The Second Wave of Science

The second wave of scientific thinking: factor investment

The second wave of scientific thinking, which is still going on, focuses on the question: are there persistent phenomena in the market that can be exploited in order to do better than the market overall? Over the past 30 years or so, a number of effects that appear to be robust – appearing in various different markets and being relatively peristent through time – have been identified by academic researchers. These are known in the jargon as ‘factors’.

One example is the so-called ‘value’ factor. It turns out that the practice of buying into companies when their share prices are relatively low, compared to their earnings or assets or some other variable, has on average produced higher returns than the general market over relatively long periods of time (data in the UK and United States go back to the early 20th century). In recent decades, finance academics have identified several of these robust effects that can be exploited in an investment portfolio.

Buckingham Street Capital makes use of these effects in its scientific portfolios. Our approach is to diversify between strategies that have worked over the long run: most of the effects suffer relatively bad periods from time to time, and by diversifying between them we aim to produce a smoother return, while adding incremental value above the general market over the medium to long term. In general, these funds are managed in a way that is both simple and transparent, buying hundreds of different shares that display the required characteristics with the aid of computerised screening. It is much like using traditional funds, except that the funds we use tend to be cheap and highly systematic in their behaviour, and follow investment processes that have demonstrably worked over long periods of time.

Our scientific portfolios are likely to be suitable for clients who would like to out-perform the general market, and who are comfortable if they do not always keep up with it. This is because, to do better, one must be different; and if one is different, there will be times when the market is ahead. We cannot guarantee superior performance every year, or even every five years, because nobody can. Rather, our scientific portfolios are designed for patient investors and aim to outperform over the medium to long term.

Next: Independent Thinking