Building on the future of enhanced asset class investing

19 Mar 2015

By Shadforth Financial Group

In the September 2014 edition of The Edge we looked at the financial benefits that can be achieved from what is known as enhanced asset class investing.

This approach currently entails three key factors, or dimensions, which have been proven to add value for investors over time. In summary these factors are:

  • The need for investors to have exposure to equities (shares)
  • Consideration of the value premium which looks at whether stocks have a low market price relative to the underlying value of the firm's assets
  • Size premium which takes into account that small companies can grow faster and deliver much higher rates of returns to shareholders than their larger counterparts

Ongoing research into the field of capital markets by fund manager, DFA, has seen the identification of a fourth dimension - profitability. This fourth dimension can now be incorporated into the traditional areas of value and size premiums to further improve the outcomes from enhanced asset class investing. Overall this new modelling approach is set to provide greater diversification, reliability and efficiency for investors whilst reducing some of the risk inherent in investment decisions when it comes to assessing future profitability or rates of return.

Building on the basics

For many years investors have known that if two companies are trading at the same relative price, the firm with the higher expected profitability will have higher expected returns. This is intuitive. However the research breakthrough has led to the development of a new systematic model which enables a clearer and more reliable approach to tilting to profitable companies.

A good analogy is to think about the new modelling in terms of development in camera technology in recent years – more pixels allows us to capture images with much greater precision and clarity.

Whilst research and fine tuning of enhanced asset class investing is ongoing, the overall aim remains the same - the delivery of better outcomes for investors through robust portfolios that deliver reliable results under a wide variety of market conditions. The introduction of the new fourth dimension can generate better than expected returns with lower volatility by more precisely targeting the sources of higher expected returns while remaining very diversified and, importantly, keeping costs low.

Putting the research into practice

So how will this research assist you? As we strive to deliver stronger investment solutions for you using robust and proven research, we have incorporated the new modelling approach into the Strategic International Equity Fund and the Strategic Australian Equity Fund. The expected benefit from this approach is to maximise opportunities of capturing higher than expected returns for you.

Again, research into the field of enhanced asset class investing is ongoing. The academic world is always asking questions and trying to improve our understanding of markets. The fourth dimension of profitability is just the latest in a line of improvements, all aimed at achieving better and more reliable outcomes in the investment journey.

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