Market cycles typically take years to play out for factor investing to fully be appreciated. But in 2018 we saw a full cycle which tells an interesting story about factor performance.
Laurie King: Factor investing from the Analytic Investors team dates back 30 years. If you want to learn how factors drive investing, this is the team to listen to. And they have a compelling reason for their approach, substantiated by the market volatility of 2018. I’m Laurie King, and you are listening to On the Trading Desk®.
I’m here in the Los Angeles financial district, in the offices of the Analytic Investment Team. And with me today is portfolio manager Harin de Silva. He has authored several articles and studies on finance-related topics, including stock market anomalies, market volatility, and asset valuation. Thank you so much for joining us today, Harin.
Harin de Silva: Thanks for coming in, Laurie. It’s a rainy day; you made it in.
Laurie: I did. I put my walking shoes on. As I look around, I see an open environment—no offices, no walls … why is that?
Harin: We really try to foster an open office environment and promote a flat organizational structure. We are a very nimble team. It promotes new ideas—promotes people being comfortable voicing their opinion about strategies. And that’s one of the ways we’ve been able to maintain a culture of innovation at Analytic.
Laurie: And speaking of communicating and getting ideas out, you also produce a quarterly newsletter called Factoring It All In. And listeners, you may contact your WFAM relationship manager to subscribe. But in this episode, Harin, we’re talking about factor investing last year, in 2018. Can you talk about that a little bit?
Harin: Absolutely. You know, last year was really a wonderful year to illustrate the benefits of looking at the world from a factor standpoint—especially an approach that had a broad level of diversification to all the major factors. And so when we look at the world, we look at it, broadly speaking, in terms of how did the world behave with respect to beta. We refer to it as low-volatility, with respect to value factors, price momentum factors, quality factors, and with respect to a factor we call small-capitalization stocks. So those are the five factors we broadly look at. And last year was really, really unusual in that the last three months of the year were dramatically different from the first nine months of the year.
Laurie: So, in a way, you could also say we saw a whole cycle in that one year.
Harin: We did, especially in terms of beta. I mean, certain other factors, like value, didn’t really work at all. Value is a factor that’s widely used in quantitative strategies, widely used in factor allocation strategies. Hasn’t worked in 10 years, but we should expect it to go decades without working. We think it’s why you need to have a diversified exposure to all these different factors, because at any one time, one of them will work; and they’ll work episodically. I mean the last three months of last year, I think, is a great example of that, where something worked really well, and there really wasn’t enough time to rotate into low beta and out of low beta throughout the year because it came as such a surprise.
Laurie: Right. So, we just talked about in 2018 how we had a full cycle that the factors all went through. Now you guys have a five-factor approach. How did that do better than other approaches that had few factors in them? And why?
Harin: Well last year, I think, especially favored an approach that had a broad level of diversification to all the major factors. Because if you think about where we are, we are in the mature stages of a business cycle, and it’s hard to predict which factors are going to work well. So by having exposure to all five major categories, we were able to capitalize on the fact that in the fourth quarter, one factor dominated. Right? Because what some people would like to do is buy three of the factors, or buy a factor approach that focuses, for example, on three factors, or maybe it’s low beta, or maybe it’s just quality and just focuses on value and momentum. Last year, unless you’d bought those other pieces separately, you’d have been disappointed.
Laurie: Right. Now, your team is constantly analyzing these factors, so I’m curious, how do you recognize change and adapt to it? How did you adapt to the changes you saw the last three months?
Harin: So, we’re always looking, on a daily basis. If you listen to the chatter in the open office, you know, in a fundamental firm you’ll hear people talk about stocks, here you hear people talk about factors. For example, they say, hey, yeah, the market’s up, how’s low beta doing? How is price-to-sales behaving? Are cheap stocks doing well today, and what’s the best measure of cheapness today? So that’s the kind of chatter we have. And then, it’s really a function of what the client is expecting. We refer to it as what kind of factor footprint the client is looking for. Because that, to us, is what we are really good at doing, is customizing the footprint the client wants to match their investment needs.
Laurie: So, you guys have a quarterly newsletter called Factoring It All In. Can you tell me a little bit about what readers can find in that?
Harin: Yes, this is actually something that we worked on over the last year or so. And what Ryan Shelby does is basically take all the factor analysis that we produce in-house and translate the quant-speak actually into English.
Laurie: And, speaking of no offices, no walls, I also see Ryan Shelby over there.
Ryan Shelby: Hello!
Laurie: He’s the head of your Factor Solutions team.
Harin: Right. And, so it’s a way for somebody who is not a quant [expert] to actually get an understanding of how the market’s working from a factor perspective in their portfolios.
Laurie: Very good. I’ll remind our audience to contact their Wells Fargo Asset Management relationship manager for Analytics’ quarterly insight piece called Factoring It All In. But for now, Harin, thank you very much!
Harin: Thanks for having me.
Laurie: And for our audience, thank you for listening. Until next time, I’m Laurie King; take care.