2017 Performance of Premiums
By now, you’ve probably seen our presentations about “factor premiums,” or “factors.” These factors are a key concept in understanding our investment philosophy. They are variables that explain differences in returns of certain groups of securities — specifically market (stocks vs. bonds), company size (small companies vs. large companies), relative price (value vs. growth companies) and profitability (high vs. low profitability companies). We increase the portfolio’s exposure to factors by using institutional mutual funds that contain more of these certain groups of securities. In this presentation, we look at these factor premiums over time.
In last year's discussion of factor premiums, we noted that they vary significantly over time. Although they are strongly positive over very long time periods, they can be negative for periods that are long enough to test investors' patience (which, incidentally, is why they continue to work). The value factor is a perfect recent example.
We also noted that factors can reverse sharply and significantly. How do these factors play into your portfolio? The portfolio that makes the most sense for you depends on your individual goals, comfort level with risk, and preferences. Robert Merton says it best in his quote: "Everything in life, individually or socially, is a tradeoff. We determine the risk levels we're willing to tolerate within the context of our goals and objectives."