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Setting Sail With Effective Use Of Factors

Apr. 03, 2018 4:12 AM ET
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Patrick Nolan talks about how to build a portfolio of factors - and why.

The America's Cup has been the international yacht racing community's battle for supremacy of the sea for over a century. From the early schooners to the catamarans of today, each advancement in boat engineering gave racing teams a leg up. In 1987, the U.S. Stars and Stripes set sail with foils protruding from the bottom of the boat, which enabled most of the vessel to float above the water. With less surface contact comes less drag and higher speeds - a game changer for today's modern racing yachts.

Friction can also hamper the performance of an investment portfolio. The impact of these inefficiencies can become more pronounced over time, and especially when conditions get bumpy. But there are ways to reduce drag that may help you reach your financial goals.

Cost is an obvious one. The impact of paying needlessly high fees year after year will make a marked difference in how much you end up with.

Another inefficiency that may be slowing down performance is market exposure - how "purely" your investments capture the outcomes you're seeking. That's where factor investing can help. Factor-based strategies use scientific, rules-based technology to focus on specific drivers of return, such as momentum, value, quality, size and lower volatility.

In our work, we see financial advisors increasingly using factors in the portfolios they build for clients. In the 7,591 advisor portfolios we've studied over the past 12 months, 4,354 (57%) have some factor product exposure.

As shown in the chart below, the most popular categories are minimum volatility and dividend-paying stocks, but many are bundling multiple factors to help clients achieve goals.

What's a factor?

Every individual security has a set of characteristics, or factors, that explain its return. A company's sector

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