The Value factor has outperformed recently as growth stocks have been hit by monetary tightening fears. Would a factor tilt be critical to bring persistent outperformance?
In this session, our Chief Investment Officer, Samuel Rhee, will explain how and why we created the Endowus Factor Portfolios. We have also invited two very special speakers from Dimensional Fund Advisors — Joel Kim, CEO, Asia ex-Japan & Head of International Fixed Income, and Joel Teasdel, Head of Wealth Management Group, Asia ex-Japan — to cover how factor investing can be the better way to invest.
03:24 Where factor investing sits in your investing strategy
04:50 What exactly are factors?
06:20 Introducing the Endowus Factor Portfolios by Dimensional
10:18 Introduction to Dimensional Fund Advisors
12:00 Built upon decades of financial research from leading Nobel laureates
14:40 What is factor investing?
18:50 Why the factor investing approach must be systematic
27:30 Equity Philosophy in Factor Investing
49:20 Fixed Income Philosophy in Factor Investing
52:30 Differences between equities and fixed income in the valuation framework
What is factor investing? (14:40)
Joel Kim: There’s different ways to define it. So one definition is that you're still seeking to outperform the market but you do this through a rules-based approach by structuring an investment portfolio around factors linked to differences in expected returns and so you can think of it more on a practical basis. You have to identify what exactly are these factors and what is supposed to work. Then you apply them on a day-to-day basis by rank ordering the universe on for example profitability on relative valuation and on the size of company and over time by rank ordering the universe on those factors and then tilting those portfolios to those factors, you look to earn premiums associated with those factors. That's driving the alpha.
Index and traditional active — we are combining the best of both worlds and this shares the benefits of both of them. With active, we seek out performance but without outguessing the markets without forecasting. We do that with a cost basis that is much more akin to passive. This should benefit investors that invest in our strategies.
Joel Kim: You got to pick the right factors and they need to be persistent. I would also add that there needs to be an underlying logic as to why the factor should work. You look for patterns and data. Another important thing is that this is definitely very important for any systematic or factor approach especially now with a lot more focus. Everybody is publishing papers on it. There are hundreds of factors out there, so the truth is somewhere in the middle. You need to research and make sure these factors are implementable. They should still be a good investment net of costs.
Why the factor investing approach must be systematic (18:50)
Sam: There's a lot of factors out there - hundreds or whatever other people tout. Some of it might you know over 15 years lead to a 10 bps outperformance, but if the cost of implementing that is higher, then there's no point in exposing yourself to that factor. So it has to be practical and the systematic aspect is really important. It can’t be based on feelings. It has to be a systematic process that makes sense and is implementable over the long term.
Joel Teasdel: You need the discipline to stick with the strategy, otherwise we can’t say that Dimensional is better than anybody else. You need to know how to drive the car before putting in a bigger engine.
Joel Teasdel: We never paid anyone to sell our products. We care a lot that investments should be bought and not sold. A lot of sun-optimal practice exists in this industry around the world. Dimensional cares about the wealth management business. The reason why we are proud to work closely with Endowus and other small number of fiduciary-based advisors in Singapore, is because we work for our clients. There’s zero conflict of interest and you want to put the best solution on the table for your clients. Dimensional refuses to pay distribution fees, trailer fees, kickbacks or whatever you call it.
Equity Philosophy in Factor Investing (27:30)
Joel Teasdel: How do you put your odds in your favour? That is what the academic contribution analysis has always been about. Back then, the groundbreaking research that was coming out of the academic community was to trust the market and not to guess it. There are millions of participants in capital markets everyday putting ideas into prices buying and selling. Somewhere in between the demand for the buy and sell, you arrive at an equilibrium price for every security. Conventional wisdom at the time, which is still prevalent today, was to find out where the missed pricings are trying to spot the right or wrong price.
Joel Teasdel: This traditional way of doing things is flawed because you need more information about the market all the time you need in order to have better ideas to spot miss pricings. We determined that we are not going to want to do that. We want to look for higher probability ways of getting better returns than the market in a systematic way, rather than guessing. This led to the revolution of factor-based investing. We aim to systematically outperform by identifying large groups of securities that have similar characteristics.
Fixed Income Philosophy in Factor Investing (49:20)
Joel Kim: [Both philosophies] have a lot in common. Like equities, it should be disciplined, rules-based, transparent, and based on academic research. It is based on the findings from Professor Fama and dates back to the early 70s. It does not rely on forecasting or outguessing markets. That is a characteristic for any successful factor or systematic approach. It's not about picking individual stocks, it's about getting exposure to the exact exact factors that are associated with it.
Differences between equities and fixed income in the valuation framework (52:30)
Joel Kim: What is the difference between fixed income and equities in this instance? For bonds unless you don't get your money back in a company default, you know what these cash flows are. It's going to be the coupons and you know the principal that you expect to get back at the end of the bond's life and clearly the discount factor in this case is something that people should be familiar with, it is the yield on that bond. That’s the price now of your fixed income asset. The biggest difference between equities and fixed income is that for equities, you are going to have to guess what exactly these cash flows are going to be in the future. So there is a lot more noise around that process. As a result there's a lot less certainty about what you expect to get for these equity related premiums in your portfolio. The nuance for fixed income is that because there's more certainty around when you get these cash flows, there's a bit more certainty on when you're going to earn these terms and credit premiums.
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