Delving into the theory behind their new model ETF portfolios, the hosts explore market assets pricing and historical views. They address the systematic risk factors in the Fama-French Five-Factor Model, discussing factor exposure through ETFs. Insights on portfolio distribution and premium expectations are shared, along with reflections on factor-loaded indexes and bad financial advice.
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Quick takeaways
ETF portfolios utilize Fama-French Five-Factor Model for efficient asset pricing.
Factor premiums enhance returns by considering size, value, profitability, and investment.
Factor diversification through systematic risk factors improves portfolio performance and risk management.
Deep dives
Introduction of New Model ETF Portfolios
The podcast episode covers the introduction of new model ETF portfolios based on empirical finance research. These portfolios are designed incorporating five systematic risk factors identified in the Fama French five-factor model. The episode emphasizes the significance of these factors in asset pricing and expected returns, highlighting how these factors impact portfolio construction and investment strategies.
Empirical Support for Premiums
The discussion delves into the empirical evidence supporting the premiums associated with different risk factors in investment portfolios. It outlines the value-weighted and academic factor premiums for size, value, profitability, and investment in various market segments, showcasing the economic significance and statistical relevance of these premiums. The analysis underscores the importance of considering these premiums in portfolio management decisions.
Practical Application in Portfolio Construction
The podcast explores the practical application of factor premiums in building investment portfolios. It highlights the implementation of factor premiums in portfolio construction, specifically comparing different indices' returns to illustrate the impact of factor loading. The episode emphasizes the relevance of incorporating these premiums in investment strategies to potentially enhance returns and diversify risk effectively.
Key Point 1: Five-Factor Regression Analysis
Using a five-factor regression analysis, the podcast discusses how excess returns generated by active managers can be attributed to exposure compared to the market, small stocks, value stocks, highly profitable stocks, and conservative investments. This analysis suggests that active managers claiming to produce alpha may actually be explained by systematic factors rather than their skill, as highlighted through Warren Buffett's historical success.
Key Point 2: Factor Diversification and Premium Reliability
The podcast explores the reliability of premiums over rolling 10-year periods, showcasing how factors like small stocks, value stocks, profitability, and conservative investments have demonstrated positive performance in the market. These factors have shown to be more reliable than the market premium itself, emphasizing the importance of factor diversification in enhancing returns and mitigating risk for investors.
After months of research, number-crunching, and receiving listener requests on the subject, today’s episode is devoted to introducing our new model ETF portfolios — which promise to offer a smoother ride to getting reliable returns. We open our conversation with a financial news roundup and by touching on our book of the week. We then dive into the theory behind our model by first exploring how market assets are priced. We discuss historical views on asset pricing models before looking at what academia has done to overcome challenges to the idea of market efficiency. Host Benjamin Felix methodically shows how our model addresses the five systematic risk factors that are included in the Fama-French Five-Factor Model. From emerging markets to stock size, we share insights into what our model accounts for and how this should impact your portfolio distribution and premium expectations. After reflecting on how factor-loaded indexes get higher returns without extra risk, we talk about the ETFs that we use for factor exposure, as well as how you can apply our findings to your portfolio. We round-off today’s show by chatting about the latest bad financial advice. Tune in to hear more about our findings in this, our last episode of 2020.
Key Points From This Episode:
We share community and listener feedback and what you can expect from the show in 2021. [0:00:15]
Hear about The Almanack of Naval Ravikant, our book of the week. [0:04:35]
Relooking at the drive towards personalized portfolios. [0:07:28]
Insights into S&P 500 stocks having a greater dividend yield than the US Treasury. [0:08:52]
How ETFs are coming to dominate Wall Street. [0:09:56]
Dying without a will; exploring the case of Zappos CEO Tony Hsieh. [0:11:05]
Introducing today’s portfolio topic — our new model portfolios, and why index funds make sense. [0:12:29]
The risks that inform how the market prices assets and your expected returns. [0:18:00]
How academics have addressed the joint hypothesis and the brilliance of the Fama-French Five-Factor Model. [0:22:18]
The predictive power of the Fama-French Five-Factor Model. [0:30:25]
Challenges to the Fama-French Model, what it accounts for, and how links to our new model portfolios. [0:31:20]
How our model weighs the value of different markets and stock sizes. [0:36:52]
Comparing the returns of a factor-loaded index with the US total market index. [0:40:44]
Answering the question — what’s special about dividend growth investing? [0:42:15]
The role of persistence in being a factor-led investor. [0:45:50]
How our model increases the reliability of your investing outcomes compared to historical data. [0:50:10]
How to apply all the information presented in this episode. [0:54:38]
Hear about the ETFs that we use for our factor exposure. [0:58:10]
Details on when you can access our upcoming paper. [01:02:25]
This week’s bad financial advice; invest in the right region to drive performance. [01:04:05]
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