Evidence-Based Investment Insights: The Essence of Evidence-Based Investing

November 5, 2026

In our last piece, “The Business of Investing,” we explored how markets deliver wealth to those who invest their financial capital in human enterprise. But, as with any risky venture, there are no guarantees. For any given investment, you might not earn the returns you are aiming for, or even recover your stake. This is one reason we strongly favor evidence-based investing.

It can be easier to stick with your investment selections if you have used a rational methodology for choosing them.

This is especially important during volatile periods, when your hopes, fears and other emotional reactions threaten to steer you off-course. So, what does evidence-based investing entail?

Alpha, Beta, And Sources Of Returns

Since at least the 1950s, a “Who’s Who” body of scholars has been studying portfolio management to answer key questions such as:

1. What drives market returns (factors)? Which factors, or potential sources of return, appear to have persisted over time, around the world and through various market conditions? Once we have identified a potential factor, are there rational reasons for why it may persist moving forward? The more robust the evidence for a factor appears to be, the more confidently investors can evaluate whether exposure to it is appropriate based on their personal financial goals and tolerance for risk.

2. What drives portfolio performance (alpha vs. beta)? When comparing the performance of one diversified portfolio to the next, how much of the difference can be explained by exposure to broad market or investment factors? These sensitivities are often described as factor betas. How much return remains unexplained by the selected benchmark or factor model? That residual is commonly referred to as alpha.

Alpha is sometimes interpreted as evidence of manager skill, but demonstrating persistent skill requires more than simply observing positive past performance. Results may also reflect luck, costs, changing market conditions or limitations in the model being used.

The More We Know

In 1992, professors Eugene Fama and Kenneth French published their landmark paper, “The Cross-Section of Expected Stock Returns,” in The Journal of Finance. Their research highlighted the importance of company size and book-to-market equity in explaining differences in average stock returns.

The following year, Fama and French formalized what became known as the Fama-French Three-Factor Model, incorporating the overall equity market along with size and value factors. Their work helped lay the groundwork for much of the factor-based research that followed.

These developments built on Harry Markowitz’s earlier work in modern portfolio theory and the Capital Asset Pricing Model, or CAPM, subsequently developed by William Sharpe and other financial economists. CAPM uses market beta as its principal measure of systematic risk. Multifactor models expanded that framework by examining additional sources of variation in returns.

Fama later shared the 2013 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel with Lars Peter Hansen and Robert Shiller for their empirical analysis of asset prices.

In 2015, Fama and French published “A five-factor asset pricing model” in the Journal of Financial Economics, adding profitability and investment factors to their earlier framework. They subsequently tested those five factors across international markets in a 2017 paper.

Many other financial economists have added to the ongoing conversation about new and existing investment factors. How do they interact and contribute to a portfolio’s returns? Which combinations may be useful in portfolio construction? For a thorough review, consider reading “In Pursuit of the Perfect Portfolio,” by Andrew Lo and Stephen Foerster. The authors reach a telling conclusion (emphasis ours):

“We can see that the idea of diversification of a portfolio as a means to reduce risk is universally accepted, but this may be the only thing our experts fully agree on. Even an idea as fundamental as the market portfolio, a portfolio of all assets in the global market, is only viewed as a starting point for the Perfect Portfolio by most of our experts.”

Bottom line, decades of factor research have helped investors better understand how systematic exposures can influence portfolio returns. At the same time, identifying managers who can generate persistent alpha in advance—and sustain it after fees, trading costs and other implementation expenses—remains a significant challenge.

Rather than depending on the pursuit of alpha, investors can focus on selecting diversified factor exposures that are appropriate for their personal financial goals, time horizon and tolerance for risk.

As Fama has succinctly suggested:

“Pick your risk exposure, and then diversify the hell out of it.”

We will explore some of the key factors involved in our next installment of this series called “Factors That Figure in Your Evidence-Based Portfolio.” But first, let’s discuss the difference between academic research that contributes to our understanding of factor investing and the much larger volume of industry analysis. Both can add value, but they do so in different ways.

The Rigors Of Academic Inquiry

In academia, rigorous research calls for far more than a limited look at a few in-house spreadsheets. Strong research methods are designed to reduce bias and subject conclusions to meaningful scrutiny. They typically emphasize:

An Objective Research Process: Rather than beginning with a desired conclusion and then selecting evidence to support it, sound research begins with a question or hypothesis and uses established methods to test it.

Robust Data Analysis: An academic analysis should seek to avoid weaknesses such as:

Suspect data that is too short-term, too small of a sampling to be significant, “cherry picked” to prove a point, or otherwise likely to distort the results.
Survivorship bias, in which returns from funds that were closed during the study period are omitted from the results.
Comparing apples to oranges, such as using an inappropriate benchmark against which to assess a fund’s or strategy’s success or failure.
Insufficient or inappropriate statistical analysis, including failing to account for relevant variables that may help explain observed results.

Repeatability And Replicability: Researchers should describe their methods clearly enough for results to be tested again. Evidence becomes more compelling when similar findings appear across different samples, time periods, markets or research teams rather than depending on a single study.

Peer Review And Transparency: Academic findings are typically subjected to scrutiny by other experts before and after publication. Researchers should explain their methodology and results in enough detail for others to evaluate their work, challenge assumptions and test whether the conclusions hold up. Access to underlying data may vary depending on the source and licensing involved.

Financial Scholar vs. Financial Professional

Building on this level of academic inquiry, fund companies and other financial professionals are tasked with an equally important question:

Even if a relatively reliable return premium exists in theory, can it be captured in the real world after the implementation and trading costs involved?

As in any discipline, academia seeks to investigate what may be possible and why. Investment professionals must then determine how—or whether—those findings can be applied responsibly in real-world portfolios.

As technology, financial products and global market access have evolved, investors have gained practical exposure to markets and strategies that were once far more difficult or expensive to reach. Emerging-market stocks and bonds are one example, along with certain investments beyond traditional stocks and bonds.

This is one reason it is important to distinguish between the roles of financial scholar and financial professional. It is also why studies, analyses, papers and other insights generated outside academia may warrant additional scrutiny before their conclusions are incorporated into an investment strategy.

Your Take-Home

As is the case in any healthy scholarly environment, those contributing to the lively inquiry about what drives market returns are rarely of one mind. Still, when supported by sound methodology, replication and a credible body of evidence, an evidence-based approach can help investors:

Apply findings supported by a meaningful body of research.
Set aside ideas that fail to withstand continued scrutiny.
Build portfolios aligned with their individual goals, risk capacity and long-term financial plans.

Next in our series, we will continue to piece together our exploration of market factors and expected returns.

This post was written and first distributed by The Writing Company.

DISCLAIMERS

This material is intended for general public use. By providing this material, we are not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact one of our financial professionals for guidance and information specific to your individual situation. This is not an offer to buy or sell a security.

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