I’m a huge fan of Ben Felix and his proposed factor tilts. Here we’ll look at how to construct a U.S. version of his proposed factor model portfolio and why you might want to invest in it.
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Who Is Ben Felix?
Ben Felix is a portfolio manager at PWL Capital in Canada. He is perhaps better known for his YouTube channel Common Sense Investing and his Rational Reminder podcast. Admittedly, he’s been a major influence for my content.
Felix is a proponent of objectively looking at the evidence and data to inform and optimize investing decisions. For example, he is a proponent of index investing and small cap value, just like famous investors like Larry Swedroe and Paul Merriman.
Ben Felix’s credentials include:
- Northeastern University – BSc, Mechanical Engineering
- Carleton University – MBA, Finance
- CFA Charterholder
- CFP Professional
- Chartered Investment Manager (CIM®)
What Is the Ben Felix Factor Portfolio?
Felix maintains that there is a tradeoff between simplicity and optimization in index investing, and that we can look at the robust data supporting the Fama-French 5 Factor Model to slightly boost expected returns by diversifying across not only geographies but also risk factors outside of just market beta, providing globally diversified index exposure with small tweaks to increase factor exposure.
Asset Pricing Models
The Capital Asset Pricing Model, or CAPM, revolutionary in its time in the 1960s, proposed market beta as the original risk factor to compare portfolios. Unfortunately, market beta only explains about 2/3 of the differences in returns between diversified portfolios.
Further advances led Fama and French to expand the model to 3 factors in the early 1990s, adding Size and Value. Over sufficiently long investing horizons, small stocks tend to outperform large stocks, and Value stocks tend to outperform Growth stocks. These 3 independent risk factors now had an explanatory power of 90% of the differences between portfolios.
The later additions of Profitability and Investment offered weak but reliable statistical evidence for the explanation of most of the final 10% of anomalies not explained by the 3 Factor Model. This newest model has since been called the Fama French 5 Factor Model.
Risk Factor Premia
The inherent statistical reliability of factors means they have been persistent and pervasive across markets. The factors with some of the most compelling evidence to enhance returns are still the original two additions of Size and Value. Specifically, the Size premium refers to the returns of small stocks minus the returns of large stocks, known as small minus big or SmB. Similarly, the Value factor is high book value stocks minus low book value stocks, written as high minus low or HmL.
The positive premiums delivered by these factors has been significant historically. Remember though that there have been extended rolling periods where factors delivered a negative premium from time to time. For example, the Value premium has suffered for about the last couple decades.
But there have also been periods of market underperformance where factors had a positive premium. Felix notes: “In fact, the market has historically been less reliable at delivering positive returns than small cap and value stocks.” This is illustrated above. I don’t employ or advise market timing, but AQR maintains that Value is basically the cheapest it’s ever been right now relative to history, suggesting that now may actually be the worst time to give up on the factor, and that it’s due for a comeback.
Interestingly, the Size premium does not seem to apply to small cap growth stocks. Removing them from the data set improves the historical returns of the Size premium significantly. Thus, it’s probably a good idea to only focus on small cap value.
Arguably more importantly, the other factors like Profitability and Investment exert greater premiums and have been more statistically robust within the small-cap universe. That is, all things being equal, essentially factors are more “powerful” in small cap stocks than in large cap stocks.
My own personal portfolio tilts toward both the Size and Value factor premia and closely resembles the portfolio below.
Felix notes that newer financial products with “Factor” in the name ironically tend to deliver poor factor exposure and carry higher fees.
There are low-cost ETF products that have existed for many years which are better positioned to deliver on factor premiums than most so-called factor funds. A fund that is called a factor fund seems to automatically command a higher fee despite not being positioned to deliver on factor returns.”
As such, the factor model portfolio here is conveniently constructed with popular, low-fee ETFs. At the time of writing, there exist no good products to specifically target the Profitability and Investment factors, but we do get some convenient exposure to Profitability via the U.S. small cap value ETF noted below.
The Ben Felix Factor Model Portfolio Asset Allocation
Since Ben Felix and PWL Capital are in Canada, the proposed factor model portfolio is based largely around Canadian index funds. A U.S. translation looks like this:
60% U.S. Stock Market
16% International (ex-US) Developed Markets
8% Emerging Markets
10% U.S. Small Cap Value
6% International (ex-US) Small Cap Value
Note that this is a 100/0 (100% stocks, 0% bonds) version of this portfolio. If you want some bonds, simply scale back each stocks holding appropriately. For example, an 80/20 allocation would look like this:
48% U.S. Stock Market
13% International (ex-US) Developed Markets
6% Emerging Markets
8% U.S. Small Cap Value
5% International (ex-US) Small Cap Value
Ben Felix Factor Portfolio Performance vs. the S&P 500
Here’s how this 100/0 factor-tilted portfolio compared to the S&P 500 index from 2007 through 2020:
Remember the Size and Value premia – and international stocks – suffered greatly over the backtested time period, so the results from this illustration alone don’t look too impressive.
Ben Felix Factor Model Portfolio ETF Pie for M1 Finance
M1 Finance is a great choice of broker to implement the Ben Felix Factor Model Portfolio because it makes regular rebalancing seamless and easy, has zero transaction fees, and incorporates dynamic rebalancing for new deposits. I wrote a comprehensive review of M1 Finance here.
Using mostly low-cost Vanguard funds, we can construct the Ben Felix Factor Portfolio like this:
- VTI – 60%
- VEA – 16%
- VWO – 8%
- AVUV – 10%
- AVDV – 6%
You can add this pie to your portfolio on M1 Finance by clicking this link and then clicking “Save to my account.”
Disclosure: I am long AVUV and VWO.
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.