Get Even More Visitors To Your Blog, Upgrade To A Business Listing >>

ViniyogIndia Core Portfolios & Multifactor Investing

If a poll was taken asking investors to name the greatest investor of all time, it is safe to assume that the vast majority would answer Warren Buffett.

For years people have tried to figure out Buffet’s methods, hoping to replicate his investment success. So, what is Buffet’s “secret sauce”?

And what if, like Po said in the movie Kung Fu Panda, there is no secret ingredient. It’s just You, or Factors in this case!

But before we go there, let’s take a step back and take a look at what factors are and what makes stock prices go up.

Asset Pricing Models & Factors


Over the years, academic community have come up with various models trying to Explain Asset Returns. These models, or asset pricing models, try to describe expected returns of financial assets, such as stocks, bonds, etc. using characteristics called factors.

Simply put, factor can be considered as a quantitative representation of a qualitative theme that can be used to explain asset returns.

Capital Asset Pricing Model (CAPM)

An example is the Capital Asset Pricing Model or CAPM. In simple terms, it says, returns of an individual stock (or any other financial asset) in your portfolio is related to Market returns.

This relationship is quantified by the following equation which says, expected return of an asset is Risk Free Rate, plus a constant times market risk premium (expected market returns minus risk free rate). Market risk premium here is the factor.

Fama-French Three Factor Model plus Carhart’s Momentum Factor

Despite its popularity, CAPM is simplistic and is often criticized for its inability of explain asset returns based on empirical data.
In particular, multiple studies indicated that value stocks and small cap stocks tends to outperform growth and large cap stocks respectively. This led Kenneth French and Eugene Fama to come up with a 3 Factor model that had value and size as two additional factors. Mark Carhart subsequently added a fourth factor, which was the momentum factor.

Factor Zoo

Subsequently, many more factors have been identified to explain asset returns and newer factors are getting discovered by academia and industry alike.

For example, a paper published in 2014, examined 600 such factors from academic and practitioner literature. Another paper in 2015, reported 59 new factors discovered between 2010 and 2012 alone. So much so, that the situation of rapidly expanding factors led to coining of the term Zoo of factors.

Buffet’s Secret Sauce (Alpha)

So, does Buffet have a secret sauce, or any unique skills?

A 2013 study titled “Buffett’s Alpha,” provides an interesting alternative perspective.

The study explains that Buffett’s success can be explained purely by exposure to factors, not by any unique stock-picking skills.

Once all the factors described in the study — market beta, size, value, momentum, betting against beta (a strategy that takes leveraged long positions in low-beta assets and short positions in high-beta assets), quality, and leverage — are accounted for, a large part of Buffett’s performance is explained, and his alpha becomes statistically insignificant.

Perhaps Po was right all along – there is no secret ingredient!

These findings however, does not in any way detract from the genius of the Buffets & Grahams of the world. Their genius lies in recognizing and applying these factors long ago, decades before modern financial theory could catch up.

Factor Returns in Indian Markets

So, how well does factor investing work in India?

Below chart summarize Risk/Return Characteristics and Risk-Adjusted Returns of Single-Factor Indices and Portfolios ns in Indian markets between October 2005 to June 2017.

Source: S&P Dow Jones Indices LLC. Data from October 2005 to June 2017. Index performance based on total return in INR. Past performance is no guarantee of future results.

Over the period from October 2005 to June 2017, portfolios for all factors, (low volatility, momentum, value, quality, dividend, and size) outperformed the S&P BSE LargeMidCap. However, only low volatility, quality, and momentum delivered better risk-adjusted return (return per unit of risk) than the S&P BSE LargeMidCap.

Factor Performance is Cyclical

Macroeconomic and market events affected each factor in different ways. Factor returns tended to exhibit cyclicality, with periods of outperformance and underperformance in different phases of the cycles. Understanding the cyclical characteristic of factors across different macroeconomic regimes is vital for implementation of factor strategies.

Below chart summarizes performance characteristics of factors in different macroeconomic regimes, including market cycles, business cycles, and investor sentiment regimes in India

Source: S&P Dow Jones Indices LLC. Data from October 2005 to June 2017. Index performance based on total return in INR. Past performance is no guarantee of future results. Table is provided for illustrative purposes. Note: Yellow, upward triangles represent favorable performance (positive excess return with outperformance probability not lower than 50%), while blue, downward triangles represent unfavorable performance (negative excess return with outperformance probability not higher than 50%) versus the S&P BSE LargeMidCap. The two factors with the highest information ratio in each of the market cycle phases are circled.

Single factor portfolios, although can beat the market over long term, they are also likely to underperform over short /medium term due to factor cyclicality.

As an alternative, single factors could be blended into multifactor porfolios that aim to deliver smoother excess return across business and market cycles.

ViniyogIndia Core Portfolios

ViniyogIndia offers three Core Portfolios based on Investor Risk Profile:

  1. Balanced Multifactor Core for Conservative Investors
  2. Dynamic Multifactor Core for Moderate Investors, and
  3. Aggressive Multifactor Core for Aggressive Investors

The Core Portfolios are based on Multifactor, Multi-asset Regime-Switching Model and they offer a calibrated exposure to risk vs rewards.

Research has shown that factor performance tends to be cyclical, with different factors, such as value, momentum, etc. performing differently across market regimes. Portfolio returns therefore can be optimized by modelling market states & controlling factor exposure based on regimes.

Market states/regimes are modelled using a combination of proprietary + macro indicators (and also using ML/ models such as Hidden Markovian Chains). This is combined with past performance to dynamically control factor exposures over market regimes.

As individual stock returns tend to be positively correlated with each other, further portfolio diversification is achieved using (asset classes negatively correlated to equities, such as) bonds (G-secs) and Gold, with asset allocation controlled based on market states.

Portfolio is balanced once every month to keep the percentage turnover low.

Balanced Multifactor Core for Conservative Investors

The conservative portfolio uses balanced asset allocation, with equity exposure varying between 60% and 40% while other assets (bond and gold combined) make up the rest.

Dynamic Multifactor Core for Moderate Investors

The moderate version of the portfolio dynamically controls asset allocation & factor exposures based on market regimes, with peak equity exposure up to 80% and other assets making up the rest.

Aggressive Multifactor Core for Aggressive Investors

The aggressive portfolio invests primarily in equities, controlling factor exposures based on market regimes, except for extreme bear markets, when it allocates up to 50% of the assets in gold and bonds (G-Secs).

The post ViniyogIndia Core Portfolios & Multifactor Investing appeared first on ViniyogIndia.com.



This post first appeared on Viniyog India - Equity Research & Investment Advisory, please read the originial post: here

Share the post

ViniyogIndia Core Portfolios & Multifactor Investing

×

Subscribe to Viniyog India - Equity Research & Investment Advisory

Get updates delivered right to your inbox!

Thank you for your subscription

×