In 2015, we have spent much of our time discussing the emotional side of the investment process. Today, we would like to change our focus to the science behind our investment philosophy.
The evolution of The Five-Factor Model is the basis of our evidence-based investment approach. It scientifically identifies the factors of excess return in the market. We have relied on this evolving theory for over 20 years.1 Below is the formula supporting this theory.
The component parts to excess return are:
What does the above formula tell you about how we construct our portfolios?
RISK AND RETURN ARE RELATED
We believe there is additional return over the long haul by investing in equities.
WE TILT OUR PORTFOLIOS TOWARDS THIS INVESTMENT EVIDENCE
We believe in tilting our portfolios toward small, value and profitable companies. The Five-Factor Model evidences small companies outperform large companies, value stocks (out of favor) outperform growth stocks (in favor), and profitable companies outperform less profitable companies, over long holding periods.
THE POWER OF DIVERSIFICATION
We add assets like International and hard asset classes to reduce long-term volatility.
WE OWN WHAT FITS
We own the stocks in each asset class which fit the above evidence.
We recognize the recent S&P 500 performance (2010-2015) relative to other indexes is noteworthy. However, this follows one of the worst 10 years (2000-2009) the S&P 500 has experienced.
In our experience, the evidence above demonstrates the market works best using a disciplined, evidence-based structured portfolio. We look forward to 2016 and what the market has to bring.