The Efficiency Hack: Return Stacking (Portable Alpha)
The DNA of Alpha: Factor Investing (Smart Beta)
Stop buying the whole haystack to find the needle. How to systematically target the specific traits (Quality, Value, Momentum) that drive outperformance.
Executive Summary
- The Flaw of Indexing: The S&P 500 is “Market Cap Weighted.” It buys more of a stock just because it’s expensive. This means you are structurally overweighting Overvalued stocks and underweighting Undervalued ones.
- The “Factor” Solution: Decades of academic research prove that certain characteristics historically beat the market. We call these Factors. Instead of buying everything, you tilt your portfolio toward these winning traits.
- The Big 3 Factors:
1. Quality: Profitable companies with low debt (vs. Junk).
2. Value: Cheap stocks relative to earnings (vs. Expensive).
3. Momentum: Stocks that are already going up (vs. Falling knives).
The Cyclicality Pain
Factors work in the long run (20 years), but can fail miserably in the short run (3-5 years). For example, “Value” underperformed “Growth” for a decade (2010-2020). Factor investing requires iron discipline to stick with the strategy when it is temporarily out of favor.
Mechanic: Extracting the Premium
Quality
Profitability
Value
Low P/E
Momentum
Trend Strength
Low Vol
Safety Anomaly
Simulation: Multi-Factor vs. S&P 500 (Long Term View)
Performance Attribution
| Feature | Market Cap Weighting (SPY) | Factor Weighting (Smart Beta) |
|---|---|---|
| Buy Logic | “Buy it because it’s big” | “Buy it because it’s cheap/good” |
| Concentration | Top 10 stocks = 30% of fund | Balanced across factors |
| Fee | Ultra Low (0.03%) | Low (0.15% – 0.30%) |
“Factors are the nutrients of the market. You can eat junk food (Bubble Stocks) and feel full for a moment, or you can eat a balanced diet of Quality and Value to survive the financial winter.”
Essential Resources
INTERNAL
BMT Playbooks