A recent Advisor Perspectives article by BAM Alliance director of research Larry Swedroe discusses the degree to which implementation costs may affect factor premiums.

Swedroe first offers a checklist of “criteria that should be met before you consider investing in a factor.” Besides demonstrating higher returns, he says a factor must be:

• Persistent, with returns holding over time and across different economic regimes;
• Persuasive, holding across counties, regions, sectors and asset classes;
• Robust, holding over different metrics (i.e. a value premium that holds whether measured by price-book, earnings, cash flow or sales);
• Investable, enduring “not just on paper but also after considering actual implementation issues, such as trading costs;”
• Intuitive, in that there are “logical risk-based or behavioral-based explanations for its premium.”

After examining several mutual funds to gauge their success at capturing the returns of small-cap and value premiums, Swedroe concludes:

“Well-designed, factor-based funds are able to capture the returns provided by both the size and the value factors. The further good news is that increased competition, in the form of mutual funds and tax efficient ETFs, has led to lower expense ratios, allowing investors to capture more of the available return.”