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Your Complete Guide to Factor-Based Investing: The Way Smart Money Invests Today Paperback – October 7, 2016
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About the Author
Andrew L. Berkin, Ph.D., is director of research for Bridgeway Capital Management, which offers expertly designed investment building blocks for select institutions and advisors. He earned a doctoral degree in physics from the University of Texas and received his bachelor's degree with honors in physics from the California Institute of Technology. Andrew has published numerous research articles in physics, computer science, and investing and serves on the editorial board of the Financial Analysts Journal. He co-authored "The Incredible Shrinking Alpha: And What You Can Do to Escape Its Clutches" with Larry E. Swedroe.
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For each factor they look at the research on five criteria: persistence across time, pervasive across countries or asset classes, robust to slight variations in definition, investable in the real world and not just on paper, intuitive explanations for why the premium exists and why it should continue to exist.
This part of the book is very strong and highly recommended.
I wish they had explored the "factor zoo" in a bit more detail. They have five criteria and it would be interesting to see some factors that DON'T live up to those criteria. They do this a little bit in the appendices, where they briefly look at low-volatility, default, and time series momentum factors. But I wish they had expanded it to include a few more.
But that's really a quibble. I think the big failing of the book is that, after 8 chapters of being bombarded by research, you'll probably feeling: OKAY, I'M READY TO INVEST!!!
Unfortunately, the final chapter, "Implementing a diversified factor portfolio" is the weakest chapter.
They offer three example portfolios where the factors are "equal-weighted". That is, instead of owning 100% total stock market, you instead own 25% total stock market (for beta), 25% size, 25% value, and 25% momentum.
That's okay as an example of how factor diversification helps. But that doesn't strike me as realistic investment advice for most people. Why equal weighting? Why not 40% size and 10% momentum? Are we talking about domestic US factors only? Or global factors only? How exactly does international and emerging markets fit it that portfolio? And what about traditional diversifiers like REITs, CCFs, managed futures, or whatever? Do you have a "factor portfolio", a "non-factor portfolio", and a "bond portfolio"? What if you invest in a fund that combines factors (say, small and momentum)? How does a real world investor even check that their portfolio is invested in "25% momentum"? What if I invest in a small cap value fund that has some negative momentum? And I want to balance that against my international quality momentum fund? How much momentum does my overall portfolio have at the end of the day?
I don't think anyone reading this books will come away with any real idea how to build a factor portfolio other than: "I think I should TILT toward factors some...but I'm not sure how much. I read in a book 20% was a good number for a tilt so I'll do that but I don't know how they picked that number."
Larry and Andrew explain these factors and the data supporting them. They describe five criteria that a potential factor must meet to be real and meaningful. The equity factors described are the market factor, size, value, momentum, profitability/quality. Although learning these factors is important and potentially profitable to the investor, there is an even bigger and more important lesson in the book. The authors teach us how to evaluate any new potential factor or potential portfolio addition. They describe the five criteria that we can apply to these five equity factors and any potential factor we may come across in the future: persistent over time, pervasive across markets, robust to different definitions, intuitive to common sense, and investable at reasonable access and expense to us common folks. Understanding these criteria are vitally important to the investor. They emphasize that an investment plan is worthless if an investor can't stick to his plan. All factors will underperform for long periods. Understanding and believing the criteria will give the investor the fortitude to stick to his well thought out plan. Moreover, by looking at correlations, they build a powerful case for diversifying across factors.
The book is very readable, but it is meant for the highly interested do it yourself investor or advisor, who already understands concepts of efficient markets, asset allocation, diversification. A serious investor will read this book and place it on his investment shelf. He will return to it periodically over the years to look at a few of the tables and some of the data as the various factors perform and underperform over the years.
An important question arises. When these factors become well known, especially the behavioral (as opposed to risk based) factors, are they still worthy of investment? The authors address this in one of the last chapters. I strongly recommend this book for anyone interested in a serious look at modern investing in language someone without a finance degree can understand.
Most recent customer reviews
This book spells out the most important factors in investing that have been rewarded across markets over...Read more
-Robert Ades CFA