- Title: A WEALTH MANAGEMENT PERSPECTIVE ON FACTOR PREMIA AND THE VALUE OF DOWNSIDE PROTECTION
- Authors: LOUIS SCOTT AND STEFANO CAVAGLIA
- Publication: THE JOURNAL OF PORTFOLIO MANAGEMENT, SPRING 2017 (version here)
What are the research questions?
The article links two current hot topics: goal based investing and factor premia by studying the following:
- Can factor premia (value, size, momentum and quality) help the aspiring retiree achieve the goal of accumulating enough to meet his retirement spending needs? In other words, can factor premia help mitigate drawdowns of the core portfolio ( a fully invested exposure to global equities over a 20-year horizon)?
What are the Academic Insights?
By using the circular block bootstrap ( Politis and Romano (1992), they study the impact of six different strategies to the terminal wealth of the retiree: the core portfolio, the core portfolio plus an overlay in one risk premium at a time and the core portfolio with an overlay of an equally weighted allocation to each factor premia. They find that: YES- positive sentiment (defined as the BULLISH percentage) on stocks is associated with positive returns
- YES- Factor premia took both individually (except for size) and in combination enhance the distribution of terminal wealth compared to the core portfolio of global equities. The authors simulate two robustness checks where they hypothesize lower future mean returns of factor premia and skill based market timing of the global equity manager. Results of the factor premia enhancement properties seem to hold up.
The authors simulate two robustness checks where they hypothesize lower future mean returns of factor premia and skill based market timing of the global equity manager. Results of the factor premia enhancement properties seem to hold up.
Finally, the authors analyze the drawdown properties of the stand-alone core portfolio and those of the overlays. They find that a strategy which overlays an equal weighted portfolio of factor premia on top of the global equity portfolio is superior in terms of drawdown protection.
Why does it matter?
This paper confirms the importance for investors to be exposed to certain factor premia (value, size, momentum, quality). In fact, it shows that an equal allocation to these four premia on top of a global equity portfolio: 1) enhances the probability to reach retirement goals, 2) mitigates drawdowns in the journey to retirement.
The Most Important Chart from the Paper: