Don’t DIY Your Factor Portfolio
Top 5 of the Week of December 18
A Wealth of Common Sense’s Ben Carlson addresses the idea of using stock market gains to pay down the mortgage in this week’s Top 5. Nicolas Rabener from Factor Research reveals the consequences of DIY factor portfolio construction. And ETF.com’s Larry Swedroe uncovers the untruths associated with passive investing.
Charlie Bilello of Pension Partners examines junk bond myths. And Jack Vogel, Ph.D., writing for Alpha Architect, explains how we’re all factor investors actually…
Swapping Liquid for Illiquid Assets
- The yield on stocks over the long run is probably likely to be better than after-tax interest expenses on the mortgage—though asset performance shouldn’t be your sole consideration when thinking about this swap
- Instead, if you consider your mortgage as a fixed income asset on your personal balance sheet you can approach this by rebalancing “one type of equity risk for another”
- And ask yourself, which you’ll regret more: forgoing future stock returns or keeping your mortgage on for longer?
Have you ever considered swapping stocks to pay off your mortgage quicker? Share your comments in the section below
Don’t DIY Your Factor Portfolio
- Factor investors have a tendency to create long-short portfolios that slice from the top and bottom 30% of the stock market
- Which inevitably creates a large—and impractical sized—portfolio to properly manage, since both long and short cross sections comprise of 480 stocks
- These can be reduced significantly by slicing just 2.5% (40 stocks from each), but the result of this is dealing with higher volatility and larger drawdowns
- Better then to buy factor products than build a factor portfolio yourself
The Subject of Ridicule
- Over the years, passive investing has been mocked by Wall Street, mostly due to the threat it poses to active management
- As such, many false accusations are made of passive investing, most recently at the rise of indexing, that it “may be reaching bubble-like proportions, driven by an exaggerated critique of active management”
- These passive investing critics though are playing sleight-of-hand with their data to promote active management—so, take their outperformance claims with a pinch of salt
Junk Bonds Explained
- Given that high yield bonds (junk bonds) correlate with stocks at 0.58 and bonds at 0.24, they are more likely to move with the stock market over the bond market
- Also, their overall risk profile doesn’t back the idea that they are riskier than stocks when they are down ‘more’, despite the accusation otherwise
- And just because they correlate with stocks more, doesn’t mean they always follow the same path in the long run—in the past, they have moved in opposite directions roughly three times a year
Covering the Divide
- The popularity of factor investing has inspired the launch of actively-managed factor ETFs to cover everyone’s bases, but some investors are still only investing passively into index funds
- While many see a divide between the two, “even passive index investors are betting on factors”
- This is because no investor can escape the biggest premium of all which every stock is subject to, i.e., the market factor—making every investment, a factor investment
Top 5 of the Week is a summarized collection of financial investment articles that we like and think you might like too. Having written thousands of pages of equity strategy and company research between us, we understand the allure of the ever-changing world of finance. Investing is an art form—and like everything, something you can work on and improve at. There are some excellent writers out there on the finance web, some offer a running commentary on today’s market, some are doing research, some have tips on how to Become a Better Investor, and some just lift the cloud of fog behind a lot of financial jargon. Each week we will keep you up to date with the top 5 articles worthy of your attention.
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