Full Moon

Did you see the recent total lunar eclipse? This phenomenon was last observed in 1982, and won’t be seen again until 2033.

Happily, it was a clear night for stargazers to admire this ‘super blood moon’.

If you weren’t able to stay up late enough to watch it for yourself, you can see some amazing pictures on BBC News and the Guardian.

It was a rare combination of factors that caused this dramatic appearance. The moon looked bigger than usual because it was in the closest phase of its orbit around Earth. At the same time, our planet was directly between the sun and moon, which caused the moon to take on a rusty colour as it was gradually covered by the shadow of the Earth.

Successful investment also depends on a unique combination of factors. (Was that too clumsy a link? Sorry!)

According to Fama and French from the University of Chicago Booth School of Business, there are three factors that drive equity performance. There are also two factors that drive fixed interest returns. It is the blend of these factors that form the art of asset allocation.

Three factors that drive equity performance

These three factors drive more than 90% of the variation in average equity portfolios:

  1. The Equities Market – Equities provide higher returns than fixed-interest investments
  2. Company Size – Small companies offer higher returns than larger ones
  3. Company Price – Low-price ‘value’ shares give higher returns than high-price ‘growth’ shares (because they are riskier)

 

Two factors that drive fixed-interest returns

In addition to the three factors that explain equity market risk and return, Fama and French added a further two dimensions which explain fixed interest returns:

  1. The Term Factor – the difference between long-term government bonds and short-term Treasury bills (we generally avoid bonds over five years).
  2. The Default Factor – the difference between long-term corporate bonds and long-term government bonds, assuming that governments are less likely to default than corporations.

Like a super blood moon, the right factors must be combined at the right time to achieve super returns. That’s what we aim to do for our investors.

Further reading

If you are interested in reading more on Tucana’s investment philosophy, please do make contact via our ‘Contact Us’ page and we will send you a copy.

Find out more about the Fama-French three-factor model on Wikipedia

While reading, here’s a blast from the past you might enjoy:

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