Since the 1950s, three generations of academic and industry research on the sources of investment returns have furnished us with a shortlist of systematic investment exposures with enduring and well-vetted economic significance. They are known as factors.
Factors have a stable economic identity over time.
Factors cut across the traditional silos of capital allocation categories. Because of that, they help investors cluster together holdings from various sectors, industries, geographies, and asset classes in a dynamic and integrated way that, from an investment perspective, is highly interpretative, tractable, and actionable.
Factors have been staples of academic research because they are able to explain the overwhelming portion of investment returns. They’re also utilized across the industry in performance attribution to analyze the sources of investment track records.
> The Evolution of Modern Investing
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At GNH Capital Group our strategies structure their exposure first and foremost across the leading, most robust, and best-vetted investment factors:
MARKET factor
The Market’s health & vitality
SIZE factor
Capitalization advantage
MOMENTUM factor
Trending investments
QUALITY factor
Well-run investments
VOLATILITY factor
Steady investments
VALUE factor
Cheap investments
- Began in the 1950, spearheaded by Markowitz’s identification of the Market Factor (1952)
- Propelled forward by the work of Sharpe (1964) and Fama (1970)
- From then on, the list of factors gradually expands with thousands of studies repeatedly testing and vetting the economic reality of each new addition
- Research conducted in the 1980s and 1990s
- Value Factor introduced by Fama and French (1992, 1993)
- Size Factor ushered in by Banz (1981)
- Was kickstarted with the identification of Momentum by Jegadeesh and Titman (1994) as well as Carhart (1997)
- Subsequent research added Low Volatility (Ang, 2006) and Quality (Novy-Marx, 2013)
For some years now, the leading edge of this research tradition has begun to cross into a new era—the 4th Generation. Our strategies are an offspring of the 4th Generation of Factor research and they make two important contributions:
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- Markets are Regimes disguising their orientation and shifts through noisy activity
- Although Factors are the ultimate drivers of investment returns, their productivity and expression is dictated by the status of the market regime and its shifts
For more on our investment research and portfolios in the fourth generation, visit Our Portfolios.
21st Century 4th Generation thinking in action:
Market regimes impose a large-scale bullish or bearish equilibrium on the market activity. While this is easy to see in retrospect, it is quite challenging to detect in real-time, as the status of the market regime is obscured by the constant fluctuations of the unfolding market activity.
That is why our strategies devote a lot of sophisticated resources and attention to filtering out the noise embedded in the raw signs that emanate from the market and the economy.
Our research has shown that there is little economic reality in traditional categories of holdings—like sectors, industries, styles, domiciles, etc. Bonds are not always low-risk income workhorses (especially in low-to-negative interest rate environments and during credit crises). Market segmentation into sectors and industries is mostly a carry-over from the labor taxonomies of a by-gone era. And various geographic differentiations (e.g., international, emerging, frontier, Pacific Rim, etc.) may have geopolitical significance but hardly any enduring market identity.
In contrast, our strategies structure their exposure first and foremost across investment factors, which carry a stable economic identity over time. Click to learn more about the four generations of factor research.
In finance, there is no shortage of ideas and tools for building and running portfolios. It would seem that there can be “as many strokes as there are folks.” However, in practice, investors quickly discover that not all ‘strokes’ lead to robust and sustainable portfolios, and that there is a pressing need for a continuous reevaluation of everything old, along with an ongoing assessment of everything new.
At GNH Capital Group we believe that the evolution of factor research provides a unifying framework that helps clarify, vet, and organize in a cohesive, nested progression the key discoveries and advancements that have punctuated the history of finance. Without such an integrating framework, the fledging concepts of Modern Portfolio Theory, the startling findings of Behavioral Finance, today’s innovative ideas, and tomorrow’s breakthroughs look more like a smorgasbord of options rather than a cohesive set of tools.
Investors need to be aware that yesterday’s ideas that still fuel traditional portfolios are the products of the 1950s, 1960s, and 1970s and are only thinly and selectively supported by empirical evidence. Moreover, those early conceptualizations were focused on the mid-20th century world and do not reflect the subsequent transformations that have radically changed the modern economy, the markets, and our societies.
That’s why at GNH Capital Group we are diligent students of the theory and practice of Factor investing and active participants in its advancement.