Factor-based investing was pioneered by Nobel prize winners Eugene Fama and Kenneth French in 1992 on the capital asset pricing model (CAPM).
Their research points out that over a long period of time, overweighting companies that are rated more favourably along the factors of value, size and profitability tend to bring in higher returns.
In this session, Samuel Rhee, Chairman and CIO of Endowus and Alvin Chow, CEO of Dr Wealth, discuss factor-based investing, the additional returns it can bring over a long period of time, and the challenges and difficulties it can take for retail investors to execute it on an individual level.
They will also compare it with some common investment strategies used by retail investors, and ask the question that is on everyone's mind - is value investing dead?
0:15 Introductions from Sam & Alvin
12:18 What is factor-based investing?
23:05 Definition of growth vs value
31:58 Why value has/will underperform
40:07 Do passive flows drive continued divergence in gap between value and growth systematically?
48:00 Is value dead or about to make a comeback?
1:02:32 Multi-factor model and diversification
1:14:01 Value stocks discussion
Who are the founders and key thought leaders around value investing?
In 1934, Benjamin Graham was credited as the pioneer of quantitative analysis in stocks investing, even though the term “value investing” had not been coined yet.
In 1992, Eugene Fama and Kenneth French came up with an asset pricing model that expands on the Capital Asset Pricing Model (CAPM) developed by William Sharpe. The risk factor of “size” and “value” was added to the market risk factor in CAPM model. It was shown that the factors of size and value can predict long term returns and hence be a way to generate higher return
In 2013, the “profitability” factor was further identified by Robert Novy-Marx in his research paper, which was a more in-depth study on the paper “Profitability, Investment and Average Returns” written by Fama and French.
How does Dimensional execute factor-based investing, with the value factor?
Dimensional systematically overweighs stocks that exhibit favourable factors around size (small market capitalization companies tend to give higher returns long term), price/value (companies that have more “value” tend to give higher returns long term) and profitability (profitable companies tend to give higher returns long term), and underweighs stocks that don't. This is done in a manner that still allows broad market exposure, while taking transaction costs into consideration.
How do retail investors execute value investing strategy?
Retail investors can use value matrices (lower price to book ratio, price to earnings ratio) to quantitatively screen for stocks, before applying qualitative analysis to pick stocks that they think are able to generate higher returns.
Is value investing dead?
The value factor has underperformed over the past 13 years. Despite that, a recent study by Fama French in January 2020 concluded that the original value premiums that were observed in 1963 to 1891 have shrunk in the period between 1991 to 2019. That does not indicate that value investing, when investing over an extended period and in a diversified manner, is ineffective.