When investors put money in the stock market, their ultimate goal is to generate as much profit as they can while accepting the least amount of risk possible. The best investors have learned to balance risk and reward so well that risks are generally in line with underlying benchmarks while their portfolios are able outperform the market as a whole.
One of the best ways to do this is through a process known as factor investing, whereby investors pay attention to factors that are known to pay a risk premium — an idea discussed in more detail below.
While factoring is a complex process, it’s possible for beginners to take advantage of this high-return investing model by simply following a prebuilt investment portfolio known as the Ben Felix Model Portfolio.
What Is the Ben Felix Model Portfolio?
As its name suggests, Benjamin Felix was one of the founders of the investing strategy, along with Cameron Passmore. Both Felix and Passmore are known for their market expertise and are portfolio managers at PWL Capital, a capital management firm with locations in Montreal, Toronto, Ottawa, and Waterloo, Canada.
Even if you’ve never heard of PWL Capital, there’s a chance you’ve heard of Ben Felix before. He’s the personality behind the “Rational Reminder” podcast and the “Common Sense Investing” YouTube channel.
When developing the portfolio, these two investing pros paid close attention to diversification both in terms of regions and market caps. Perhaps more importantly, the portfolio was designed to take advantage of premiums paid for added risk based on various factors.
Ultimately, the portfolio was designed to provide safety through diversification but to expose investors to potential returns that outpace the market as a whole.
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Portfolio Asset Allocation
Unlike most other prebuilt portfolios, there’s not much of a mix of asset classes — The Ben Felix Model is an all equities portfolio. However, these equities are highly diversified. Here’s the makeup of the base portfolio.
- 30% in Canadian Stocks. Both Felix and Passmore are Canadian nationals, so it comes as no surprise that the portfolio includes heavy allocation to publicly traded companies in Canada.
- 30% in U.S. Stocks. The United States is the largest and most robust economy in the world. As such, most investment portfolios include heavy allocation to domestic stocks, offering up the opportunity to produce compelling performance with a stable economy that reduces risk.
- 10% in U.S. Small-Cap Value Stocks. Small-cap value stocks are among the most prized assets on the market for factor-related investing. Despite their volatility, they’re known to produce significantly higher returns than their large-cap counterparts over the long run.
- 16% in a Mix of Stocks in Europe, Australia, Asia. The portfolio calls for an allocation in a mix of stocks from Europe, Australia, and Asia, helping investors gain exposure to more developed markets around the world.
- 8% in Emerging Markets. Emerging markets are known for volatility but also for producing compelling growth. So it’s no surprise to see stocks in this category included in the portfolio.
- 6% in International Small-Cap Value Stocks. The compelling performance of small-cap value stocks isn’t exclusive to the United States. In fact, stocks in this category around the world are known for similarly strong performance.
The Investment Thesis Behind the Portfolio
The name of the portfolio — specifically, the prominent inclusion of the word “Model” — hints at the thesis behind the portfolio. It seems as though Felix and Passmore were heavily influenced by data from the Fama-French 5-Factor Model, which points out that stocks displaying specific factors come with increased potential returns. This model is the basis of factor investing, also known as factoring.
Investors who want to mimic the returns of the broader market as a whole invest in index funds — a process known as indexing. Factoring takes that concept a step further. Factor investing gives additional weight to factors that are known for paying risk premiums in an attempt to create higher returns.
For example, the small-cap factor has long been correlated with increased profitability compared to large-cap stocks. So factor investors prefer small-cap stocks over their large-cap counterparts.
Value is also a major factor in terms of generating outsize growth. Value stocks have historically outperformed growth stocks, making value the better investment option to a factor investor.
Adding factor exposure to an investment portfolio is known as a factor tilt, and it has the potential to generate significantly larger returns than standard indexing. At the same time, investors that use factor tilts enjoy the same protection diversification offers in more traditional portfolios, helping to keep the risk manageable.
The Ben Felix Model Portfolio was built around these concepts. As you’ll notice in the portfolio’s allocation, a heavy tilt is given to small companies with value characteristics, emerging markets, and international opportunities, all of which tend to generate more meaningful returns than traditional indexing.
Pros and Cons of the Model Portfolio
Factoring is an exciting concept, and it does have the potential to result in outsize returns compared to an index-based model. However, as with any other portfolio strategy, the Ben Felix Model strategy comes with some drawbacks as well. Here are the pros and cons you should consider before following this investment style.
Ben Felix Model Portfolio Pros
The strategy has been widely accepted by investors at all levels, and for good reason. There are plenty of perks to the strategy, with the most significant including:
- High Returns. First and foremost, the portfolio strategy is known for creating outsize returns, historically beating the average returns of the overall market. In fact, from 2000 through 2020, the compound annual growth rate (CAGR) on the portfolio was 8.18%, outpacing the S&P 500’s 7.37% CAGR.
- Easy Setup and Management. The portfolio model is one in a long line of “lazy portfolios,” meaning it was designed to be easy to set up and require very little work in terms of rebalancing. As a result, it’s a great fit for beginner investors or those who simply don’t have the time required to research opportunities in the market.
- Heavy Diversification. Finally, the portfolio was built with diversification in mind. The highly diversified nature of the portfolio adds significant protection against risk, as well-performing assets help to offset declines when some assets in the portfolio experience drawdowns.
Ben Felix Model Portfolio Cons
Although there are plenty of reasons to consider using this style of investing, there are also some drawbacks to consider. Some of the most important include:
- Volatility. One of the main draws for factor investors is the risk premium, which relates to the increased gains you can expect as a result of accepting added risk. But the strongest factor-related assets will generally experience higher levels of volatility, increasing your portfolio’s risk.
- Heavy Exposure to Canadian Assets. Canada is a developed nation and it manages decent growth in national GDP. Historically, however, assets in the market to the north don’t have the track record of performance nor the stability of domestic companies based in the U.S. Some argue it would be wise to dial back exposure to Canadian assets and bring some of those investing dollars back home.
- No Safe-Haven Exposure. Following this allocation strategy does have the potential to generate big returns, but as an all-equities portfolio, it also has the potential to end in big losses. Without the use of fixed-income assets to hedge against equity risk, this portfolio could result in significant losses during bear markets and corrections.
Who Should Use the Ben Felix Model Portfolio?
No portfolio model is a one-size-fits-all opportunity for investors, and very few are even designed to address the needs of the majority of investors. This particular portfolio is neither.
Due to the risks associated with following this strategy, it isn’t a fit for most investors. The perfect investor for this investing style is:
- Young. Younger investors should be more willing to take risks in exchange for the potential for a big payday. These investors have plenty of time to recover should things go south, whereas investors closer to retirement may never recover from a major drawdown in the market.
- Risk Tolerant. Even some of the youngest investors may find this portfolio too risky for their taste. The fact that it doesn’t include investments in any fixed-income securities is worrisome, leaving investors 100% exposed to the ebbs and flows of the stock market. Therefore, any investor considering this investing style must have a strong appetite for risk.
- Willing to Do What It Takes to Outpace Average Market Returns. Again, this portfolio model is a risky play. Nonetheless, there are plenty of investors out there who have such a desire to beat average market returns by a wide margin that they’re willing to accept this increased risk of loss in exchange for bigger payoffs.
How to Duplicate the Model Portfolio
The portfolio is relatively simple to duplicate using a mix of exchange-traded funds (ETFs). Moreover, the mix comes with a market-leading average expense ratio, allowing you to hold onto a larger portion of your returns.
There are three simple ways to go about duplicating this portfolio strategy. Of course, you can use the traditional model that follows the prescribed asset allocation to the letter, or you can use slightly modified versions — one designed to reduce exposure to Canada and increase exposure to domestic opportunities and another designed to bring a little safety into the equation. Here’s how they work.
The Traditional Ben Felix Model Strategy
The traditional Ben Felix Model strategy can be created by using the following low-cost investment-grade funds:
- 30% in iShares Core S&P/TSX Capped Composite Index ETF (XIC). The first part of the allocation is exposure to Canadian stocks. That’s exactly what the XIC fund provides by investing in a diversified portfolio of stocks across a wide range of sectors and market caps.
- 30% in Vanguard U.S. Total Market Index ETF (VUN). The VUN fund provides diversified exposure to the U.S. stock market, including a list of mostly large-cap companies across a wide range of sectors.
- 16% in iShares Core MSCI EAFE IMI Index ETF (XEF). The XEF fund invests in 1,500 stocks from across Europe, Asia, and Australia, offering international exposure and a perfect hedge against the Canadian dollar.
- 10% in Avantis U.S. Small Cap Value ETF (AVUV). AVUV is the first ETF on the list that really brings the factors into play. The fund was designed to provide exposure to smaller domestic companies that display strong value characteristics and offer a valuable risk premium.
- 8% in iShares MSCI Core Emerging Markets IMI Index ETF (XEC.TO). The XEC fund (found on the Toronto Stock Exchange) is another factoring play, bringing in a strong risk premium that’s often the result of investing in fast-paced emerging markets. The fund invests in 1,500 stocks in emerging markets around the world, ranging in market caps, sectors, and regions.
- 6% in Avantis International Small Cap Value ETF (AVDV). Another factor investment, the AVDV fund provides diversified exposure to international stocks that represent small companies that come with impressive value characteristics.
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The Domestic Ben Felix Model Strategy
Some investors would rather the majority of their core holdings be invested in domestic stocks, whereas this portfolio has half its allocation in Canadian stocks. While you may not want to get rid of these stocks completely, it’s simple to dial back Canadian exposure to bring more of your allocation home.
All you need to do is trade some of the allocation out for the Vanguard Total Stock Market Index Fund ETF (VTI), a fund invested in domestic companies with ranging market caps and sectors.
For example, you could invest 15% in the XIC fund rather than 30% and put the remaining 15% in the VTI fund, increasing your exposure to domestic opportunities while maintaining a similar mix of equities.
The Safe(r) Ben Felix Model Strategy
There’s no such thing as an investing strategy that’s 100% safe. No matter what assets you choose to invest in, you’re going to have to be willing to accept some level of risk. With that said, a portfolio that invests 100% of its assets in stocks is a bit too risky for most people.
However, you can make a few small changes to the model to provide a high level of balanced exposure to the market while bringing some fixed-income investments into the mix.
To do this, reduce your exposure to the XIC and VUN funds to 22% and 23%, respectively. You’ll also need to reduce exposure to the XEF fund to 12%, the AVUV fund to 8%, the XEC fund to 6%, and the AVDV fund to 5%.
This will leave 25% of your portfolio’s asset allocation left open for investing in safer assets.
Because the allocation to safe, stable assets is still quite small, it’s best to invest this portion of the portfolio in long-term Treasury debt securities. Both the issuer (the U.S. government) and the longer term to maturity of these assets offer further stability, making these some of the safest investments on the market. This gives you the most protection to offset the risk in an equity-heavy investment portfolio.
Keep Your Portfolio Balanced
No matter what portfolio strategy you decide to follow, balance is a crucially important factor. After all, portfolio strategies are thoughtfully designed to both expose you to potentially significant returns and reduce your risk as much as possible in the process.
Every day, the investments in your portfolio will see value fluctuations. Over time, these price changes will result in your portfolio falling out of balance, ultimately leading to either increased exposure to risk or reduced exposure to potential gains, neither of which is known to end well.
As a result, it’s crucial to rebalance your portfolio on a regular basis.
As a lazy portfolio, the Ben Felix Model strategy was designed to require little work, so you won’t need to rebalance daily, weekly, or even monthly. However, quarterly rebalancing is an absolute must that will help you avoid unnecessary headaches.
The Ben Felix Model Portfolio is an interesting take on investing, especially from such a highly regarded investing expert. While most financial experts advise against putting 100% of your assets in equity investments, there’s no questioning the performance. Risky as it may be, so far the portfolio has been known to outperform the S&P 500 index and other highly-regarded benchmarks.
Nonetheless, if you’re going to follow this strategy, it’s important to seriously consider the risks. If you’re not comfortable with a portfolio that’s invested entirely in equities, consider swapping out some of your equity holdings for fixed income, or picking another portfolio strategy entirely. Some popular options are the Ray Dalio All Weather Portfolio and the Golden Butterfly Portfolio.
No matter how you go about investing, always be sure to do your research and get a good understanding of what you’re buying before you risk your first dollar.