Larry Swedroe is a principal and the director of research for Buckingham, an independent member of the BAM Alliance, and a regular contributor to ETF.com. He was among the first authors to publish a book explaining passive investing in layman's terms—"The Only Guide to a Winning Investment Strategy You'll Ever Need," and his latest book looks into factor investing, "Your Complete Guide To Factor Investing.” He will be giving a talk at Inside ETFs, “Thinking Differently About Diversification” in Florida on Jan. 24, 2017. We sat down with him to discuss factor investing, diversification and more.
ETF.com: Let’s talk about your new book, "Your Complete Guide To Factor Investing.” Why did you decide to write a book on smart beta?
Larry Swedroe: I would say two things. One, factor-based investing has now become the new-new thing, especially after the crisis of 2008. And secondarily, there are over 600 factors that have been identified and there was no book out that helped the individual investor make a good decision on which of the 600 they should focus on.
My colleague Andrew Berkin and I put together a list of criteria we think are helpful for people when they think about any strategy in the future. It should be persistent across economic regimes, meaning long periods of time, so you know it wasn't just a lucky, good economic tie-in period for that factor.
The factor or strategy should be pervasive wherever you look; meaning across industries, sectors, countries, regions and even asset classes. It should be robust to various definitions. For instance, I would be less confident of the value factor if it only worked for price-to-book. But it works for price-to-cash flow and earnings. And momentum works for various holding periods and formation periods.
It should be intuitive. And lastly, it has to be implementable. A factor has to survive transaction costs.
ETF.com: You bring up 600 factors. That’s staggering.
Swedroe: Most of the 600 either don't pass the tests that I just laid out, or using the technical term, they can be subsumed by other factors; meaning, their returns are explained by other well-known factors that we already have. You don't need all the 600.
The good news is that there are really only a relatively small number of factors. For equities, we have market beta, size, value, profitability and quality. You also can add carry, which works across asset classes. And for bonds, the only one we think meets our criteria is term premium. That’s eight out of the 600.
