Morningstar Compares Research Data to Real-World Investing

There is an abundance of research data regarding how investors can maximize returns, but it doesn’t necessarily translate into real-world results, according to a recent Morningstar article.

Alex Bryan, Morningstar’s director of passive research in North America, shared his insights on some discrepancies between the two:

Fama-French Value Factor: In 1992, these economists found that stocks trading at low valuations, specifically low price-book ratios, have tended to provide higher returns than those trading at higher multiples.  However, their research targeted a particular number of stocks traded (30%) which is quite different than how most funds are constructed (by market capitalization).  This “gives you a bit of an imbalance” with respect to performance, Bryan argues.

Momentum investing: On paper, Byran says, this strategy is “the highest returning factor of all the ones that academic researchers have documented. The problem is, in practice, momentum is a very high turnover strategy than can be difficult to actually implement net of transaction costs.” Fund managers, he says, adapt the strategy to reduce turnover by applying “buffering rules” to reduce turnover or “they look at actually explicitly estimating what their costs are to trade.”

Does it make sense, then, to pay attention to factors examined by the academics? According to Bryan, “there is still a case for factor investing. What’s really nice about academic research is that it’s subject to a lot more scrutiny than industry research. So, I would give more weight to what the academic community has found than what a big fund provider might come up with.”