Before digging into the construction of this factor-based portfolio, let me recommend an excellent book on the subject. I’ve not found any volume to surpass “Your Complete Guide to Factor-Based Investing” by Andrew L. Berkin and Larry E. Swedroe. Swedroe has an excellent reputation for his analytical skills when it comes to investing and portfolio construction. While his writing style cannot match William J. Bernstein, what investment writer can. In my opinion, there are none better than Bernstein.
While there is no “Holy Grail” portfolio, it does not keep one from trying to put together such a portfolio. In this factor-based portfolio here are the principle pieces to the puzzle.
- Beta – These are ETFs that cover the broad market and we expect the securities (red background) to reflect broad market movement. Three ETFs fill this part of the factor portfolio.
- Size – Based on Fama-French research, smaller companies tend to outperform larger companies. We have the large companies covered with the three Beta ETFs. The four ETFs (light gray background) VB through SCHC cover the smaller size factor.
- Value – Once more, Fama-French research identifies value as another market anomaly. Value (ETFs with dark green background) tends to outperform growth. Not always, but over the long run, value stocks are the beaten down companies and when they rise, they tend to do very well. Once more, we have growth stocks contained within the Beta ETFs. We also pick up some growth stocks in the VB ETF so growth is not eliminated from this factor based portfolio. We just tilt the investment quiver toward value stocks.
- Momentum – This market anomaly continues to be a mystery as to why it continues to work well. MTUM is the momentum representative and we really need only one as the Kipling is built to take advantage of this market anomaly.
- Quality or Productivity – This last primary factor is one of the more recent additions to the Fama-French five-factor model. This factor was discovered by a former student of mine. I’ll just add that he has one of the top minds I ever taught and I was fortunate to work with some great ones. For example, a former student was one of the developers of Windows. Enough of that.
- Other – VNQ and REET cover real estate. This is really a special asset class rather than a factor. I include these ETFs as they are a hedge against inflation.
- Term or Bonds – Berkin and Swedroe include “term” as another factor. I think of them as more of an additional asset class. The five ETFs (dark brown background) are present for periods when equities are out-of-favor.
There you have the basic makeup of what I call the Factor Model.
Here at Investment Trend Analysis (ITA) we monitor several different investing models and they are:
- Robo Advisor or computer managed portfolio. The Schrodinger is the lone example.
- Stocks Only: This is the Dirac portfolio.
- Dual Momentum: Currently, six portfolios follow this model and they are:
- Factor Model: I’ve not completely decided which portfolios will use this model.
- Relative Strength: This is somewhat of a catchall description for all the momentum portfolios, regardless whether they employ the HA, BHS, or LRPC investing systems. Portfolios currently in this group, and some will move over to the Factor Model, are:
- Carson HA (This portfolio specifically follows the HA model)
- Carson BHS (This portfolio specifically follows the BHS model)
- Carson LRPC (This portfolio specifically follows the LRPC model)
Below is the Factor Model investment quiver. Once more, I’ve laid my maximum asset allocation (Max AA) percentages into the third column from the left. You may prefer to leave these settings at 100% and let the Kipling allocate the percentages.
Factor BHS Recommendations
Based on prices mid-morning of 7/16/2020, the Factor investment quiver, operating under the BHS model, recommends buying QQQ, SCHB, SCHC, MTUM, and HYT. The tilt is definitely in the direction of equities.
If these purchases were current holdings, I would immediately place the appropriate TSLO under each so as to preserve capital. Look for one or more of the Relative Strength portfolios to move over to the Factor Model within the next two months.