Overview & Factor Methodology


Our Adaptive Wealth Strategy US Factor Index employs a reversion to the mean process to dictate which investment theme we own at any given time. The underlying themes utilized have academically sound investment philosophies and significant historical advantages compared to traditional indexing.  Over time, our concept uses minimum volatility, value, and momentum.  The end goals are low tracking-error, minimal internal expenses, downside protection, and alpha generation. 

Academic History of the Factors

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The first factor, minimum volatility, was one of the earliest innovations in the investment profession. The starting framework, “Modern Portfolio Theory,” was developed by Harry Markowitz in 1952. While 1952 is far from modern, the idea that risk and return are inherently linked as applicable today as it was over 60 years ago.  The minimum volatility theme essentially recreates the Modern Portfolio Theory by maximizing the return for a similar amount of risk, and better downside protection than the overall market.  We believe this factor helps to provide both stability and diversification inside our factor adaptation model. 

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The second factor, value, derives significance from the research of Eugene Fama and Kenneth French in their “Three Factor Model.”  This model suggested that value stocks tend to outperform growth stocks over time.  While there are multiple ways of defining the value factor, we feel a balanced approach of earnings, book value, and dividends provides an intuitive and common sense way of screening for value.  This factor also has a tendency to revert to the mean, which means there are times when value will both underperform and outperform.  We believe that over time, just as the Fama and French model concludes, investors are rewarded for buying equities at discount prices. The implementation of this concept by Warren Buffet and Benjamin Graham since the mid-twentieth century also adds credibility to this theory.

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The third factor in our strategy, momentum, has its roots in the behavioral side of investing.  In 1997, Mark Carhart expanded on the research done by Fama and French, and added a fourth factor to complement their research: momentum.  The easiest explanation is to say that stocks that have outperformed recently will tend to outperform in the future.  We think of this as the herd mentality.  Investor behavior tends to lead to buying the prior winners and avoiding the prior losers.  This factor, much like value, tends to mean-revert and will both outperform and underperform during different cycles.