John Davi – Astoria Portfolio Advisors
Diversified Approach to Factor Investing
John Davi is the Founder & CIO at Astoria Portfolio Advisors. The firm specializes in construction, management and subadvising of ETF model portfolios. We recently spoke with John, who will be speaking at our ETF Strategy Summit (Oct. 15 – 16 – Dallas), as he provided his thoughts on having a diversified approach to factor investing.
ETF Strategy Summit: What are the advantages to using a multi factor or factor-cycling product versus implementing single-factor ETFs in portfolios?
John Davi: The evidence suggests that higher risk adjusted returns are available if one were to invest in a set of factors that are robust, persistent, pervasive, intuitive, implementable, etc. compared to a single factor strategy. This is a large reason why Astoria invests in a diversified portfolio of factors not only across equities but across asset classes. I don’t know (and I doubt many others would know) when a particular factor will go in or out of style. The data suggests that some factors can be in and out of favor for decades. Astoria prefers a diversified approach to factor investing.
ETF Strategy Summit: Factor investing mavens often warn that it’s impossible or incredibly difficult to time factors – are they right?
John Davi: There is no evidence to suggest that you can time factors in such a way that is systematic, repeatable, and profitable across varying time periods. Do people try anyways? Of course, people are human and will try anything even if the odds are stacked against them. Do some people profit from factor timing? Anything is possible. But the key is can you do it systematically, repeatably, and in a scaled fashion? Astoria believes (which aligns with the actual evidence) that it’s significantly more important to pick a set of factors which are robust, pervasive, repeatable, explainable, implementable AND to invest in them for the long run. The bottom line is that investors should pick factors that have strong evidence, harvest them in a cost-effective manor, and stick with them for the long run – this gives you a higher probability to achieve attractive risk adjusted returns rather than trying to time factors. Moreover, I need to make an important point. Unfortunately, the investment management industry has become enamored with short duration capital. I don’t know too many strategies (if there are any at all) that have a high probability of making money in a systematic, repeatable, and scalable format with short duration capital.
ETF Strategy Summit: What are the advantages to actively managing factor exposures?
John Davi: People will always justify some rationale for doing what they do. How many people do you know that can time the market in a repeatable, systematic, and scalable format? Not many. If market timing is difficult, why on earth would you think you can time factors?
ETF Strategy Summit: What are the implications for interest rate increases and monetary tightening for factors widely available in ETFs?
John Davi: The repercussions of monetary tightening are quite significant, especially on the margin, and has enormous portfolio implications. Nobody is prepared for an aggressive fed rate cycle or a cycle with liquidity declining on the margin. People have plowed $2.5 trillion into bond funds since 2009 and I have yet to see any meaningful outflows. Keep in mind that aside from the Fed implementing QT and hiking rates, liquidity will further decline due to the ECB curtailing their QE program and eventually the BOJ will follow suit. My point is that we are entering a new cycle of less liquidity and liquidity is what ultimately drives markets. This year financial conditions have tightened significantly, and we believe this is a primary reason why the S&P 500 couldn’t sustain a more meaningful rally despite the blow off the top earnings in Q1. Stocks and bonds are positively correlated, people are underweight alternatives, and cash is an asset class that nobody wanted to own during the past decade. The bottom line in our view is that portfolios are not prepared for this transition period. A meaningful change in the liquidity cycle will likely revert in meaningful price action across factors. Astoria believes that the overarching theme in one’s portfolio should be value, quality, and mixing in other factors (Astoria likes momentum, carry, trend) to further enhance your portfolio risk characteristics.
ETF Strategy Summit: Where has the “value” factor gone – are there ETFs still delivering strong returns using value?
John Davi: The value factor has been out of favor – just like it has many times throughout history – as investors have been enamored with growth and momentum stocks. Astoria believes that investors should allocate now towards value & quality (along with the various other risk premiums we are harvesting) and avoid growth as the market transitions to this new liquidity cycle. We simply think there is a greater margin of safety in value stocks while growth is crowded with a high degree of vulnerability as this liquidity transition period picks up pace.
Be careful with how you pick your factor ETFs. Investors need to run bottom up screens to ensure they are getting the desired exposure they want. Most value ETFs have extremely low active share. In a previous life, we would work with institutional investors to construct optimized long/short baskets to purely isolate a factor exposure. There is a long/short Value ETF (CHEP) but it never got any significant traction. QVAL and IVAL are 2 long only value ETFs that provide meaningful active share. We use the latter for our international value exposure.
ETF Strategy Summit: Thanks John. We look forward to hearing more of your thoughts at the ETF Strategy Summit October 15 – 16 in Dallas.