Episode 213: Expected Returns and Factor Investing

In today’s episode, we beg the question: is factor investing worth it? Factor-tilted portfolios tend to perform independently of the market and today, we break down a few of the characteristics associated with higher expected returns, as well as the challenges of factor investing. We give a brief history of pricing models and walk step-by-step through a hypothetical factor investment; taking the Fama and French five-factor model into account. Additionally, we discuss liability duration and bond returns and speculate whether pooling finances results in greater relationship satisfaction. Tune in to hear our take on everything from book clubs and the impact of inflation on consumption liability assumptions to our final verdict on whether factor investing is, in fact, worth your while.

Key Points From This Episode:

• The latest phenomenon of people paying to go on popular podcasts. [0:01:58]
• Interesting feedback we’ve received for our Crypto series. [0:03:49]
• Why not to make an investment decision based on one person’s opinion. [0:04:53]
• The evaluation skills our Crypto series equips listeners with. [0:06:05]
• Upcoming guests on the Rational Reminder Podcast! [0:07:31]
• Some interesting LinkedIn connections we’ve made in the past few weeks. [0:16:06]
• Recommended book for kids: Way of the Warrior Kid 3. [0:18:11]
• Recommended book for adults: The Psychology of Money. [0:21:08]
• The model of our firm’s book club and our experience of it so far. [0:22:02]
• Does pooling finances result in greater relationship satisfaction? [0:24:35]
• Liability duration and bond returns according to the current change in bond yields. [0:26:22]
• How inflation impacts consumption liability assumptions. [0:29:11]
• The positive effect the changes in the bond market have had on pension funds, relative to their liabilities. [0:30:20]
• The main topic of the day: is factor investing worth it? [0:32:30]
• The long-term volatility for factor-tilted portfolios. [0:33:56]
• What factor investing is and the added risk it entails. [0:34:51]
• A brief history of pricing models. [0:35:53]
• A few characteristics associated with higher expected returns. [0:39:25]
• The challenges of factor investing. [0:39:47]
• How to determine the mix of factors that captures all relevant state variable sensitivities. [0:42:56]
• The significance of size premium. [0:46:07]
• Speculating whether factors deliver premiums. [0:47:57]
• The steps involved in a hypothetical factor investment. [0:48:57]
• A few important facts about factors. [0:53:23]
• The benefits of having more independent risk premiums in a portfolio. [0:54:56]
• Our verdict as to whether or not factor investing is worth it. [0:57:02]
• Why it’s important to take tracking error into account. [0:57:38]
• The tendency of factor-tilted portfolios to perform differently from the market. [0:57:48]

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