Fee, Fie, Foe, Factors?

What is factor investing?

Public Domain: Source: Wikipedia

Factor investing is just a new way to talk about stock-picking. Thirty years ago Gene Fama and Ken French discussed what goes into stock market returns, and why stocks gradually go up. They came up with three major elements: the equity market itself, the size of the companies, and their market valuation relative to their accounting valuation.

The market captures economic growth and put it into a company’s share price. That is, when the economy grows, a residual of that growth goes into the stock market. So the market grows faster than the economy. Small companies grow faster than large companies, because small companies eventually become big companies. And cheap shares return more than expensive shares, because at some point they stop being cheap.

Photo: Kevin Connors. Source: Morguefile

These factors work – and keep working – because they embody economic and financial verities. It’s risky to own stocks, and more risky to own small stocks, and even more risky to own small, cheap stocks, because things can go wrong and firms can fail. Small companies have fewer resources – financial, human, customer – than large companies, and cheap companies are cheap because they don’t look good. People don’t like them. As the world turns around though, enough small, cheap firms become large, rich corporations to make factors valuable.

Over time, people have found other factors that seem to work—things like company quality, or corporate governance, or operating and market momentum. But identifying a factor and finding an investable thesis can be two very different things

If you’re going to use these to invest, just make sure you can stick with them if things don’t work out right away. Because things often do go wrong—just when you can’t afford it.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2017-07-17T12:21:51+00:00 August 10th, 2016|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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