Perspective’s Role In Factor Returns

June 12, 2018

 

 

  HML SMB* QMJ BAB UMD
Median Years Until Failure 67 43 132 284 339

*Since size is no longer statistically significant at the 1% level, we use the 5% level as the threshold.

 

It is worth noting that these figures for a factor-like momentum (“UMD”) might be a bit skewed due to the design of the test. If we examine the long-run returns, we see a fairly docile return profile punctuated by sudden and significant drawdowns.

 

 

Conclusion

While an evidence-based investor should be swayed by the weight of the data, the fact is that most factors are so well-established that the majority of current practitioners will likely go our entire careers without experiencing evidence substantial enough to dismiss the anomalies.

Therefore, in many ways, there is a certain faith required to use them going forward.

Yes, these are ideas and concepts derived from the data. Yes, we have done our best to test their robustness out-of-sample across time, geographies and asset classes. Yet we must also admit there is a nonzero probability, however small, that these are false positives: a fact we may not have sufficient evidence to address until several decades hence.

So a bit of humility is warranted. Factors will not suddenly stand up and declare themselves broken. And those that are broken will still appear to work from time to time.

The death of a factor will be more Fimbulwinter than Ragnarok—not so violent to be the end of days, but enough to cause pain and frustration among investors.

Newfound is a Boston-based quantitative asset management firm focused on rules-based, outcome-oriented investment strategies. Newfound specializes in tactical asset allocation and risk management solutions. Founded in 2008, Newfound offers a full suite of tactical ETF managed portfolios covering global equity, U.S. small-cap equity, multi-asset income, fixed income and alternative asset classes. For more information about Newfound Research LLC, call 617-531-9773, visit www.thinknewfound.com or email [email protected].

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