Mind the Gap Between Academic Research and Practice
The returns of factor investment strategies often look more impressive in academia than in practice.
A version of this article was published in the December 2016 issue of Morningstar ETFInvestor. Download a complimentary copy of ETFInvestor here.
Often ideas don't work as well in practice as theory would suggest. In the investment world that is often due to differences between how investment ideas are formulated in theory and how they are put into practice. Many rules-based investment strategies claim heritage to independent academic research demonstrating that certain factors like value, profitability, momentum, and small size have been associated with higher expected returns. But there are critical differences between the way academic researchers have documented those factors and how investment managers design actual strategies. These adjustments are often necessary to mitigate transaction costs and increase capacity, but they can prevent a strategy from fully capturing the returns shown in the academic literature.
Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.