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Factor Investing with Don Calcagni – Part 1


In this episode of the Science of Economic Freedom, you’ll learn about the characteristics that have been identified by Nobel prize-winning economist and academics as some of the key factors that drive stocks higher.

Joining me in this discussion is Don Calcagni, Mercer Advisor’s Chief Investment Officer. Don is an expert on factor investing, and his breadth of knowledge will enlighten your understanding of the subject and its potential place in a well-rounded investment portfolio.

Plus, you’ll discover:

  • Why factor investing involves objective, quantifiable measures of a stock, bond, etc.
  • What factors Mercer Advisors look for first when evaluating a stock. Is it a value or a growth stock?
  • Why “size matters” in factor investing.
  • How the “momentum factor” operates in stocks, and how it plays a role in an investment’s performance over time.
  • The “quality factor,” and how best to measure quality in a company and a stock.
  • The “low volatility factor” and why corporate debt levels are a key component.
  • Plus, how to blend these factors in an investment portfolio based on where you are in your investing lifecycle.

Here are the “Action Step” takeaways from this episode:

1) Go to the website and get the special supplement to this episode on factor investing.

2) Look at your portfolio and determine if you currently have exposure to factor-style investing.

3) Research the various factors investing choices and look to see what your options are from your investment custodian.

4) Send me an email with your questions, show topic suggestions, or other ideas to


Doug Fabian: Are there techniques and strategies to enhance your investment returns? Yes, there are. Today we’re going to introduce you to factor investing on the podcast with Mercer Advisors’ Chief Investment Officer, Don Calcagni. He will explain how to use factor strategies in your portfolio.

Announcer: The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment perspectives carefully before making any changes to your investment portfolio.

This program is sponsored by Mercer Advisors. Mercer Global Advisors Inc is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc is the parent company of Mercer Global Advisors Inc and is not involved with investment services.



Doug: Welcome to The Science of Economic Freedom. I’m your host, Doug Fabian. This podcast is about helping you achieve your financial dreams – we call that economic freedom. This program is about your journey to achieve economic freedom for yourself and your loved ones. Today we want to help you identify your next step on that journey.

Before we get into today’s program, let me ask you a question. Are you a VIP member at VIP status gives you access to all of our special reports, tools, and resources. In addition, anytime we publish a new episode, we will notify you via email. I encourage you to sign up for VIP status at It is absolutely free.

This is episode 14 Factor Investing Explained. In today’s program, you’re going to learn about the unique traits of stocks that have consistently proven to attain above-average market returns.

These characteristics are called factors. Factor strategies screen for persistent drivers of return. They can relate to the size, price, or volatility of a group of stocks and more.

The evidence behind factor investing is scientific. It has been proven through extensive historical research that screening certain factors can generate higher returns than a typical index fund over time. These unique characteristics have been proven by Nobel prize-winning economists and academics.

Joining me today in this discussion is Don Calcagni, Mercer Advisors’ Chief Investment Officer. Don is an expert on the subject of factor investing and his discussion will enlighten you today. Don, welcome back.

Don Calcagni: It’s great to be here, thank you, Doug.


Factor Investing, our general investment strategies

Doug Fabian: Don, let’s begin by talking about the Mercer Advisors’ general investment strategies.

Don Calcagni: Mercer Advisors offers a wide variety of different investment strategies. They’re really designed to dovetail with clients’ personal financial planning.

So, we have strategies that focus on young couples that are in the wealth accumulation phase. They’re just getting started in life.  They’re looking for something very low cost, something that’s diversified, something that’s going to help them grow wealth over time.

We have clients, of course, who are retired, who need income, who are looking to sustain a certain lifestyle throughout retirement but maybe are also looking to leave behind an estate for their heirs and pass on wealth to future generations. So, we have a wide variety of strategies that really speak to the unique financial planning needs that all of our clients have.


Mercer Advisors unique approach

Doug Fabian: When it comes to our actual investment strategies, what makes our approach unique?

Don Calcagni: What makes Mercer unique is we are very scientifically oriented in how we design and execute our portfolios. So, unlike most firms or most advisory firms that are really just looking for a hot manager of the month to go out there and talk about. There’s something along those lines. They’re trying to sell a fancy product that’s maybe new.

Mercer works very closely with members of the academic community, professional researchers who really focus on the science of investing. What we do is we take that science and we find the best ways to execute that for clients in the most cost-efficient manner possible.


What is factor investing?

Doug Fabian: We’re going to talk about our factor approach. Let’s just begin with describing what factor investing is.

Don Calcagni: Factor investing is really how academics and professional scientists who sort of study the world of finance, it’s how they refer to investing.

So, what a factor really is, is it’s fundamental. It’s a certain attribute or characteristic of a company or even a bond or anything else for that matter, that is very quantifiable, something that we can look at a specific company and say based on this company’s structure, based on their earnings, based on their debt to equity values, that they possess a certain factor.

They’re either value or they’re a high momentum company or a small kept company. So, a factor is something that we can quantify and really objectively look to as a means of categorizing different types of companies.


What is the first factor you should screen?

Doug Fabian: Let’s get specific. What’s the first factor we screen for when we’re building an equity portfolio?

Don Calcagni: So, the first and probably the most popular factor that investors should look for and certainly we do is really where does the company fall on the value to growth spectrum. The most important part of any investment decision candidly is what you pay for the investment.

So, we really want to study the price of stocks, for example, and understand what we are getting in return for a certain price for a certain stock in a certain company.

We want to understand what are the earnings. What are the assets that the company owns and how does that compare to its peers, for example, in the marketplace?

That helps us determine whether or not we’re getting a good value or maybe a not so good value. We fundamentally, one of the first things we’re looking for is exposure to underpriced stocks relative to their inherent intrinsic value.


Why is this important?

Doug Fabian: Why does this work? Why does this factor? Value is going to outperform growth. Why does it do that over time?

Don Calcagni: There’s certainly a number of different investment theories that try to explain that. The way that I would explain it is value stocks generally are not your popular stocks. The financial markets, for better or for worse, have really become a popularity contest.

So, oftentimes investors are bidding up stocks to insane price levels in companies that are maybe really neat or they’re new or they’re popular among a certain age demographic. Value stocks tend to be boring. They’re not interesting. They probably pay steady dividends or they’re just not interesting. So, I think a big part of this is behavioral.

The reality is, we like to buy the things that aren’t popular because, at the end of the day, the only reason to buy stock in a company is because of the future earnings that it’s going to generate and payout in the form of a dividend. There is zero other reasons, no reason whatsoever why someone should buy stock in a company without the expectation of future earnings.


How do value stocks compare to growth stocks in different market environments?

Don Calcagni: Let’s look at today’s market. The S & P is trading around 18 times earnings. Typically when bear markets occur or market corrections occur, one of the things we see is that the higher-priced stocks on the market are the ones who bear the brunt of the correction. That makes intuitive sense, right. If it’s overpriced already going into a bear market or a correction of some sort, it logically follows investors are probably going to sell those first and hold on to their lower-priced stocks longer.

What we typically see is value stocks tend to outperform higher price growth stocks during market corrections. We most recently witnessed a very profound difference in return between value and growth stocks when the dot com bubble imploded in the early 2000s. We saw as much as a 20 to 30 percent difference in performance between value stocks and growth stocks.


What is factor size and market capitalization?

Doug Fabian: Let’s move on to the next factor. This is factor size, large-caps versus small-caps. How do we segment and take advantage of factor investing in this category?

Don Calcagni: So, when we talk about size as a factor, I think it’s important to understand how are we measuring that? Size is measured by something that we call market capitalization, big fancy word.

All it really means is the number of shares that the company has outstanding times the share price. What that does is that tells you what the company’s market cap is. It tells you how big the company is in terms of capitalization. Small-cap companies are generally defined as companies that, depending on who you talk to, have a market capitalization of less than one-billion dollars. Some firms push it as high as five-billion dollars. It’s irrelevant. It’s a spectrum.

So, small-cap companies are companies that have market capitalizations that are smaller relative to larger-cap companies in the market. Right now the largest company in the world is Apple and I forget what their market capitalization is off the top of my head. But, it is rapidly approaching a market capitalization of one trillion dollars.

So, that’s how we measure factors. The size factor makes a lot of sense because small companies have more room to grow than larger companies. They can take on more projects. They can be more innovative. Oftentimes, they’re more nimble. They can shift quickly.

For larger companies like Apple or General Motors, for example, just to highlight a manufacturing company, it’s very difficult for them to be nimble because they’re so large and they have oftentimes some pretty significant liabilities. So, it’s hard for them to be flexible in the marketplace. Next up is the momentum factor. How would you describe this?

Don Calcagni: Momentum is a phenomenon that we observe in physics which states that objects in motion tend to stay in motion for a prolonged or extended period of time. We witnessed that in security prices. We witness it in stock prices, bond prices, currencies. It’s something that is very well documented in the literature.

So, what momentum is, it’s really the price change in the price of a stock over a prior period of time. So, oftentimes we’re measuring momentum over the prior 12 months.

So, momentum, the way we measure it, we look at the price of the stock. We look at the price return on the stock over the prior 12 months and then we just rank them. Which stocks had the greatest return, just on price? We ignore dividends. Which stocks had the lowest returns based on price? Again, ignoring dividends.

What we find is very interesting, is that those stocks in the top 30 percent, let’s say, of that ranking actually tend to continue to outperform going forward over the next six to nine months, depending on who you talk to. So, we see that phenomenon. Stock prices in motion tend to stay in motion at least for a period of time.


Is there a lot of turnover with this strategy?

Doug Fabian: How do we, and with the tools that we use, regarding the momentum strategy, is there a lot of turnover in that particular strategy within the funds and investment vehicles we use?

Don Calcagni: That’s a great question. In terms of what’s a lot of turnover, I mean, that’s a relative term. A lot can be different things, different people. But, it is fair to say that momentum strategies do indeed have higher turnover relative to other types of investment strategies or factors.

For example, value typically has among the lowest turnover. Momentum does have high turnover and that is something investors should pay very close attention to. All momentum strategies are not created equal. So, it is important for investors to pay very close attention to the turnover.


How does momentum differ from a pure growth strategy?

Don Calcagni: Growth is really the opposite of value. If we think of what really is a growth stock, it is a company that has a very high price relative to its earnings or what we call book value of its assets.

Momentum, though, can vary. There are times when value stocks are in vogue and momentum is observed most forcefully in value. We witnessed this in the early 2000s after the implosion of the dot coms.

Value stocks were at the same time also very high momentum stocks, because investors were all engaged in what we call this flight to quality. Well, that flight to quality phrase is just another way of saying that that’s where the momentum is at this point in time.

So, momentum is not a function of price in the same way that value and growth is. It can swing. Value stocks can be momentumy and growth stocks can be momentumy. Next up is quality. Now, what does that mean and how do we measure it?

Don Calcagni: Quality is the newest factor and certainly there is a significant amount of academic research right now being directed towards understanding quality. There is a number of different ways to measure it.

The most popular measure and the one that I think makes the most sense is what we call return on equity. It is an accounting measure. If you’re looking at a company’s financial statements, it’s something that you can calculate. So, return on equity, we’re looking at how well the companies are doing deploying the capital that shareholders have given them to finance their company.

So, a high-quality company, for example, would be companies that have very high returns on equity, but they would also have a very high growth in their return on equity over prior periods. It tells us that the management team is doing better and better sequentially with investing investor’s capital and putting it to work in growing the company.

So, return on equity is one. Dividend yield is one of those measures. We often hear people talk about high yield dividend stocks. There is some research now that shows that companies that pay above-average dividends are also very high-quality companies in terms of how they’re run.

Quality companies also tend to be companies that have low debt to equity ratios, meaning they’re not overly leveraged. These are just well-run companies with very strong balance sheets and management teams who really know how to do a good job running their enterprises.


The challenge of quality

Doug Fabian: Now why aren’t we, because of the way you just described to the quality factor, why aren’t we investing all of our assets in quality? I mean, quality sounds great.

Don Calcagni: It sounds great and one of the challenges with quality is it tends to be a little overpriced relative to value stocks. So, you have to be a little careful. The price that investors pay for stock or for any investment for that matter, is the most important determinant of what their return is going to be in the future.

There are many phenomenal high-quality companies out there that are just extremely overpriced because every other investor in the marketplace has looked at that company and said, “Wow, this is an exceptionally well-run company. It’s high quality. I want to own it.” What happens then is we bid up the price and there could come a point where the price is just too high and it does not make sense to own.


What is the low volatility factor?

Doug Fabian: Finally, there is the low volatility factor. What is this?

Don Calcagni: So, low volatility is really referring to the fact that the company has a low sensitivity in terms of its stock price, relative to movements in the broad U.S. stock index, for example, the S & P 500 Index.

So, if the index is down ten percent, minimum volatility or low volatility stocks tend to maybe only be down five percent. So, that’s a pretty significant hedge, if you will, relative to market corrections and things like that.

Well, what are these companies and why do they not go down as much as the market? These tend to be companies that have very low levels of debt relative to the assets that they own. If you think about somebody who owns a home with a 90 percent mortgage on the home, naturally that person’s remaining ten percent equity, the value of that is going to be very volatile, depending on what’s happening with the real estate market.

Most of the home, frankly, is owned by the bank. Let’s contrast that with someone who maybe has no mortgage on their home. Well, naturally, their equity is more stable, regardless of what happens to real estate prices in their particular locality.

Companies aren’t very different. So, companies that have lower levels of debt, their stock prices tend to be less sensitive to what’s happening in the broad equity markets.


The mechanics of finding the best investment vehicles

Doug Fabian: So Don, we’ve talked about these five factors. How do we blend these together? How do we make this work for our client’s portfolios? How are we allocating to these factors and how are we finding the best investment vehicles for these factors? Kind of explain the mechanics of what you do and the leading of the investment committee.

Don Calcagni: So, one of the key drivers of how we construct portfolios at Mercer Advisors is to diversify across these risk factors, these different five factors. These five factors tend to perform differently during different times in the economic cycle. For example:

  • Value and small companies tend to do very well when we’re coming out of a recession.
  • High momentum companies tend to do very well when the economy is at a peak.
  • Minimum volatility and high-quality companies tend to do very well as we begin to slide into recession.

The challenge is knowing where the economy is at, at any given point in time. You can talk to ten economists and you’ll get 13 different opinions on what the economy is going to do next year. So, rather than try to forecast what’s going to happen with the economy over a short-term horizon, all of the evidence, all of the science tells us to diversify across all five of these factors.

Now, when we build portfolios there are certain portfolios that are geared more towards growth and don’t need, for example, low volatility stocks, because those investors are looking to maximize returns.

These could be your younger investors who are looking to build wealth. If we have an older couple who is transitioning into retirement, but they still need equities, obviously, we’re going to focus on building a portfolio that has less momentum and focuses more on owning low volatility type companies. These are more conservative type stocks.

We take these factors very seriously when we’re constructing different types of portfolios for investors at different places in their investing life cycle.


Asset allocation

Doug Fabian: Talk to us about allocation, because you have asset allocation in a 60/40 portfolio, 60 percent equities, 40 percent bonds. We can deploy the five-factor model on that 60 percent equities and also, talk about international. We haven’t talked about international yet and are we able to apply the factor model to international investing?

Don Calcagni: Those are great questions. So, yes, within an asset allocation model you can deploy our five-factor investing approach. In fact, I would argue and all of the science would suggest that that’s the optimal way to implement a diversified asset allocation.

We are doing it to the T in alignment with what the science and best practices would dictate in terms of how to diversify across asset classes using a factor model approach.

So, we do diversify across these different factors in most of our models. Certain models, we don’t even have equity exposure, so naturally, we wouldn’t have some of these. But, we are diversifying across these factors in our model portfolios.


International investing

With respect to the non-U.S. markets, these factors are oftentimes even more robust, meaning they offer better returns and more frequent outperformance in non-U.S. markets than oftentimes they do in the United States.

Non-U.S. markets are a critical element of a diversified portfolio. Non-U.S. markets are lower value. They offer better values to investors these days. So, certainly, you can definitely implement a globally diversified portfolio using all five of these factors.


What to pay attention to in factor investing

Doug Fabian: Now, the research, the evidence that these factors work overtime is a part of the reason why we’re doing this. We’ve posted at a special supplement to today’s podcast on factor investing to give investors some of this evidence.

Kind of talk about how this evidence work relative to value versus growth or small-cap versus large-cap. If you can kind of just generalize where we see the performance premium in some of these factors.

Don Calcagni: All of these factors have been shown in empirical evidence and academic research to significantly outperform, for example, a traditional index only portfolio. One of the things investors should be paying attention to when they look at their investment portfolio and they look at either the managers or the ETFs or the separate account strategies or even the advisory firms that they’re working with is understand are they taking a scientific factor-based approach to implementing the portfolio in terms of picking stocks and things along those lines.

At Mercer Advisors, we are entirely product agnostic. We use ETFs. We use mutual funds. We use individual equities and bonds to implement these factor-based investment approaches. So, the first thing I would do if I were an investor would be to understand, “Are my managers aware of factor investing? Do they know what it is? Are they investing based on these factors or are they not?”


How to start building your own factor-based portfolio

Doug Fabian: Talk to us a little bit more about how an investor would put this information to work, Don, relative to there are now factor mutual funds and there are factor exchange-traded funds.

So, you can start to build on your own a factor-based portfolio. If you had an index portfolio and you wanted to add factor investing to it, those options are out there in the marketplace today.

Don Calcagni: There are. I mean, one of the great things we’ve witnessed over the last couple of years is really a proliferation of factor-oriented ETFs and other mutual funds that are focused on taking a more scientific approach to investing.

So, one of the first things I would pay very close attention to, though, is I would look at the manager, whether it be an ETF provider or a mutual fund provider, and really do some research. Do they really have a commitment to factor investing or is it just a marketing strategy? I would understand, sort of, the intellectual lineage of the firm.

Is it something that they’re really committed to or are they sort of just the Johnny Come Lately to the factor party and they’re trying to cash in on it from a marketing perspective? I would understand, really, the bios of the firm. Who are they? Do they have academic ties? I do think that’s an important distinguishing characteristic of a good factor-based mutual fund or ETF provider.

So, understand their background. I would also take a look at the actual ETFs for example. I look at ETFs every day and there are many ETFs out there that ostensibly claim to be factor-oriented, but are really just a more expensive index fund. That’s dangerous. We don’t want to overpay just to buy the index. If we are going to invest in a factor-based strategy, let’s make sure they’re actually doing what they say they’re going to do.

I would look at the average price to earnings ratios or price to book ratio. These are different accounting measures to really understand, for example, are they targeting value or do they just say they’re targeting value. Certainly, an advisor working with you could help you distinguish who is really targeting these factors and who is just claiming that they’re targeting them.

Doug Fabian: Great. Don Calcagni, Chief Investment Officer, Mercer Advisors explaining the five-factor Mercer approach to building the equity portfolios. Don, thank you very much for your contribution to the podcast today.

Don Calcagni: Thank you, Doug. It’s been great to be here.


Action steps

Doug Fabian: Ladies and gentlemen, I always like to wrap up each podcast with some action steps. So, we’ve got three steps for you to take today.

  1. We want you to visit in the resources section of the website. This is where we post our special reports and any exhibits that tie back to the podcast. We have posted an exhibit on factor investing that gives you the historical evidence on how these different factors have performed in the past, so you can gauge for yourself the worthiness of this particular investing approach.
  2. We want you to take a look at your existing portfolio. Is there a manager that you’re using in a mutual fund or an ETF or within your 401K that has factor orientation? This could be delineated within the title, for instance, a value mutual fund or a small-cap mutual fund. That’s an indication of a factor that is being used to select the stocks in that particular category. So, look at your existing portfolio before making any changes.
  3. Then lastly, we would encourage you to research factor choices. Now, depending upon your custodian, where you have your money invested, there can be some tools, some search tools, to be able to research exchange-traded funds or mutual funds, look at your choices within your 401Ks. But, you want to look at whether or not you have any factor-oriented investment available to you. So, those are the three steps from today’s podcast.



I want to remind you, please send me an email. Give me your comments, your questions, your show ideas. My email address and thank you for joining us today.

Announcer: The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio.

This program is sponsored by Mercer Advisors. Mercer Global Advisors, Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors, Inc. is the parent company of Mercer Global Advisors, Inc., and is not involved with investment services.

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