Learning FactorE Features

The Factor Radar [video & article]

By October 13, 2020October 16th, 2020No Comments
Factor fingerprint, spiderweb chart, beta fingerprint, that thing…

A Picture is worth 1,000 words
The factor radar has a lot of information in it, and for those who learn how to use it and apply it, it can be an incredibly powerful, time-saving tool.

Skip right to the 8th inning in your quantitative analysis

To get you started, there are a few things you should know:

  1. The numbers represent betas to the various factors.
    (Investopedia has some good information on beta here)
  2. The black dotted line is the _zero_ line. Anything inside of it is a negative beta. Everything outside of it is positive.
  3. The factors are separated into three sections:
    Alternative: 12 o’clock to 4 o’clock
    Equity: 5 o’clock to 9 o’clock
    Fixed Income: 9:30 to midnight (or noon)
  4. We calculate the betas to these various factors using returns-based analysis. If you want to learn more about the creation of the factors, you can click here.
  5. The factorE risk decomposition algorithm does not have an opinion.

Why use the factor radar?

Although “past performance is not indicative of future results,” past factor exposure is actually quite representative of future factor exposure. While that isn’t always the case–there are always unforeseen events and no tool is magic–it can help a user to understand what he/she can expect from an asset or portfolio given certain market conditions.

Comparing the factor radars of two assets can help to immediately highlight the differences between them. Let’s take a simple example of a hedged European equity ETF and an unhedged European equity ETF:

(The below example is illustrative and does not represent any sort of endorsement or disapproval of an asset)

The green line is the “hedged to USD” ETF, while the blue line is the “unhedged to USD” ETF.
It becomes quite clear that although the two ETFs are quite similar in their radars, their major difference is in the currency exposure (the “Alt – Dollar” factor).

Now, let’s take an example that is a little more involved:

The ETF above is a “passive” market-cap weighted ex-US ETF. But, the radar shows positive exposure not just to equity, but also to emerging markets, small cap, and value. It is worth repeating: The tool does not have an opinion, but it can help to shed light on risks.

Also, notice the negative US dollar exposure (i.e. if the US dollar goes up then this ETF will probably not do as well, all else being equal)

Exercising Your Factor Radar Muscles

Okay, getting back to the first factor radar, what are we looking at?

What is this fund?

In fact, we are looking at:

  • A hedged-equity fund
    (~0.5 beta to equities)
  • Trafficking in developed markets
    (Negative beta to FI/Eq – Emerging Markets)
  • That tends to own large-cap stocks
    (Negative beta to Eq – Small Cap)
  • And provides persistent exposure to stocks with value, momentum, and defensive characteristics

Whew! All with a single image! Pretty powerful stuff.

We encourage you to try this yourself. It will not be long before you can quickly understand the risk characteristics of a new asset or of a portfolio!

Learn More:

Article: Understanding the Factors: Factor descriptions, constructing the factors, understanding risk models.

Article: The Factor Analysis Dashboard: Adjusting settings, using time window analysis, and other various easter eggs.

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