The Four-factor Model
The first consideration for creating multi-dimensional returns.
In the market, Mercer Advisors' Quantitative Investing strategy is grounded in the academic research of the Three-factor Model, developed by Eugene Fama and Kenneth French, and a fourth factor, Momentum Investing, pioneered by Toby Moskowitz, Mark Carhart and Cliff Asness.
The Three-factor Model established that the expected return for a portfolio is determined by three factors: sensitivity to the stock market, sensitivity to the size of the stock (small stocks outperform large stocks) and sensitivity to the value of a stock (value stocks outperform growth stocks).
These academically validated factors provided a new method for capturing incremental return – risk premium investing. A risk premium paid by an asset class can provide incremental return for the additional risk taken.
More recent research has identified a fourth factor, Momentum Investing, which Mercer Advisors added to its Asset Optimization portfolios in 2010. Momentum Investing captures returns on the natural energy of the market's strongest stocks across asset classes.
Collectively, the Four-factor Model is designed to maximize return for a given level of risk. To accomplish this, Mercer Advisors uses complex quantitative algorithms to identify the ideal asset allocation to match a client's objectives, based on the Four-factor Model. These algorithms incorporate not only academic theory and research but extensive historical data as well.
Once the allocation is determined, Mercer Advisors executes the portfolio using elite Quantitative Institutional funds — characteristically unavailable to the average investor. The funds themselves are managed using sophisticated scientific algorithms and include all of the advantages of Quantitative Institutional funds.
Source: S&P 500, Center for Research and Security Prices (CRSP), Fama-French, French Data Library
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