For a few months I have been researching Factor Investing, and have come to three conclusions:
1. I consider Carhart's Four Factor Model, and The Low Volatility Factor Premium to be more useful than the Fama and French Five Factor Model
2. Value and small size premiums tend to move opposite of the momentum factor in academic research. Small Cap Value moves on an opposite cycle rotation as growth stocks. Thus Large Cap Growth is, in my opinion, explained by the momentum factor premium.
3. High Yield Bonds tend to offer equity-like performance with approximately half the volatility. In Portfolio Visualizer they offer almost exactly the same returns as International non-us stocks with about half the volatility.
A High Yield Bond Fund offers some exposure indirectly to market risk with the low volatility premium.
A Small Cap Value fund from Vanguard offers exposure to size and value premiums.
A large cap growth fund from Vanguard offers exposure to the momentum premium.
These factor exposures in in some research can have lower correlation with one another than US stocks have with stocks from other geographic regions. The value/growth cycle rotation is not really something you can time, but it happens, thus owning both fund allows you to gain advantage regardless of when that rotation takes place.
Risk Adjusted Returns are similar that of an 80/20 Portfolio
Several years ago I was looking at research by Smithers and Co. that showed that 80% Stocks and 20% ST treasuries was, in its time, an optimal asset allocation on the efficient frontier. I was surprised that the 80/20 stock/bond portfolio's risk adjusted returns were similar (slightly worse) than this above lazy portfolio.
Interestingly enough Nispus mentioned, thank you for that analysis by the way, that high yield bonds tend to behave in a way that is similar to a portfolio made of 2/3's bonds and 1/3 stocks. If we look at the Three Fund Blend through that lens we see it would be comparable to a portfolio of:
22% bonds and 78% stocks. Of course there are a few time periods and situations where high yield bonds do offer better risk adjusted returns than 2/3 bonds and 1/3 stocks in comparison, but for the most part they track similarly.
This lazy portfolio is simple, uses low cost funds, and offer relatively good risk-adjusted returns. Its major weakness is its lack of international diversification.
I hope those of you interested in factor based investing enjoy my factor Weighted three Fund portfolio.
Statistics: Posted by Benjamin Buffett — Tue Nov 26, 2024 8:01 am — Replies 0 — Views 21