Outperforming the market has long been a goal for investors. However, the odds of consistently achieving this through traditional management strategies are low. According to S&P Global’s annual SPIVA report, over 90% of managers fail to beat their benchmarks after accounting for fees. But research has identified certain characteristics that can indicate potential long-term outperformance: these are known as “factors.”
Understanding Factor Investment Strategies
Leading finance scholars like Eugene Fama and Kenneth French have studied thousands of stocks over decades. They discovered that specific traits, or factors, could help identify stocks that might outperform the market. Eduardo Repetto, Chief Investment Officer at Avantis Investors, emphasizes that these factors help investors identify stocks with high potential returns.
Key Factors for Outperformance
Investments using factor strategies focus on three primary characteristics:
- Size: Emphasizing small and mid-cap companies, which historically yield higher returns compared to large-cap firms.
- Value: Targeting stocks that are undervalued based on fundamental analysis, particularly using the adjusted book-to-market ratio.
- Profitability: Selecting firms with high cash-based operating profitability to avoid financially distressed companies.
These factors act as markers that capture different risk dimensions. While portfolios exposed to these factors can carry higher risks, they also offer the potential for significantly improved long-term risk-adjusted returns, according to Alain-Philippe Fortin, Assistant Professor at the University of Montreal.
Avantis Investors and CIBC’s Factor ETFs
In partnership with CIBC, Avantis Investors launched a series of eight exchange-traded funds (ETFs) in March designed to capture these factor-based outperformance strategies in the Canadian market. Among these offerings is a comprehensive ETF that uses a factor approach, marking a first in Canada.
Greg Gipson, CIBC’s Managing Director and Head of ETF Strategy, notes that factor investing is a natural extension of indexing. It allows for complete market exposure while also emphasizing stocks with certain desirable characteristics.
Expected Performance and Risk Management
According to Avantis, their factor-based portfolios are projected to outperform comparable index portfolios by 1.5% to 2% annually after fees. The anticipated tracking error—annual deviation from indices—ranges from 3% to 4%. This discrepancy highlights the systematic approach factor investing employs compared to traditional active management.
Avantis adopts a highly diversified approach, maintaining over 10,000 stocks in their portfolios. This breadth allows them to harness market premiums effectively while focusing on stocks that exhibit strong risk factors.
Cost Efficiency in Factor Investing
Cost efficiency is another advantage of factor strategies. With approximately 50 employees, Avantis operates with lower overhead costs, ensuring that their management fees are competitive, ranging from 0.19% to 0.39%. In accordance with Canadian regulations, total fees for these funds will be disclosed soon, anticipated to be between 0.22% and 0.45%.
The systematic nature of factor investing minimizes emotional biases that might affect traditional active management strategies. This analytical approach ensures that any identified market premium benefits the clients directly.
The Future of Factor Investing
As more investors recognize the overhead benefits of factor strategies, the question arises: could the risk premiums associated with these factors diminish? Eduardo Repetto advises that while undervalued stocks will eventually be corrected by the market, there remain numerous opportunities in undervalued companies.
Thus, maintaining a focus on these factors will continue to play a crucial role in achieving consistent outperformance in the investment landscape.
