Visualizing Factors & Themes — What You See is What You Get

Categories Insight, OSAM Research, Value, Yield

“Is there a point where index funds theoretically can’t work a course?” asked Charlie Munger at this year’s Daily Journal Corporation Annual Meeting.1 “If everybody bought nothing but index funds, the whole world wouldn’t work as people expect.”

We agree.
So to help animate Munger’s premonition in real-time (see the cheery motion graphics below), our Team’s Developer / Performance Analyst)2 rolled up his coding sleeves and hacked into our “Factor Style Grid”. 

FULL DISCLOSURE: the charts below run contrary to our M.O.3 In a perfect world, there would be multi-theme hybrids on the Y-axis (e.g., “Value + Quality”) rather than just “Value” in isolation.

First, let’s put our custom-built tool to work on two strategies (both use “a hybrid of multi-factor themes”) stacked up against their corresponding bi-factor “smart beta” indexes. Here’s how to interpret the charts:

  • Each circle is sized according to the stock’s weight in the portfolio. Its weight in the portfolio is determined by how well it scores in each theme.4 These weights are calculated on a monthly basis.
  • The cheapest, highest-yielding stocks gravitate toward the bottom left of the chart:
    1. X-axis: the leftmost position is for the highest-yielding stocks5
    2. Y-axis: the bottom position is where the cheapest stocks get sorted6

EXAMPLE 1: Our Factor Alpha-driven large cap value strategy (left, blue) versus its Russell 1000® Value Index.7

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EXAMPLE 2: Not be outdone, our global large cap, yield-seeking strategy (left, blue) takes on its bogey: the MSCI All-Country World Index (green).8
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If you believe in the power of factor investing, as we do, then your investments should remain exposed to a certain factor profile. A disciplined approach continually adjusts weighting (represented by the size of the circle), increasing it with higher scores and decreasing when it scores lower:9 Here (highlighted in pink), the Factor Grid can also track individual stocks’ investment journeys within the portfolio. To avoid the distracting noise of headlines and backstories, we won’t reveal the stock’s identity.{note]Gotta know? Reach out to info@osam.com and of course we’ll be more than happy to unmask it for you.[/note] As a result, you get an unbiased view of how the strategy’s conviction corresponds to chart location.

EXAMPLE 2-a: A laggard. Never moves away from the low-yielding, expensive section of the grid.

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EXAMPLE 2-b: A laggard… fleeting visit to the bottom-left but then gets chased away.

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Much more to come on visualization techniques.
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  1. It’s well worth reading Richard Lewis’s full transcript, or listening to the recording, of the Charlie Munger Q&A in its entirety. Archived here: latticeworkinvesting.com/2017/02/17/charlie-munger-full-transcript-of-daily-journal-annual-meeting-2017/
  2. Meet Mr. Danny Nitiutomo at aboutosam.com
  3. We suggest using various hybrids of several multi-factor themes to help build conviction-weighted, high Active Share portfolios.
  4. OSAM strategies use various combinations of up to 6 different multi-factor themes to comprise each stock’s factor profile and drive returns. See our “Factor Guide” for a more granular view of the themes.
  5. Shareholder Yield represents total return of capital to shareholders and represents the two most tangible ways that management can align their interests with shareholders: dividends & net buybacks.
  6. Our Value theme is used as a building block in every one of our strategies — even growth-oriented strategies. We believe that the price you pay for an investment is one of the most predictive characteristics of future alpha and is therefore the theme we’ve researched most thoroughly.
  7. The Russell 1000® Value Index measures the performance of those Russell 1000® companies with lower price-to-book ratios and lower forecasted growth values.
  8. The MSCI ACWI is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global developed and emerging markets. The index currently includes securities from 24 countries but excludes stocks from emerging and frontier economies, making it less “worldwide” than the name suggests.
  9. In strategy guides, our “static” version of these charts uses a single oval to represent 75% of a portfolio’s holdings, and uses a strategy-specific multi-theme X/Y axis.