How to invest with style

(MoneyWatch) Diversification has been said to be the only free lunch in investing -- done properly, you can reduce risks without reducing expected returns. Since it's free, smart investors know to take advantage of that. Recent research has shown a new way you should consider diversifying your portfolio.

The traditional way investors think of diversifying is across asset classes -- domestic, international and emerging markets; small-cap and large-cap; value and growth, etc. More recently, alternative investments and strategies -- such as hedge funds and private equity -- have popped up, though the research on such strategies for individual investors is pretty clear. They simply haven't provided added value.

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Now, we're seeing research on what might be called investment styles. Academic evidence so far has shown that adding these styles to portfolios has resulted in improved risk-adjusted returns. In simple terms, there are three main investment styles to be considered:

Antti Ilmanen, Ronen Israel and Tobias J. Moskowitz of AQR Capital Management studied the period 1990-2011 and found that each of these styles produced:

The evidence makes a compelling case for investors to consider taking a broader view of diversification, expanding their traditional view of diversifying across asset classes to also diversifying across "styles," or to what could also be called other sources of returns.

Some mutual fund families -- including AQR, Dimensional Fund Advisors and Bridgeway -- have already begun including these style strategies in their offerings. (Full disclosure: My firm, Buckingham Asset Management, has Dimensional Fund Advisors, Bridgeway and AQR funds in client portfolios.)

In addition, there are also ETFs and ETNs that provide access to at least some of these strategies. Thus, these strategies, which were once limited to the world of hedge funds, are now becoming available to individual investors at reasonable costs and without any liquidity constraints.

If you have not yet done so, perhaps it's time for you to consider investing with style.

Image courtesy of Flickr user Tax Credits. 

[t0xin]

Larry,

I'm very confused!

"Momentum" sounds like technical analysis.
"Carry Trade" and "Defensive" sound like Fundamental analysis.
Both, of course, are shunned by science.

Could you please explain the differences?
Thanks!

[CFP, EA]

Larry,

Is your "Defensive" style referring to DFA's new Growth (Profitability) funds or are you referring to something else?

From my early understanding and from DFA itself, the strategy is based on purchasing stock on a "measure of profitability scaled by book value." I haven't heard any mention of also including low volatility or quality criteria.

I know that you've written about the recent research that cracked Buffet's code and, more or less, proved Bet Against Beta. Does DFA's profitability dimension related to BAB?

Maybe I need to go back and reread some of those papers.

Thanks,

CFP, EA

[gastelumo]

'there are also Div/yild companies that give you $$ return every quarter, i personally think those are my best bet as right now., Long term investment.

[ERinSTL]

I'm with ChristopherSadowski. How is "buying assets that have recently outperformed their peers and selling those that recently underperformed" different from chasing yesterday's winners or buying high and selling low?

ERinSTL

[christophersadkowski]

How does this advice square with passive investing?

Chris Sadkowski CFP

[LarryswedroeCBS]

macdaddy
Simple search on Internet would do it
Like try ETF + carry trade
or ETF + Momentum

Or you can just look at the list of ETFs that exist, sites like indexuniverse.com

Best wishes
Larry

[macdaddy333]

"there are also ETFs and ETNs that provide access to at least some of these strategies."

How would an individual go about finding the appropriate ETF's ?