Factor/Style Investing

Building a Better Core Equity Portfolio

Topics - Factor/Style Investing Value Momentum Portfolio Construction

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Building a Better Core Equity Portfolio

Traditional active portfolio management relies on an investor’s ability to identify individual stocks that will outperform the market, or on finding a manager to identify those stocks. However, investor experience and economic theory have not been encouraging. A new approach, style investing, offers what we believe to be a better alternative to active management.

Style investing seeks to capture sources of returns that are supported by economic theory and by decades of evidence across stocks, sectors and geographies. Unlike the traditional approach to active management, which relies on unique investment theses for each stock, styles focus on more pervasive, persistent, and deeper sources of excess returns. These include value, momentum and profitability.

In this paper, we provide background and economic intuition behind value-, momentum- and profitability-based investing, and we examine their performance. We find that while hypothetical portfolios of each strategy has outperformed a core benchmark over the long term, each has also suffered multiyear periods of underperformance — though, interestingly, they have not underperformed at the same time. This suggests that a portfolio of complementary styles may be able to provide more-consistent outperformance. We believe it should more reliably beat core benchmarks.

Combined with our focus on such passive-investing elements as portfolio construction and diversification, we believe that style-based investing represents a better approach to active management. AQR’s approach to core equity investing seeks to provide three additional sources of returns, each of which has been shown to provide better risk/reward tradeoffs than both the broad market and traditional core strategies.

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.

 

Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. Hypothetical performance results are presented for illustrative purposes only.

 

Diversification does not eliminate the risk of experiencing investment loss.

 

Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.