Factor Foundations for Digital Assets
Aug 24, 2023
What is factor investing?
A “factor” (sometimes called a "signal" or more intuitively an “investment theme”) is a type of distinct investment exposure that exists beyond overall market exposure. Think of factors as predictive indicators rooted in investing fundamentals that can help inform the drivers of expected asset performance, and thus how investors should allocate to those assets.
Put differently, instead of holding a portfolio of assets proportional to their market capitalization like passive investment products commonly do, a portfolio’s asset weighting scheme can be partially or entirely determined by one or multiple factors.
The efficacy of factor-based portfolio construction has driven its broad-based adoption among institutional investors in traditional markets. Given the uniquely data-rich nature of blockchain-enabled digital assets, we think crypto markets may stand to benefit from similar methods.
Why choose factor investing?
A factor-driven investment approach can have attractive properties, such as the potential to outperform purely passive portfolios, the ability to diversify a portfolio’s risks, and the potential to harvest returns more efficiently.
Factor-based investing is also systematic in nature, meaning it follows a rules-based, computational process. Rather than a portfolio manager making discretionary investment decisions and manually executing on those ideas, a quantitative investment manager employs a systematic investment process that harnesses automation to codify intuitive investment rules (factors) and automatically invests and trades according to those rules. A major advantage of such a process is that systematic factor portfolios are by design highly transparent and well-explained in terms of portfolio positioning, making it easier to understand why a portfolio is behaving the way it is at any given time. Another is that computerized rules-based processes may exhibit greater discipline, freer from the potential psychological or behavioral biases and misjudgments that can accompany a non-systematic process.
Example: Price Momentum
Let’s examine a hypothetical application of the popular price momentum factor:
The price momentum factor identifies price trends in the market and attempts to take advantage of them by buying (or giving more weight to) what’s rising and selling (or giving less weight to) what’s falling. The thinking goes: outperforming assets will continue to outperform for a period of time and underperforming assets will continue to underperform for a period of time. These trends may revert, but the momentum factor seeks to exploit that particular period during which the trend is continuing (hence why it is also sometimes referred to as a trend-following strategy):
Factors can be categorized, constructed, combined, and used in many different ways. Digital assets in particular present a new and exciting area of factor research given systematic investors can look to both off-chain markets and blockchain data to attempt to explain the drivers of asset returns.
Factor Investing with Truvius
We believe systematic factor-based investment strategies inherently fit into the digital asset landscape, and that these strategies should be compliant and scalable to institutional allocations.
At Truvius, we take the systematic approach to portfolio management and have a simple mission: build diversified portfolios of digital assets that target exposures to various investment themes. By harnessing the power of a systematic theme-driven process, investors can unlock a durable long-term process for harvesting returns from the crypto asset class.
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