research, I would stick to market cap funds like VT.

[@me-myself-i787]

I think it's better to go whole-world. You get the benefit of diversification without any of the downside, since worldwide factor funds perform just as well as US ones. IWMO.L has drastically outperformed MVOL, whilst IWQU.L has only slightly underperformed vs QUAL.

[@johnson8c]

So what are some example of momentum etf?

[@Pensioncraft]

Hi Jonson C for US investors just google "ETFdb growth ETF" and for European investors "JustETF growth ETF". Thanks, Ramin.

[@StephenJeal]

What would be examples of USA quality ETFs?

[@Pensioncraft]

Hi Stephen I'd suggest using ETFdb etfdb.com/themes/quality-factor-etfs/ and you'll find lots to choose from. Fees range from 0.12% upwards so that's pretty cheap for a strategy that churns a lot. Thanks, Ramin.

[@jroig824]

The problem is the so called "Value ETFs" don't represent what value really means. Warren Buffett himself doesn't make a distinction between value and growth. Growth is also a component of the value equation. When calculating present value based on future cash flows, the value will depend on the growth of such cash flows. So buying at a lower price from that calculated value is still value investing.

[@muffemod]

A more accurate term may be undervalued investing or buying at discount.

[@gotnoname3956]

Most people seems to habe a problem to understand the background of value ETFs. It’s just the value factor based on fama/french. There you need a distinction between a qualitative (WB) and a quantitative approach (Fama/French). While you can use factors for a passive investment, a qualitative approach, like the one you described, needs an active selection process.

[@masoncnc]

Beetar?

[@TM-hw5tq]

Great video Ramin! How do you evaluate what percentage factor tilt is appropriate for your portfolio?

[@JamyOats]

Just depends how many extra ulcers you'd like. If you believe in long term trends then it makes sense to go 100% smallcap value. But you'd have to be pretty sure about that trend continuing to be valid, and be willing to take on a lot of pain.

[@johnson8c]

Is arkk consider low ulcer and high return type for period of 40 years?

[@Pensioncraft]

Hi Johnson C there's not much data for ARKK yet, as it hasn't been around for long. But I suspect that it will have a large ulcer risk measure. Growth has been a poor long-term performer, probably because people overpay for growth, so the last decade might be misleading. If growth outperformance does fade back to its long-term performance that will be bad news for ARKK. Thanks, Ramin.

[@crawfordviolin]

Over which time period do you define a “momentum stock”. Is it a momentum stock if it goes up for one week, month, quarter, year, 2 years? Thanks.

[@Pkmafffy]

You find the percentage change in stock price for 1 month, 3 month, 6month and 12months periods and then you rank these percent changes for all tickers by calculating the percentile (which is analogous to normalising the row) and choosing stocks in the top percentile (or greater) for whatever time period you're interested in. As a simple example you could take the mean of the percentile column for each time period and the stocks with the highest mean correspond to a stock that has a best average momentum over all time periods - a high quality momentum stock.

[@crawfordviolin]

@@Pkmafffy the idea of taking “whatever time period you are interested in” is arbitrary and I’ll-defined. One person might consider a stock to be momentum while the other person may not, depending on the time horizon. I’m curious how PensionCraft defined it for this video. Thanks!

[@Pensioncraft]

Hi @crawfordviolin MSCI defined it (I simply show the historic returns for their indices). For MSCI World Momentum Index, for example, they say "A momentum value is determined for each stock in the MSCI parent index by combining the stock’s recent 12-month and 6-month local price performance. This momentum value is then risk-adjusted to determine the stock’s momentum score. A fixed number of securities with the highest momentum scores are included in each MSCI Momentum Index, generally covering about 30% of the parent index market cap. Constituents are weighted by the product of their momentum score and their market cap. Constituent weights for broad MSCI Momentum Indexes are capped at 5%. The indexes are rebalanced semiannually; in addition, ad hoc rebalancing may occur, triggered by spikes in market volatility." The factsheet is here www.msci.com/documents/10199/904e031c-94e4-4dbc-a314-7c373446dffa Thanks, Ramin.

[@vincentbellamy9825]

No mention of quality factor which has outperformed performed msci world index?

[@Pensioncraft]

Hi Vincent I talked about quality here: kzbin.info/www/bejne/rXKWdq2ket93epo Thanks, Ramin

[@txn4yt7mc5]

I thought small cap value has consistently outperformed over large periods of time not only in the US but globally

[@phil1edinburgh]

So why did Vanguard uk bin momentum ETFs?

[@Pensioncraft]

Hi Philio Gosling it was due to lack of interest. They have to make sure that each fund gets a certain amount of assets to be viable and the UK factor funds never really took off. They also want to concentrate on growing their offering elsewhere in Europe so I guess that's where their money will be spent in the next couple of years. Thanks, Ramin.

[@wellman636]

small caps ???

[@lazolangcengula9511]

Thank you for this. Can you please shed light on how to systematically/quantitatively create the quality factor.

[@Earth3077]

The Quality factor is strong profitability and steady cash flows.

[@lazolangcengula9511]

@@Earth3077 what descriptions would you use to capture strong profitability and growth?

[@Earth3077]

@@lazolangcengula9511 Growth is a separate factor. Based on the research, you'd want to avoid it despite its recent performance, and tilt towards value instead.

[@CoastEast75]

So Factor investing is cyclical?

[@andersstengaardjensen2208]

If Value has underperformed for a decade - is there any reason to think that this could now change? Is there any point in going contrarian on this - buying what has performed most poorly - in the expectation that it somehow needs to “catch up”

[@paulhudson8342]

Wondering the same thing. I'm thinking buying value in FTSE as it's cheap, lower risk and less volatile... if the pound is set to strengthen and US buyers come back and/or folks generally switch to value after disillusionment with tech/growth then it's bonus tail winds.

[@Jose_Lima]

iShares Russel 1000 Growth costs 0.18%, the similar SCHG costs only 0.04% 😉

[@kekwirsching]

This is disappointing. Just read Graham's Intelligent Investor and Fischer's Common Stocks and Uncommon Profits . I was hoping to stick with value but the data shows i should reconsider

[@Duke-225]

Are those total returns with dividends reinvested?

[@Pensioncraft]

Hi Mark I couldn't get total return data so those are capital gains. Thanks, Ramin.

[@paulhudson8342]

@@Pensioncraft oh, that could have huge implications, no? Especially if value fund buyers place greater emphasis on DRIP. Some of those value funds currently at 8% could be way up on the return scale towards the 11% and still low risk?

[@paulhudson8342]

Amazing video BTW incase you read this, I"m not sh**ing on it :)

[@ciaoatutti11111111]

The correlation of these dependencies is extremely fragile.... 97% of the time the real world cases Campbell soup will begljave exactly as mgm when conpared to sp500

[@ShivamSingh-jw8ey]

Ideal portfolio for 20 years?

[@CaseyBurnsInvesting]

The Fed won’t stop this growth strategy.

[@nickdoyle-achievefinancial2464]

The market is more powerful than the fed. At some point, the trend will shift for several years.

[@snakevenom39]

You look a little bit like Jerome Powell. Great Video though

[@bigworm3886]

"Bee -tah" - Love your videos but I cant stand the way beta is pronounced 😖

[@Pensioncraft]

Potahto 8-)

[@ridethecurve55]

Beet-a? I prefer Bae-da

[@Pensioncraft]

English pronunciation is usually "beater" rather than "bayta". I've got a greek-speaking friend who reliably informs me we've both got it wrong 8-) Thanks, Ramin.

[@auldmart]

Thanks

[@Pensioncraft]

Hi @David Sharman thank you for the Super Thanks, that's very kind of you! Ramin