There are many inherent risks when investing in the stock market, however, one such risk that is often ignored or misunderstood is that investors regularly need to interpret vague or ambiguous information to make an investment decision. This is all too often reflected in models and forecasts in a systematically incorrect way which causes the stock price to deviate from fundamentals.
The Human Factor (hereafter referred to as the H-Factor) is an actuarially based portfolio tool, developed by New York-based asset managers New Age Alpha, aimed at mitigating the risk of this human behaviour. The strategy comprises developing probabilities which indicate the chance of a listed company NOT being able to achieve the growth implied by its current share price.
The probability uses the only two things we know to be certain about a listed company, the current share price and the profitability of a company as reported on the published financial results. From these two data inputs, we calculate the probability of the company being able to produce the results implied in its share price. The lower the H-Factor score the higher the probability of the stock meeting its implied growth expectations.
I will not get into the nitty-gritty of how the H-Factor score is statistically calculated, however, I will give evidence showing its use within the investment management space. I will compare two H-Factor funds (one local and one offshore) and compare them with other comparable funds. Let’s begin with the local equity H-Factor fund which is made up of local stocks picked based on their H-Factor score.
The above chart plots each fund’s 10-year annualised return on the y-axis against their three-year standard deviation (risk measure) on the x-axis. Funds A through to H are other comparable SA equity funds. The chart depicts a visual representation of the relative risk-reward tradeoff for each fund. The quadrant in the Northeast is the most desirable area as it provides the highest return for the lowest risk. The SA H-Factor fund is just outside this quadrant, however, exhibits the highest 10Y annualised return and comes out middle of the pack with regards to standard deviation.
This next chart is identical to the one above except it plots comparable offshore funds (A-H) against the offshore H-Factor fund which is made up of offshore stocks picked based on their H-Factor score. As you can see, the Offshore H-Factor Fund not only has the highest 10-year annualised return but also exhibits the lowest standard deviation.
While the charts may be a simplistic comparison, they both point to how effective the Human Factor tool can be as an investment approach. Both H-Factor funds printed the highest 10-year annualised returns with the offshore fund also printing the lowest standard deviation. This shows how the H-Factor funds could be effective as stand-alone funds as well as within a fund of funds scenario. By including the H-Factor funds you could potentially reduce risk (as measured by standard deviation) whilst at the same time creating additional sources of alpha.
If you have any further questions or require more information about the H-Factor and how it is calculated, and works do not hesitate to contact Global & Local Asset Management on 011 486 2500.
Disclaimer: Past performance is not an indication of future performance. All data was gathered from Morningstar.