Episode Transcript
[00:00:00] Speaker A: This episode of Ghost stories is brought to you by Satrix, the leading provider of index tracking solutions in South Africa and a proud partner of Ghostmail. With no minimums and easy, low cost access to local and global products via the SatrixNow online investment platform, everyone can own the market. Visit Satrix dot co dot Za for more information.
Welcome to this episode of the Ghost Stories podcast. It's another one with Satrix. It's with Niko Katsuka, this time a voice who is very familiar at this stage to ghost male listeners. He just shared some excellent personal news with me, which I won't embarrass him on. I'll let him decide whether to share it or not about an upcoming sports event that he's training hard for. So not just a man of the market. Snicker.
[00:00:42] Speaker B: Yeah, let's not divulge too much. I don't want to show my hand before we participate. Yes. Okay.
[00:00:47] Speaker A: There we go. Look, at some point when we do a podcast, in a few months time, though, we're going to need feedback. We're going to need feedback. I'm not going to let you completely get away with this, but for now, I'll let you off maybe with a.
[00:00:55] Speaker B: Broken nose and a tooth or two missing, but, yeah, let's see.
[00:00:59] Speaker A: Yeah, like that gives a clue as to what might be happening here. But we'll move on to investing, which, of course, is why you are here and why our listeners are here, much as I'm sure they're interested in your potential broken nose and missing tooth. And on this episode, we are talking about factor investing, which is a really, really, really meaty topic that I don't think is necessarily widely understood. So very keen to delve into it. And I guess, you know, let's just start right at the beginning, Nico, with, you know, what is factor investing?
[00:01:32] Speaker B: I even want to take a step back and let's first ask ourselves what type of investment vehicles investors actually have access to, you know, apart from sort of buying single stocks. But what can you actually access as a retail investor? Now, we've all heard of unit trusts and ETF's, but what do they actually really do? At its most basic level, they represent the collection of funds for stakeholders that are pulled together and then managed by investment professionals according to some set of rules or an internal strategy. That's the gist of it. Now, these strategies that the investment managers employ, these can be either transparent, for example, those tracking a simple index like the Satrix top 40 ETF, or the s and P 500, or there can be no clear rules. For example, when a fund manager applies a combination of the internal research and applies conviction, and at times some emotion as well, to determine how the fund is constructed. So, in other words, you either have rules that you live by or you have some set of internal processes, but that's a bit more vague. Now, investors may think that foreign investment strategy to be successful, actually needs to be mysterious in its design, but this is actually not true. In fact, unlike a gripping novel where you want to be left by surprised by twists and turns, the most consistent strategies, investment strategies over time have actually been those that are transparent and consistent in design and very importantly, have a low cost structure. And where unnecessary and emotional trades are limited, these actually have proven to be extremely successful. Now, rules based strategies are generally referred to as index strategies because they follow a set of index rules and they can be used as useful building blocks in constructing, you know, well diversified, transparent and low cost strategies. Now, very simply, to your question, factor investing is a form of indexation where the set of rules are, call it refined somewhat from the simple vanilla indices that we all know well, you know, the top 40 and the s and P 500, and the measure for weighting stocks for those simple indices are actually just the size of a company. Now, factory investing instead looks to refine this by considering other features of companies to use to weight that. So not just size, for example, using measures of value or balance sheet quality, or soundness of cash flow management, et cetera, and then use these company features to determine how much of each company to hold. So, if I may use an analogy, and if you'll forgive me for that factor strategies are similar to the thinking process involved in buying a house. If I come home tonight and I tell my wife excitedly, I bought a house for a million rand, and it's a bargain, hooray. I probably bet you she's going to want to know more information to be able to know, to share my excitement of whether it's a good investment or not. So she'd want to know, for example, whether I considered other features like the quality of the furnishings, how many bedrooms the house has, what area it's in, what are similar houses selling for. She doesn't just want to hear the price that I paid for it and make a conclusion on that. So only when she knows that additional information and considering all these factors together, are you then actually able to determine whether a house is a bargain or not. You know, 1 million rand, four bedroom house in Constantia, that's a bargain. You know, you can almost make that conclusion just by having that additional information. Now, we'd never only buy a house simply because it's big or because it is in a popular area. That's really not a good strategy to buy houses. Some might, but generally speaking, it's not a good idea. We'd like to refine our strategy for buying houses to get a more holistic view of the appropriate price that we're paying. Now, factors investing is actually similar to this in that we are trying to find systematic ways of determining which companies provide the best holistic value to clients, so to speak, where we consider measures of valuation, measures of management quality, cash flow, and many more. Now, it's very important to note that, that the same benefits still apply in that these factor index strategies are also low cost, also transparent, also consistent, which are the attributes that the new generations of investors favor very highly. So if you understand those passive investment vehicles that you're comfortable with and you like it from a low cost perspective, factor investing is also that, but it has the additional benefit of considering other company features as well.
[00:05:57] Speaker A: So, Nico, I think that Haas analogy is fantastic. I mean, that really does talk to just the factors that you would take into account. It really is great when it's just a simple analogy that just makes a lot of sense. And this obviously brings us back to that age old debate, which is something we've talked about before, which is active versus passive. And what are ETF's, really? And I know you've historically, and I'm sure it is still, your view, had this view that passive is a bit of a misnomer. Yes, they might be tracking something, but that's really about as passive as it gets. When I hear you talk about all these different factors that you can take into account, I mean, that is certainly starting to sound a little bit more active than passive. So what do these factor strategies mean for this relationship of active versus passive investing in ETF's?
[00:06:43] Speaker B: So that's a very important and a great question. At the surface, a factor or quantitative strategy may seem like an exotic strategy with a lot of risk involved, but actually, at its core, it is really no different from traditional passive strategies that I'm sure your listeners no doubt have heard of, such as the s and p 500 or locally the satrix top 40 funds, which are in fact themselves factor or quant strategies. So that might seem like a strange statement, but if you think of it, the top 40 index in South Africa is a factor strategy, even though it only uses one factor. That factor is size in order to weight stocks. So it's a factor strategy, but it's a very rudimentary and simple strategy at its heart. More refined factor strategy, if you like. The satrix value strategy, for example, instead uses common fundamental measures of value, like a company's price to earnings or its book value, to identify companies that are systematically undervalued. Now, the difference between the s and p 500, and for example, an s and p value strategy, would just be that the one uses size and the other uses a systematic measure of value to build the portfolio. That's really it. You know, we can dress it up as being this complicated, exotic investment style, but in truth, it is nothing. As to your question of whether it is active or passive, this really speaks to the gray area that the simple active passive dichotomy ignores. Systematic strategies that we manage are simultaneously active and passive in their design. Now, the set of rules used to construct our factor strategies are actively determined, for example, in how we determine whether a company is cheap or has strong momentum. This is a subjective measure, and we actively decide how we are going to determine whether a company is cheap. But thereafter, the implementation of our strategy that is passive or rules based, meaning we don't deviate from our objective in capturing the factor that we've identified. So if we say this is a statrix value strategy, and we use certain metrics to determine whether a company is cheap or not, well, we're not going to deviate from that. You're not going to see us tomorrow. Now change, stack, and have a different style. So it is really a blend of being both active and passive, where we actively determine the company features we're interested in, and then we systematically apply those rules without deviating from it. Now, of course, there's more to simply just identifying the company suggested by the factor. We also utilize advanced optimization techniques to further ensure that portfolio is designed in a way to achieve our objective of, for example, the value factor, capturing that, and also ensuring that we manage risk carefully. If you're not careful, you might actually end up with concentrated risks. And we can unpack this in a bit as well. But to answer your question very simply, if you are comfortable holding the top 40 or the S and P 500, you should actually also be comfortable with holding a well designed factor strategy. Because in reality, it's just diversifying the factors that you're exposed to.
[00:09:39] Speaker A: It almost takes out the human emotion piece, right? Because, you know, you can have the best fund manager in the world and they'll tell you, oh, this is the type of strategy I followed.
[00:09:47] Speaker B: I.
[00:09:47] Speaker A: But the human condition is the human condition, right? We are magpies and we like shiny things, and we see something on the market that looks juicy and maybe it's slightly outside of strategy, and then it's like, oh, you know, let me have a punt at this thing. That, I guess is what ETF's don't do. You know, they have a set of rules, and if something is in, it's in, and if it's out, it's out, and that's it. There isn't someone sitting back there saying, hang on. You know, I actually feel like including this and that, that is really the difference between a passive, if I can use that term, ETF, and then actively managed ETF's, which are a thing overseas and I think are becoming a thing here, that really is the difference. Right?
[00:10:22] Speaker B: Yeah. So I want to stress that factor strategies need not be housed in ETF's. In fact, our multi factor strategy, smartcore, is in a unit trust form. So it's not that the structure of the fund determines whether it is effective strategy or not. It is rather what is behind the strategy. In other words, what it is that we're trying to achieve that determines whether it's a factor strategy or nothing. So a lot of our factor strategies are in ETF form, our value momentum quality strategies, they are in ETF's. But in fact, our multi factor strategy is in a unit trust. But that should be neither here nor there for investors. In reality, what you can take comfort from is that all our strategies are index strategies. In other words, we follow a set of rules, and we are consistent in applying those rules. And it's that consistency, really, over time, that makes a big difference. If you think about very much like beauty, a measure like value or company quality is absolutely in the eye of the beholder.
My definition of value might differ completely from yours. We might walk by car and you might say, oh, that's a bargain. I might say, oh, that's super expensive. For this little two door car, it's all about value is very much a subject of needs. There's actually two very important determinants when it comes to how well a factor strategy performs. The same two important components to when you consider when you bake a cake. So I want to use another analogy, maybe to just get this across for how factor strategies can actually differ. So the first thing that you need to get right when you bake a cake is to consider the ingredients that you use. You know, what you put into your cake matters massively. Having fresh eggs, fresh milk, I mean that's going to be a determining factor in whether your cake is good or not. Now, similarly, you need to ensure that the measures you use, for example, to determine your value score, that these are valid for the stocks you consider and the sectors and markets that you're trading in. For example, think of price to book. This may not be relevant for tech companies, where book value is not a fair reflection of the value of the ip that they control. But even if there is agreement on the correct measures to use for, say, determining value scores, how the measure is used to put together an investment portfolio can and does differ massively. So this gets to the second important thing to consider when baking a cake. It's not just about the ingredients, it's also about the recipe, right? So having the best, freshest ingredients, but you have a crappy recipe, well, that's going to lead to a flop now. So in other words, you know, think of it similarly. If you use the same measure, two managers use the same measure for value, and the one only picks 20 stocks and then equally weights them. You know, you can easily get to a point where you have undesirable sector or stock specific concentration. In other words, you just hold 20 financial companies. And so that concentration, the risk that that has and the impact on your portfolio might actually dwarf whatever performance the factors would have had delivered had you designed a better portfolio. So for the same way, bad recipe, bad outcome. So our approach has always been to balance capturing factor signals while managing absolute risk, as well as relative risk to an appropriate benchmark. And you might ask, well, why do we care about managing relative risk? It is to ensure that our factor strategies are invasible and that they act as tilts within the markets that we serve. So in other words, if an investor wants to earn the local equity premium, but wants to do so with having a value tilt, then we offer that as a building block, you see. And so this takes a lot of the risk off the table and makes it an investible portfolio that we offer. So it means our value strategy will never hold only banking stocks or only resource stocks. But instead we focus on balancing factor capture and risk management. That's always a key outcome for us. So in summary, factor investing, really think about it. It's a piece of cake, but getting your ingredients and recipe right will determine whether it's a good cake or not.
[00:14:10] Speaker A: Yes, absolutely. I love that. It really is a great way to explain what's going on, and it shows how people can use the different ETF's and unit trust. To your point to actually get their portfolio to do what they wanted to do. You want to give it a bit of a value tilt? Well, here's a, here's a low cost way to do it where you don't have to rebalance yourself, you don't have to go and trawl through the financials of 100 companies because that's the thing. These are also massive time savers. Right. If you kind of know what you're looking for in your portfolio, then something like this, yes, you obviously need to do the research to go and have a look at what's in it and what are the factors and how do they work and all that stuff. But once you're comfortable with that, the rest is going to happen for you. These funds will be rebalanced as required, I guess like any other fund, ultimately. And away it goes.
[00:14:55] Speaker B: Yeah. And you know, the funny thing is, I've heard many skeptics saying that factor investing is a fad and it doesn't deliver value to investors, which is really an odd statement for a few reasons. One is it has a proven track record and it has shown to deliver value over time. But secondly, it's also an odd statement because the factors that we consider are measures that's also used by active managers in their own research. So, terms like price, earnings, return on equity, eV to EBITDA, these are all commonly accepted measures and can either be used as part of an investment strategy or it can be used systematically. Now, we, with the design of our factor indices, we use them systematically. And so we then effectively say to active managers that are following these well accepted measures and their research, that we can do so unemotionally and do so very consistently. And I think that is the key that we bring to the market, is just the consistency with which we harvest these factor premiums, if you like. Now, a very important thing to keep in mind when it comes to factor investing in really any fundamental measure, I want to stress this, is that it works on the whole, not necessarily on the individual. And I know this is a concept that you very well understand in your writing. I've picked this up, but very many call it inexperienced analysts often fall into this trap.
These fundamental measures of value work on the whole, but really never on the individual. In other words, what I mean by this is looking at a company and making conclusions based on accounting measures is oftentimes misleading as it ignores company level specifics that may make such measures completely irrelevant. Take, for example, a company like Microsoft. They might have a very high price to earnings ratio. And if you only look at that, you'll conclude, oh, this thing is expensive, I'm not touching it. But that's not necessarily because the market is irrationally pricing the stock. In fact, it may very simply, and in the case of Microsoft, probably be that the market is believing that future earnings will be so much higher than what current accounting measures suggest, making the current price actually very low relative to future potential. So that means when we look at these accounting measures, any measure of value, quality, etcetera, it really doesn't work on picking individual stocks. But these measures actually work remarkably well over time when we aggregate them and apply them on many companies. And this is because the company level specifics start to matter less, because you're diversifying across a range of companies now. And this is where the fact that premiums actually start to come to the fore. Now, this is similar to, again, if I can just go back to my analogy, when buying a single home as an investment.
If you wanted to know whether a four bedroom house, let's say, in a good area on the Western Cape, priced at 5 million reals, if you want to know whether that is a good purchase or not, you definitely need to know a lot more about the home's specifics, like whether the roof leaks, whether the kitchen is modern or not, etc, etcetera. Now, you'd probably be better off in that scenario, buying this 5 million rand house. You'd probably be better off just hedging your bets and holding a 5 million rand share in a fund that owns 104 bedroom houses at an average cost of 5 million rand in the same area in the Western Cape. So, in doing so, you hope to have the possible lemon house with a leaking roof offset by another house that has redone wooden floors and three fireplaces and travertine tiles. So you'd hope that your lemons are being offset by the surprises in your portfolio. And then ultimately, if you aggregate them, then those good features, the fact that it's a good price and a good area actually starts to come to the floor. Now, this principle also applies to casinos as well, because they don't want you to spin the roulette wheel just once. They actually want you to spin it a thousand times. Now, increasing the spins mean they increase their own odds of winning relative to whoever is walking through their doors. So they never want you to just spin once. Now, the same applies with factor investing. When the principles are applied to a larger universe, but more so than just a handful of stocks, that's when it really works its magic.
And also, of course, it goes without saying. Another key ingredient to ensuring factor investing works is to give it time to let the factor premiums deliver. Now, what do I mean by factor premiums?
It's been well established in the finance literature that over time, markets reward investors for taking on certain types of risk. Well known risk premium that I believe a lot of your listeners will be comfortable with is the premium that you earn for holding stocks over time. So we all know that long term you expect to earn more from holding stocks than, for example, just putting your money under the mattress or holding bonds, as you are rewarded for taking that additional risk. Now, for the same token, holding certain types of companies have actually been shown to offer similar premiums. Notably cheaper companies, for example, is a premium that's been shown to deliver over time as opposed to buying expensive companies. And I'm sure that resonates with a lot of your listeners. But this comes with a problem that some companies might actually be cheap for a reason. And so we always like to condition cheapness with other attributes, like balance sheet quality, strong price momentum, where the sentiment changes, which is a multi factor approach and one that we certainly subscribe to and definitely recommend to our clients, especially if they're new to factor investing. Consider having a multi factor strategy, which means if we supplement our measures of value with other measures of, say, management and cash flow quality, and then find the companies that have positive price sentiment momentum, improving analyst recommendations, what happens is then you are buying good companies that are cheap companies and where the markets are realizing their potential. That's a good combination. That actually gets us back closer to Benjamin Graham's simple summary of what investing is all about. Benjamin Graham said it very simply. He said, oh, investing, that's very simple. All you need to do, you just need to buy good companies at a good price. It's as simple as that. But we try to systematically identify what is good and what is cheap, and then we blend that into multi factor. And I think that for investors, should be quite an attractive investment proposition.
[00:21:03] Speaker A: Yeah, and some of these factors, if you just use one to your point, can be really, really dangerous. So trailing dividend yield, that is a good way to hurt yourself honestly, because often the dividend yield goes up because the expectation is that the dividend itself, itself is going to drop drastically going forward. There is a very big difference between a trailing and a forward dividend yield. Anyone who bought commodity stocks in the past few years has learned that the hard way. You go and look and say, oh my goodness, the stock is paying a 20% dividend. No, the stock paid a dividend, which, if you divide it by today's share price, is 20%. That is not the same thing. Next year's dividend, when it is a quarter of what it was last year, is suddenly a 5% dividend yield. And so the lessons get learned. You know, that's a tough one. And then the other one, that's really interesting. And I think it's, especially in the us market, we see this a lot, especially on some of the old school stuff, is they often have negative equity on the balance sheet because they've done so many share buybacks over the years. You know, it's just the way it's worked out in terms of their accounting. And so you get to this very weird situation. You know, if they've gone and borrowed money to do share buybacks, they've actually ramped up liabilities, brought down equity. And this thing looks insolvent using accounting rules. But then you go and look and has a gigantic market cap, because the market is not that stupid. They understand that when shares were bought back a long time ago, it's just these kinds of things. You can just really break the formulas if you're not careful. Return on equity equal, then look super weird, or it'll have a very, very low equity balance. And the return on equity is gigantic because they've done so many share buybacks over the years. So that kind of thing is obviously something to be careful of. But that's why it's important when you design these things to obviously know about these pitfalls and to be careful of them, as you've mentioned. And I guess that if you get it right, then outperformance is possible. So what does that look like? What is the outperformance track record of factory investing? It must be strong enough to justify all this effort. But what does it really look like?
[00:22:56] Speaker B: I think you're right. You mentioned that that factor investing, I mean, it's been fertile ground for research.
It's produced an absolute explosion of new factors over time. It feels like every month you'll find a new best shiny factor that promises to deliver.
In fact, some have termed it a factor zoo that's emerged, that looks to identify the next big strategy to follow to beat the market. So you can really keep yourself busy by just following the literature on latest greatest craze. But strategies that look to chase the next best factor, or even strategies that continuously try to time their factor exposures through time, have seldomly succeeded. Globally, the most consistent performing factor strategies have actually been those that stick to core principles of finding good companies that are cheap and consistently applying their methodology unemotionally through time. They've certainly been factor strategies that have done exceptionally well over time. In fact, we have in our stable, we have a multifactor strategy, global multifactor strategy, that's managed by a team in Boston, the US. They've done remarkably well over a 20 year period. They've outperformed the MSCI acqui, which very, very few active managers have been able to do. So, they have exceptional performance, and it's all based on a systematic factor strategy applied on the global scale, which is an incredibly efficient market. So the question of whether it's factor strategies can deliver even if markets become more efficient. It absolutely can. But you have to keep your words about you, and you have to try to unemotionally stick to the principles that, you know, deliver over time. And that's also, incidentally, exactly what we do with our multi factor strategy, which we call smart core. It is a systematic approach whereby we look to identify good companies that have sound balance sheet characteristics and positive pricing and sentiment momentum, but that also happens to be attractively valued. And then we apply advanced optimization algorithms, like I mentioned earlier, to arrive at an optimal blend of factor capture. And we also ensure that risk is well managed in the portfolio to create ultimately, for investors, an investable alternative to the broadly used and simple market cap weighted benchmark that most of your listeners, I'm sure, are quite comfortable with. You know, the passive alternative, if you like. Now, we then go about finding the factors that make up these definitions, like I mentioned, quality, good momentum, measures of value. And we do so by looking at our own history and local specifics. Because this fund, smart corps, is a local multi factor fund, global best practices might not apply in South Africa. So we very carefully consider our own local specifics or local idiosyncrasies when we decide which factors to use. And then the last thing I'll say on sort of how to identify it is really for us, there needs to be three things or three boxes that have to be ticked. First is, do the factors make sense? For example, price earnings. Is there a reason why the market is paying you a premium? Because take, for example, the quality factor. If you just say, oh, my investment philosophy is to buy good companies, well, that might not be a good investment. It might be that you hold good companies, yes, but is the price going to go up, or is the markets already priced? The fact that they are good? And so you have to be very careful in terms of how you define it that there must be a premium that you earn, or at least stand to earn, or at least likely will earn over time. So that's the first thing. Do the factors make sense? Will there be a premium to be paid? The second thing is, has it delivered in the past? Because it's called comfort. If we say, oh, this factor should work, but then it has never worked. And so we need to also understand the performance dynamics. And then thirdly, and like I said, these three are, you can't separate them, is, will it likely continue delivering? So it's, again, it's cold comfort if it delivered over the past 20 years, but you can actually make an argument to say, well, this factor has been arbitraged and so it won't deliver in the future. That is not an attractive factor for us because we can't retroactively give you the premium that it's paid. So what we want is factors that make sense, factors that have worked in the past, and there's a reason why it worked. And then factors that will continue delivering. And only if it ticks all these boxes will we actually consider it as part of our factor mix. And we believe in smart, we've identified those factors and we do a good job of balancing factor capture with managing risk as well.
[00:27:21] Speaker A: And in this factor zoo, I love that term as well. I would imagine some of the factors are very, very objective to calculate, or are they all like that? Or do you get some softer ones where now we're really starting to strain to, like eyeballing whether or not the ESG looks good or whatever else might be in there? It's just an example. Do you get to that point where some of these factors are starting to look very. I bet you the subjective ones, if they exist, come with a beautiful market impact. And then please pay us to use this factor because we're very clever and we've come up with something excellent.
[00:27:52] Speaker B: It's interesting, every now and then you see a factor emerge and you go, that doesn't make sense. I recall in 2014, pharma and French, I mean, sort of big names in the factor space, sort of canonical papers that came out of their pens, and they introduced a new factor called the investment factor. Basically made the case for companies with high capital expenditure tend to be companies that underperform their market peers. So in other words, all things equal, if companies spend more on capex, they will likely underperform. And so when you read that initially, you go, but doesn't really make sense because it's a good. Surely it's a good thing when companies spend right and improve their activities, or at least potential to expand. Once you read that a bit more carefully and you see the reasoning behind it, comes an interesting factor because, well, and you and I have actually mentioned this in past conversations, is when you see management just build a big castle just to own it and manage it and run it, that's generally not a good thing. So unbridled capital expenditure, or at least unproductive capital expenditures, never a good thing. You're probably better off waiting for good opportunities as opposed to just caving into spending. And so that, for example, is an interesting factor. There's other factors that, again, to your point, absolutely reside in the eye of the beholder, but they are also, this is very subjective. Again, stuff like value. I mean, value for one is not value for the other. But there are some industry accepted definitions that can be used to classify stocks broadly and that the market accepts as relevant. But when it comes to measuring, for example, quality, that's a very interesting one. It can be quite difficult to actually get it right. And I've seen different definitions get it completely wrong, especially for local companies. Now, for us, quality, a company's quality has two legs that we try to balance. Now, the first is how profitable a company is, and the second is the quality of a company's balance sheet of, and effectively its ability to turn activities into cash flow.
It might sound like the same thing, but it really is not. Companies can actually be quite profitable, but very easily run into cash flow problems. Similarly, very well managed companies can become unproductive for a variety of reasons and oftentimes unrelated to management's own efforts. You know, think of it. If industry dynamics change or competition materially increases, it might make very good companies less profitable. It's as simple as that. And you can think, I'm pretty sure, and I've seen you cover many company examples like that. You can bore us with a ton of detail on where it happens at great companies just for bad luck or for whatever just happen to be in a cycle where they become unproductive. So for us, good quality company is one that's both profitable, but also that is able to turn their potential into cash flow.
So the take home really for me is we can hop on, take every factor, and sort of unpack it. But really, the take home for me is that factory investing is as much an art as it is a science. And to my earlier point, of the ingredients and the recipe mattering, and you can't split the two. One cannot simply apply a cookie cutter approach when it comes to factor investing. And you've seen global asset managers that bring to our market just globally applied factor strategies, and oftentimes these are the ones that end up not working well, because there's no such thing as a cookie cutter approach. You actually have to tailor your factor strategy to the local market specifics that we experience. So our experience in managing local factor strategies date back almost 15 years. And so we've certainly cut our teeth in this space. And we believe we now currently have a suite of interesting factor building blocks for our investors to consider.
[00:31:31] Speaker A: I enjoy the reference to the capex because what that would imply, of course, is filling a portfolio with tech companies. But then what it misses is that the tech companies capex is sitting on the income statement, whereas for old school businesses, it's sitting on their balance sheet, because the tech companies can't go and properly capitalize the fortune they spend on R and D. So I've read some interesting research on that topic as well. You know, people are quick to talk to, oh, look at the crazy R and D in tech companies, but then they're completely fine that this big old lumbering thing that has factories has spent a fortune on Capex.
It's about understanding, and it's something you said earlier in the show, how the specifics work for that business. You know, that is the thing. I have no problem with low capex in very inverted commas in a great tech company and then a high R and D ball, because that's their business. Their business is not to sell you factory type stuff. Their business is to sell you a tech platform. So yeah, it's pretty interesting stuff. And obviously these are all of the challenges that you face in managing these portfolios, choosing the factors, I mean, you've touched on quite a few of the challenges already, I think. But are there any others that come to mind that you think are worth highlighting?
[00:32:36] Speaker B: So, different factor strategies often face different challenges. So take, for example, momentum. Now, what you're trying to do is when you have a momentum style, you're trying to look for companies that have experienced recent tailwinds and where market sentiment is improving, and you hope and you expect that that sentiment will continue in the future. But think of it this way. Momentum is a signal that changes very quickly as the whim of the market changes. So, in essence, for a momentum strategy to be successful, you need to rebalance your portfolio far more often in order to refresh the information in order to keep it relevant. Because momentum measures of six months ago today is almost completely stale. And so you need to trade far more often if you have a momentum strategy. Now, if you're not careful, this can actually lead to very high and costly turnover. And certainly there's been strategies in our local industry that have experienced this in the past where it's a momentum strategy that has very, very high turnover costs. And so you might end up chasing your tail. I'd say the main challenge in factor investing is actually in addition to identifying good ingredients and having a good recipe, it's also balancing how often you trade to refresh information versus allowing time to pass for factors to deliver. And so certain factors like value, I mean, or let's say quality. A good quality company today is likely going to be a good quality company in six months time. So you don't need to refresh that information as often. And it's understanding these dynamics and heuristics for different factors and understanding how to blend them in a portfolio optimally really makes the differentiating factor. I've seen some skeptics point out that point to certain type of factor strategies and say, look, factor strategies haven't delivered because x, y and z has underperformed. But then you go and look how x, y and z is constructed, and you see they fell into the obvious traps. It's a value strategy that holds 20 stocks.
I mean, what do you expect, right? You've decimated your breadth. You only hold 20 stocks, and of those 20, there's a significant proportion that are cheap for a reason. And so you've not diversified, you've only picked cheap stocks. The same with the dividend yield strategy that you mentioned. You might end up if it simply picks the 20 most attractive. From a dividend yield perspective, you might end up with extreme risk concentration. In other words, you just obey the whim of the market in buying the companies that have been sold off because the price has gone down, the dividend yield has gone up. You have to be careful and really understand those dynamics. And each factor actually has its own challenges. And just having experience in this field and building the portfolios to capture the premiums, but also be safe and investable, that's the trick.
[00:35:26] Speaker A: Yeah, absolutely. So I think let's bring it home with what investors can get from Satrix in this space. I mean, you've mentioned a little bit of that as well, but I think let's do a nice wrap up of the Satrix product suite in the factory investing space.
[00:35:40] Speaker B: Sure. So we've used the recent acquisition of ApSA investment management to really as an opportunity to consolidate our factor offering, which means we now actually have a consistent and a very coherent set of style building blocks that investors can use to reflect their style views. Or oftentimes, a lot of our clients add these building blocks or single factor building blocks as a means to diversify their style exposures, where they might, for example, feel lighter. So they might look at their holdings and say, we're a bit light on momentum. As an example, they can then use our momentum strategy to supplement it. Now, I've mentioned smart core. So smart core is our multi factor strategy, and since inception it has delivered one and a half percent outperformance compared to the capswix since inception five years ago. This is nothing to scoff at. The capswix has been over time. The local benchmarks have actually done very well relative to active managers, so it's pleasing to see that a well designed systematic strategy can actually add value above and beyond quite an efficient benchmark as well. For smart core, we blend company quality, price and sentiment momentum as well as value in order to arrive at a multi factor score. And then we use that multi factor score to construct the portfolio using optimization considerations as well. In addition to smart core, we also offer single factor strategies. Now these include Cetrix momentum, which is in both a unit trust and an ETF form. We also have Citrix quality that looks to identify good quality companies, also in ETF and unitrust form. Then we have value single strategy, where we listed in March our Satrix value ETF. We've been managing it internally, but we've actually brought it to market as a single style factor now as well. So that's an ETF form, citrix value.
Then we have other, call it more traditional factor strategies that we've been running for a long time, the Satrix divi divi plus that a lot of your listeners might know, as well as a raffi fundamental value index. But those two are not indices that we design, so they're not bespoke to us. They are kind of off the shelf indices that we've historically offered investors. But I think those are the three key pillars from a single style perspective, the momentum, the value, and the quality indices, and then the multi factor strategy as well. And then we also have a low volume strategy, which we developed and launched as well in March. So these are that kind of offers you a range of styles that you can capture. But look, I think I'll be remiss, and if I don't mention it, then I'm at pains to stress that we full well know that these factor strategies will never replace active managers in the same way that, for example, a computer algorithm effectively have cornered the chase world. So I just want to make that clear because I'm always scared that a casual listener or even an industry professional might listen to this podcast and go he's hopping on about factor investing. And people might think that this replaces active management. It can't ever do that. Instead, and think about interesting the emergence of systematic investment strategies are it instead offers active managers the opportunity to be truly active in finding unique opportunities that may not be obvious using well known accounting measures. So active strategies that simply use well established tourism as the investment strategies that think value, think quality, they should perhaps fear being replaced one day because it leaves managers that are able to find the opportunities that are not obvious in the data and that we cannot systematically identify. But where they let's say the manager has an inkling and a feeling that it might deliver, or based on experience, say, you know what, this company, I know all the metrics suggest we shouldn't buy it, but I like this company.
And so it offers those managers that have the ability to differentiate themselves the opportunity to come to the fore.
But one thing is certainly it does raise the bar for active managers if they are being compared to a benchmark that's not only determined by the size factor like the capswix or the S and P 500, but instead also compared to an index that considers other company features that are systematically harvested. Ultimately, look, I believe ultimately, as the industry becomes more systematic, as it is happening in the US, incidentally, where currently more than half of the assets in their market is being managed either according to a vanilla index strategy like the S and P 500, or a non vanilla like the factor strategies we discussed today, more than half of their assets are invested using some form of rules. And so if our market is heading that way, I honestly believe that this will put investors, or be to the benefit of investors, because you can harvest the premiums on offer, but you also then have the good managers that remain that can offer something else that's not easily identified. And so a combination of consistent, low cost, transparent strategies and good active managers that can offer you something different. I think the combination of that is, that's absolutely the future of investing.
[00:40:49] Speaker A: Nico, that's been fantastic. Thank you so much for sharing not just the excitement of this factor cake, but all the stuff that goes into it, all the recipes, some great analogies in there, just some really sensible stuff. It almost feels like marrying the sort of active and passive side of ETF's and unit trusts really, really well. It's a lot to take in, but I think for our listeners, I've no doubt they've enjoyed this. Maybe go and listen to it again, or go and read the transcript and just make sure you've absorbed everything that was available to you in the show. It really is a wonderful opportunity to have someone like Nico sharing his insights with us. So Nico, thank you so very much. I look forward to doing another one with you. As always, I feel like we're going to have to do another show on factory investing. I think you were only just warming up for the past 40 minutes, and I think we can really dive into trends, in fact, investing maybe more on the ones that work and the ones that don't. And so some of the research in this space, I think for people who have more of an interest in this stuff. Thank you very, very much Nika, and to our listeners, thank you as well for your time on this podcast. And I look forward to welcoming you back to another ghost stories with the Satrix team in the next month or so.
[00:41:52] Speaker B: Thank you ghost. And it's always, the pleasure is mine.
[00:41:55] Speaker A: Satrix Investments Pty Limited and Satrix managers RF Pty Limited are authorized financial services providers. Nothing you have heard in this podcast should be construed as advice. Please do your own research and visit the Satrix website for more information on all their ETF products.
