Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

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RNJ
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Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by RNJ »

A write up on factor investing and new factors. Should make for an interesting discussion.

http://news.morningstar.com/articlenet/ ... ?id=644994

From the essay: "My colleague Lee Davidson alerted me to an interesting working paper by Eugene Fama and Kenneth French, "A Five-Factor Asset Pricing Model." Fama and French are famous for their three-factor model, which uses market, value, and size characteristics to explain stock returns. The Fama-French model is taken as holy writ by many investors of the passive persuasion, especially advisors who've been through Dimensional Fund Advisors' boot camp. After more than 20 years, Fama and French have embraced the notion that size and value may not be the best factors to explain stock returns. Their new paper, the first draft of which was released in June 2013, finds that two additional factors--profitability and investment--make redundant the value factor. In other words, value stocks--defined as those with low price/book—only beat growth stocks because they historically tended to be more profitable and less voracious users of capital."
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Re: "A Come-to-Buffet Moment" (from M*)

Post by pkcrafter »

Thanks for the link, but the creation of two new factors has the effect of diluting their importance. We've lost the highly touted value effect and replaced it with profitability and investment intensity. Fama and French define investment intensity as the year-over-year growth in total assets. Similar to momentum, but not quite.

Anyway, this has no effect on my investing strategy, which is to be broadly diversified.

Note: you might be more interest if you changed the title to reflect F/F factor changes.

Paul
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Re: "A Come-to-Buffet Moment" (from M*)

Post by nisiprius »

Hmmm. Very interesting. I knew that MOM and profitability were a meme on the rise, but did not realize that the current thinking amount to "burying the value factor."

If so, that means we've now written obituaries for two factors. The original "size effect" discovered by Rolf Banz in 1981 has been all but discredited. (Rather than accepting that characterization, the slice-and-dice advocates insist that nobody ever really said that size in itself was important, and that the size effect yes too does still exist of course it does, but that everybody knowledgeable understands that small-cap means small-cap after you throw out small growth and eliminate utilities, and oh you can't settle for "small caps" as defined by small-cap index providers or the Morningstar style boxes).

But now value bites the dust, too. Maybe that explains why there has been virtually no difference in total return between Vanguard Total Stock Market Index and Vanguard Value Index, eh?

Image

Of course, the slice-and-dice advocates will not spin this as "I guess we were wrong," but rather as "we are now even more right than we ever were before."

So, any pools on how long it is before we get a seven-factor model and are told that profitability and investment are uh, well, still valid but you'd be naïve to think you can get results by tilting on them alone when all the knowledgeable people know that they only really work if you know enough to add a screen for the two new factors, lubriciousness and salacity?
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Re: "A Come-to-Buffet Moment" (from M*)

Post by RNJ »

pkcrafter wrote:Thanks for the link, but the creation of two new factors has the effect of diluting their importance. We've lost the highly touted value effect and replaced it with profitability and investment intensity. Fama and French define investment intensity as the year-over-year growth in total assets. Similar to momentum, but not quite.

Anyway, this has no effect on my investing strategy, which is to be broadly diversified.

Note: you might be more interest if you changed the title to reflect F/F factor changes.

Paul
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by larryswedroe »

The new model, which I wrote about while ago is known as the q factor model, using four factors of beta, size, investment and profitability. The investment factor is highly correlated with value factor and profitability highly correlated with MOM. And the model eliminates most (but not all) of the anomalies presented by the three factor model. Fama himself has stated that if he knew 20 years ago what he knew today he would use the q model to explain returns but adding value helps to show the sources of returns better. And it doesn't subtract any value from the q model when added

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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by Levett »

"Fama himself has stated that if he knew 20 years ago what he knew [knows?] today"

That's the nature of human existence. It's meant to keep us humble.

Lev
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

larryswedroe wrote:The new model, which I wrote about while ago is known as the q factor model, using four factors of beta, size, investment and profitability. The investment factor is highly correlated with value factor and profitability highly correlated with MOM. And the model eliminates most (but not all) of the anomalies presented by the three factor model. Fama himself has stated that if he knew 20 years ago what he knew today he would use the q model to explain returns but adding value helps to show the sources of returns better. And it doesn't subtract any value from the q model when added

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More specifically, Larry detailed this here for those interested: http://www.etf.com/sections/index-inves ... =1&start=2
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Re: "A Come-to-Buffet Moment" (from M*)

Post by dkturner »

nisiprius wrote:
But now value bites the dust, too. Maybe that explains why there has been virtually no difference in total return between Vanguard Total Stock Market Index and Vanguard Value Index, eh?
True, if one simplistically defines the value factor as VIVAX has - three separate times. However if you rerun your chart comparing VTSMX to the DFA Large Value fund you get a much more accurate indication of what is possible when one uses the power of a computer to properly construct a passively managed value fund. The majority of Vanguard value investors have chosen to pursue the value premium by opting for one of Vanguards old line value funds (Equity Income, Windsor and Windsor II) and they have been well rewarded for passing on VIVAX.
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Re: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

dkturner wrote:
nisiprius wrote:
But now value bites the dust, too. Maybe that explains why there has been virtually no difference in total return between Vanguard Total Stock Market Index and Vanguard Value Index, eh?
True, if one simplistically defines the value factor as VIVAX has - three separate times. However if you rerun your chart comparing VTSMX to the DFA Large Value fund you get a much more accurate indication of what is possible when one uses the power of a computer to properly construct a passively managed value fund. The majority of Vanguard value investors have chosen to pursue the value premium by opting for one of Vanguards old line value funds (Equity Income, Windsor and Windsor II) and they have been well rewarded for passing on VIVAX.
You mean like this?!?!? And to think earlier today Nisi was being a bit cynical/snarky about the CRSP graphic (though I agree with your point Nisi). :)

Image
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Re: "A Come-to-Buffet Moment" (from M*)

Post by steve_14 »

dkturner wrote:However if you rerun your chart comparing VTSMX to the DFA Large Value fund you get a much more accurate indication of what is possible when one uses the power of a computer to properly construct a passively managed value fund.
But the vast majority of the value permium exists only in small cap stocks. This is why 90% of DFA topics here concern the SV, not LV fund, Larry Swedroe has 100% of his stock portfolio in SV fund and 0% in LV fund, etc. By your logic, DFA, using the power of computers(!), would have dramatically outperformed passive funds like the Vanguard SV fund over the last 10 years.

Problem is, it didn't. So your reasoning doesn't hold:

Image

What's happened here is simply that DFLVX has a much smaller market cap than VIVAX, and small caps are having a run.

When small caps violently underperformed (80s and 90s), DFA funds did as well.
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Re: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

steve_14 wrote: What's happened here is simply that DFLVX has a much smaller market cap than VIVAX, and small caps are having a run.
Methinks not. Though I will admit that Morningstar isn't always the most accurate when it comes to DFA, DFLVX and VIVAX are both very large cap funds. Your post is written like the comparison is between a SCV fund and a LCV fund and just size is the difference. In reality it appears that VIVAX has more Giant companies than DFLVX but DFLVX has more Large than VIVAX. I wouldn't say it has "a much smaller market cap" in the context we are discussing. EDIT to add: And actually, VTSMX has a smaller market cap than DFLVX!! So by your logic then VTSMX should have outperformed DFLVX just because it is "smaller" cap. See how that turned out in the performance chart I posted earlier...

DFLVX
Image

VIVAX
Image

VTI/VTSMX
Image
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Re: "A Come-to-Buffet Moment" (from M*)

Post by steve_14 »

matjen wrote:Methinks not. Though I will admit that Morningstar isn't always the most accurate when it comes to DFA, DFLVX and VIVAX are both very large cap funds. Your post is written like the comparison is between a SCV fund and a LCV fund and just size is the difference. In reality it appears that VIVAX has more Giant companies than DFLVX but DFLVX has more Large than VIVAX. I wouldn't say it has "a much smaller market cap" in the context we are discussing. EDIT to add: And actually, VTSMX has a smaller market cap than DFLVX!! So by your logic then VTSMX should have outperformed DFLVX just because it is "smaller" cap.
Well, if you don't think it's a result of the size premium, and it's clearly not DFA capturing any value premium (which again exists mostly in small stocks), you're going to have to come up with a reason why DFA's large cap value fund outperformed. The answer is likely random variation, not "the power of computers" or any special sauce.

The fact that it performed the same as the S&P for the first 15 years of its life, only outperforming in the last five, reenforces this.
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Re: "A Come-to-Buffet Moment" (from M*)

Post by berntson »

matjen wrote:
steve_14 wrote: What's happened here is simply that DFLVX has a much smaller market cap than VIVAX, and small caps are having a run.
Methinks not. Though I will admit that Morningstar isn't always the most accurate when it comes to DFA, DFLVX and VIVAX are both very large cap funds. Your post is written like the comparison is between a SCV fund and a LCV fund and just size is the difference. In reality it appears that VIVAX has more Giant companies than DFLVX but DFLVX has more Large than VIVAX. I wouldn't say it has "a much smaller market cap" in the context we are discussing. EDIT to add: And actually, VTSMX has a smaller market cap than DFLVX!! So by your logic then VTSMX should have outperformed DFLVX just because it is "smaller" cap. See how that turned out in the performance chart I posted earlier...
DFA Large Value (DFLVX) and Vanguard Total Market (VTSMX) are almost precisely the same size (you can see this in the regressions). Note that DFA Large Value outperformed Vanguard Total Market even with the added drag of 40-50 basis points in fees. This is expected, since DFA Large Value has a strong value tilt and value maintained its edge on growth over the last twenty years (i.e. HML was positive). This looks like a real passive fund capturing a real value effect.

The unimpressive performance of Vanguard Value (VIVAX) is easily explained. Look again at the regressions. Vanguard Value has half the value tilt of DFA Large Value and is significantly larger than Vanguard Total Market. Vanguard Large Value got a boost from its value tilt and suffered a drag from its large tilt. That (perhaps combined with some poorly engineered index hopping) explains why it merely kept pace with Vanguard Total Market.

As always, past performance is no guarantee of future returns.
Last edited by berntson on Tue Apr 29, 2014 6:32 pm, edited 6 times in total.
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Re: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

steve_14 wrote: it's clearly not DFA capturing any value premium (which again exists mostly in small stocks), you're going to have to come up with a reason why DFA's large cap value fund outperformed. The answer is likely random variation, not "the power of computers" or any special sauce..
See what Berntson just said. Just because there is more value in the small cap space doesn't mean there isn't any in the large cap space.
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Re: "A Come-to-Buffet Moment" (from M*)

Post by dkturner »

steve_14 wrote:
dkturner wrote:However if you rerun your chart comparing VTSMX to the DFA Large Value fund you get a much more accurate indication of what is possible when one uses the power of a computer to properly construct a passively managed value fund.
But the vast majority of the value permium exists only in small cap stocks. This is why 90% of DFA topics here concern the SV, not LV fund, Larry Swedroe has 100% of his stock portfolio in SV fund and 0% in LV fund, etc. By your logic, DFA, using the power of computers(!), would have dramatically outperformed passive funds like the Vanguard SV fund over the last 10 years.

Problem is, it didn't. So your reasoning doesn't hold:

Image

What's happened here is simply that DFLVX has a much smaller market cap than VIVAX, and small caps are having a run.

When small caps violently underperformed (80s and 90s), DFA funds did as well.
Well, what would you expect when comparing small value funds over a period when small value didn't do as well as small growth? DFSVX being more "valuey" than VISVX didn't do as well during a period when small value was in the dog house. I'm not worried though, because I have a long term time horizon. If you run the two funds back to the earliest comparison date you get a completely different picture of the value added by the more intelligent DFA methodology.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by nisiprius »

DFA says "It's scientific and it's all based on the factors." But the problem is that DFA funds are not index funds. They have secret sauce. And the secret sauce is important, because if you look at a fund that just uses the factors, you don't see the same thing. So then they say "Vanguard is incompetent, because everyone knowledgeable knows factors alone are no good without secret sauce." The problem with that argument is that once you allow secret sauce in the game, why shouldn't you admit other mutual fund companies that are even saucier?

As an investor, I might be happy with DFA's results, however they get them, and not quibble over whether they should be considered passive. Just as I might invest in Wellington and be happy that it has been Balanced Index. But the question is whether it is the factors that are doing it, or whether the factors are just a sort of storyline for good old-fashioned tastefully conservative active management.

Image
Last edited by nisiprius on Tue Apr 29, 2014 6:46 pm, edited 2 times in total.
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Re: "A Come-to-Buffet Moment" (from M*)

Post by steve_14 »

berntson wrote:DFA Large Value (DFLVX) and Vanguard Total Market (VTSMX) are almost precisely the same size
I was looking at the average market cap of DFLVX vs VIVAX on M*, which shows VIVAX having a much market average market cap. But that could just be the simple average, now that I look at their VTSMX number.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

nisiprius wrote:DFA says "It's scientific and it's all based on the factors." But the problem is that DFA funds are not index funds. They have secret sauce. And the secret sauce is important, because if you look at a fund that just uses the factors, you don't see the same thing. So then they say "Vanguard is incompetent, because everyone knowledgeable knows factors alone are no good without secret sauce." The problem with that argument is that once you allow secret sauce in the game, why shouldn't you admit other mutual fund companies that are even saucier?

Image
EXCEPT virtually ALL of the major DFA equity funds have performed amazingly well since inception. I know Larry has written some things on this. They are all in the top quartile I think and some in the top 10% or so. You can't say that about Fidelity I would guess. You can cherry pick one fund after the fact though.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by nisiprius »

matjen wrote:...EXCEPT virtually ALL of the major DFA equity funds have performed amazingly well since inception. I know Larry has written some things on this. They are all in the top quartile I think and some in the top 10% or so...
And Allan Roth has written some things on this and concluded that they haven't. He used Morningstar ratings, which take multiple factors into account including risk: "I took a weighted average of the four categories based on each asset class size and calculated a 3.0 average rating from Morningstar. This is in spite of having expense ratios that Morningstar defines as very low. By comparison, Vanguard funds average nearly 3.6 stars." And says Russel Kinnel of Morningstar says "Kinnel agreed that, as a whole, DFA had outperformed the category average during the five year period. Kinnel stated, however, that this wasn't true on a risk adjusted basis." He also quotes a DFA spokesperson who disagrees.

The point is, Roth seems to think the outperformance is real but fully explained by taking extra risk.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by berntson »

nisiprius wrote: DFA says "It's scientific and it's all based on the factors." But the problem is that DFA funds are not index funds. They have secret sauce. And the secret sauce is important, because if you look at a fund that just uses the factors, you don't see the same thing.
I don't follow. Vanguard built a large value fund with a large tilt and it behaved like a large value fund with a large tilt. DFA built a large value fund without any size tilt. It then behaved like a value fund without a size tilt.

Over the years, Vanguard has built better index funds. The new CRSP indexes they track have trading bands and fancy features to prevent front-running. Old index funds didn't have those features, so value funds suffered drag from unnecessary turnover, negative momentum, and front-running. Small things like that make a difference, especially when you also have a size drag and only a small value tilt. Investing is a game of inches.
nisiprius wrote: The point is, Roth seems to think the outperformance is real but fully explained by taking extra risk.
This is just DFA orthodoxy: Small and value are risk factors and investors have been rewarded for taking on extra risk.
Last edited by berntson on Tue Apr 29, 2014 7:12 pm, edited 1 time in total.
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Re: "A Come-to-Buffet Moment" (from M*)

Post by steve_14 »

berntson wrote:The unimpressive performance of Vanguard Value (VIVAX) is easily explained. Look again at the regressions. Vanguard Value has half the value tilt of DFA Large Value and is significantly larger than Vanguard Total Market. Vanguard Large Value got a boost from its value tilt and suffered a drag from its large tilt.
dkturner wrote:Well, what would you expect when comparing small value funds over a period when small value didn't do as well as small growth? DFSVX being more "valuey" than VISVX didn't do as well during a period when small value was in the dog house.
Well you can't both be right - either there was a value premium over the last 10 years or there wasn't.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by steve_14 »

matjen wrote:EXCEPT virtually ALL of the major DFA equity funds have performed amazingly well since inception.
Wouldn't agree there. DFA started its flagship small cap fund in the early 80's. It promptly underperformed the market by 6.5% per year for the next 15 years. Not including that extra advisor fee layer, of course.

Of course, when DFA underpeforms, it's just bad luck. When it outperforms, it's because of some secret sauce.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by VennData »

nisiprius wrote:The point is, Roth seems to think the outperformance is real but fully explained by taking extra risk.
And extra advisor fees, since everyone is too stupid to use DFA on their own.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

nisiprius wrote:
matjen wrote:...EXCEPT virtually ALL of the major DFA equity funds have performed amazingly well since inception. I know Larry has written some things on this. They are all in the top quartile I think and some in the top 10% or so...
And Allan Roth has written some things on this and concluded that they haven't. He used Morningstar ratings, which take multiple factors into account including risk: "I took a weighted average of the four categories based on each asset class size and calculated a 3.0 average rating from Morningstar. This is in spite of having expense ratios that Morningstar defines as very low. By comparison, Vanguard funds average nearly 3.6 stars." And says Russel Kinnel of Morningstar says "Kinnel agreed that, as a whole, DFA had outperformed the category average during the five year period. Kinnel stated, however, that this wasn't true on a risk adjusted basis." He also quotes a DFA spokesperson who disagrees.

The point is, Roth seems to think the outperformance is real but fully explained by taking extra risk.
On my quick perusal:
1) Morningstar Star ratings? Seriously?
2) That also appeared to include the bonds which aren't in discussion here.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

steve_14 wrote:
matjen wrote:EXCEPT virtually ALL of the major DFA equity funds have performed amazingly well since inception.
Wouldn't agree there. DFA started its flagship small cap fund in the early 80's. It promptly underperformed the market by 6.5% per year for the next 15 years. Not including that extra advisor fee layer, of course.

Of course, when DFA underpeforms, it's just bad luck. When it outperforms, it's because of some secret sauce.
Are you serious? Did you mean to write that? The "market" however you are defining it isn't the SCV fund's benchmark. And who EXACTLY has claimed this: "Of course, when DFA underpeforms, it's just bad luck. When it outperforms, it's because of some secret sauce."

Here is what I quickly found on this topic: http://www.cbsnews.com/news/does-dfa-hi ... enchmarks/

And from a Barron's article in January 2014 (presumably including Bonds): "And yet its overall performance is headline-worthy. More than 75% of its funds have beaten their category benchmarks over the past 15 years, and 80% over five years, according to Morningstar"
http://www.aegisadvisory.com/wp-content ... eaters.pdf
Last edited by matjen on Tue Apr 29, 2014 7:28 pm, edited 2 times in total.
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Re: "A Come-to-Buffet Moment" (from M*)

Post by berntson »

steve_14 wrote:
berntson wrote:The unimpressive performance of Vanguard Value (VIVAX) is easily explained. Look again at the regressions. Vanguard Value has half the value tilt of DFA Large Value and is significantly larger than Vanguard Total Market. Vanguard Large Value got a boost from its value tilt and suffered a drag from its large tilt.
dkturner wrote:Well, what would you expect when comparing small value funds over a period when small value didn't do as well as small growth? DFSVX being more "valuey" than VISVX didn't do as well during a period when small value was in the dog house.
Well you can't both be right - either there was a value premium over the last 10 years or there wasn't.
Clearly I'm right. :D

Here's what we know. DFSVX and VISVX have almost exactly the same value tilt. DFSVX is significantly smaller than VISVX, so should have outperformed over the last ten years. It didn't. Why? Because its higher fees were a real drag. The DFA investor took on more small risk than the Vanguard investor, but the rewards went to pay the management.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by steve_14 »

Are you serious? Did you mean to write that? The "market" however you are defining it isn't the SCV fund's benchmark. And who EXACTLY has claimed this: "Of course, when DFA underpeforms, it's just bad luck. When it outperforms, it's because of some secret sauce."
Entirely. Doesn't matter what the DFA benchmark is - you can't eat a benchmark. It matters whether you diversify with TSM or concentrate your risk. And clearly the comments on this thread show how folks ignore underperformance and remember when funds do well.
And from a Barron's article in January 2014 (presumably including Bonds): "And yet its overall performance is headline-worthy. More than 75% of its funds have beaten their category benchmarks over the past 15 years, and 80% over five years, according to Morningstar"
Chasing performance of the hot fund family written up in Barrons, while not a sure road to underperformance, is a fairly reliable one. You can sure they weren't singing the praises of DFA circa 1998 (when the stocks it held were relatively cheap).

Small caps are due for a long period of underperformance, and when that happens DFA will lag right along with it (and you'll be eating advisor fees while it happens).
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by berntson »

On a side note, here's a great chart of the rolling five-year returns for value.

Image

As you can see, the US is now in the middle of the longest and worst downturn for value stocks in 30 years. If you believe in the value premium, this looks like a golden time to be buying value stocks. The time to buy into a strategy is when that strategy is out of favor. Others will see this as evidence that the value premium has finally been killed off or was never there to start with.

I think "the night is always darkest before the dawn."
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by stlutz »

The point is, Roth seems to think the outperformance is real but fully explained by taking extra risk.
This is just DFA orthodoxy: Small and value are risk factors and investors have been rewarded for taking on extra risk.
Not the way Nisi used it. By "risk-adjusted" returns, he was simply referring to risk as standard deviation. "Risk" in the DFA sense is intended to explain why what worked in a backtest is all but guaranteed to work in the future; it's not related to what you might lose when the market goes down.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by stlutz »

As you can see, the US is now in the middle of the longest and worst downturn for value stocks in 30 years. If you believe in the value premium, this looks like a golden time to be buying value stocks
I'm not seeing this in real-world index fund returns. When I look at the last 5 or 10 years, at both small and large cap stocks, I see growth winning by just a bit, and I definitely don't see that value is some sort of massive downturn. Value stocks have done just fine over the past 5/10 years.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by stlutz »

I think the M* article is overstating a bit (actually a lot) by saying that F/F have "buried" the value factor. If you read the actual paper, you don't get that at all. Rather, there are simply other ways to "explain" returns that also work very well. Saying that the 3 factor model is not the only way to explain returns is not the same as saying that the model has been "buried".

However, I think the new research does put more nails in the coffin of the argument that value outperforms because it's riskier (unless you define risk as "guaranteed to outperform").

From Larry's earlier article on the subject:
Additionally, Fama and French found that the value, profitability and investment factors are negatively correlated with both the market and the size factor, providing important information regarding potential benefits from portfolios that diversify exposures across factors.
Note, the value and market factors are negatively correlated with each other. As I've pointed out other times, most of the historical backtested value premium occurs in down markets, not up markets.

In my view, this new paper is lending credence to the idea that value's outperformance is due to these stocks having less risk, not more.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

steve_14 wrote: Entirely. Doesn't matter what the DFA benchmark is - you can't eat a benchmark. It matters whether you diversify with TSM or concentrate your risk. And clearly the comments on this thread show how folks ignore underperformance and remember when funds do well.
And from a Barron's article in January 2014 (presumably including Bonds): "And yet its overall performance is headline-worthy. More than 75% of its funds have beaten their category benchmarks over the past 15 years, and 80% over five years, according to Morningstar"
Chasing performance of the hot fund family written up in Barrons, while not a sure road to underperformance, is a fairly reliable one. You can sure they weren't singing the praises of DFA circa 1998 (when the stocks it held were relatively cheap).

Small caps are due for a long period of underperformance, and when that happens DFA will lag right along with it (and you'll be eating advisor fees while it happens).
Well since we are playing this senseless game I will just say that I now have twice as much to eat as you! (well except for VTI and VXUS being my largest holdings) Moreover, there are different types of diversification. There is beta and then there is diversification among factors. A tilted portfolio values the latter more.

Image

In your last sentence it sounds to me like you are making a prediction. All my points are based on the actual facts not on what is going to happen or may happen. As Nisi well knows, bonds haven't had their inevitable crash that everyone knows is going to happen...for the past 4 years.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by Blue »

larryswedroe wrote:The new model, which I wrote about while ago is known as the q factor model, using four factors of beta, size, investment and profitability. The investment factor is highly correlated with value factor and profitability highly correlated with MOM.

Best wishes
Larry
Are these correlations stable (i.e., investment factor with value and profitability with MOM)? It seems so many correlations in finance are not stable. Should an investor prefer a value fund or an investment factor fund or does it not matter because correlations between the two are stable across time periods and geographies?

Thanks for the good work you do keeping us abreast and educated on these interesting topics.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by Roy »

steve_14 wrote:
Small caps are due for a long period of underperformance, and when that happens DFA will lag right along with it (and you'll be eating advisor fees while it happens).
The fee consumption is always happening, even during SCV outperformance; what matters in this context is the portfolio performance after the fee.

That said, these conversations always devolve to comparisons in isolation—usually the SCV and Value funds get targeted. But AUM advisor fees apply to the entire portfolio, and that includes fixed income. So if one has a lot of bonds, the chance of portfolio outperformance (vs. some non-fee allocation) may be lower depending on how much fixed income one has.

But I'm guessing most investors with good advisors are happy regardless of their allocations or the fund families used. And the reasons for having an advisor should go beyond fund access—according to some excellent advisors here—although those good reasons are harder to quantify than fund comparatives.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by JoMoney »

matjen wrote:...Well since we are playing this senseless game...
I WANT TO POST A CHART TOO!
Image
Back in 1935 a group of folks simply bought an equal number of shares of the New York Stock Exchange's top 30 dividend stocks.... AND NEVER TRADED OR ADJUSTED THE PORTFOLIO. They beat the TOTAL MARKET and DFLVX too! ... <SARCASM>...The fact is, they must have understood factors a lot better back then... </SARCASM>
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by richard »

From the M* article:

"Fama and French admit that their original three-factor model was not motivated by theory. They chose value and size because they worked better than other characteristics in back-tests. Grounded in the efficient-market hypothesis, they came up with risk-based stories for these patterns. Small-cap stocks provided excess returns because they're more vulnerable to the business cycle. Value stocks did so because they were distressed."

Where did they admit this?

"While the value factor has been found almost everywhere, it's largely been driven by small stocks. While that would seem to support value as a risk factor, it's difficult to actually tie value to some measure of risk. Distressed stocks actually have bad returns."

Long a problem with the value as risk story. If value is a distress story, why should book to market work better than more direct measures of distress, especially if direct measures don't work at all.

"Fama and French add to the puzzle by finding that the value premium can be explained away as a combination of profitability and investment intensity. An efficient-market theorist would argue that profitable firms and firms with low capital intensity must therefore be riskier in unique ways in order to have commanded return premiums."

Is there a plausible risk story? As the article says, that "profitable firms with low capital requirements" would be riskier "defies common sense".
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by BigJohn »

Saw this article just before I went to bed last night. Figured there would be a thread this morning with all the usual participants in this debate and am not disappointed. In reading the comments this article obviously hasn't changed anyone's position and I didn't think it would. For me it just confirmed by belief (or my bias according to Matjen :happy ) that the whole DFA thing is largely constructed on back testing which as I've learned on this forum can be used to "prove" a lot of things that are not correct. This is now beginning to look a little weaker and even the creators are having to cast about for new complications to add to maintain the back tested performance. Maybe it was just statistical variation that this particular back tested scenario lasted longer than most?? Still feels like "skating where the puck was" to me and even if you avoid advisor costs the ER of DFA is still higher than VG.

I'm sure my post won't change the beliefs of any DFA advocates either but couldn't resist putting in my two cents.
Last edited by BigJohn on Wed Apr 30, 2014 7:18 pm, edited 1 time in total.
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CORRECTION

Post by Taylor Larimore »

virtually ALL of the major DFA equity funds have performed amazingly well since inception.
In May, 2000, Morningstar's Research Director, John Rekenthaler, conducted an 18 year comparative study of DFA vs. Vanguard. He concluded: "Vanguard in a landslide."

Why Investing Isn't Engineering

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: CORRECTION

Post by Roy »

Taylor Larimore wrote:
virtually ALL of the major DFA equity funds have performed amazingly well since inception.
In May, 2000, Morningstar's Research Director, John Rekenthaler, conducted an 18 year comparative study of DFA vs. Vanguard. He concluded: "Vanguard in a landslide."

Why Investing Isn't Engineering

Best wishes.
Taylor

Hi, Taylor. Never read this. Is it available without joining Morningstar?

For me, I just see two great fund families. But I'd like to read Rekenthaler's take on things now.
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Re: CORRECTION

Post by matjen »

Taylor Larimore wrote:
virtually ALL of the major DFA equity funds have performed amazingly well since inception.
In May, 2000, Morningstar's Research Director, John Rekenthaler, conducted an 18 year comparative study of DFA vs. Vanguard. He concluded: "Vanguard in a landslide."

Why Investing Isn't Engineering

Best wishes.
Taylor
2000? Taylor are you trying to help me argue with BigJohn?!?! :P Talk about Skating Where the Puck Was! What happened after the once in a lifetime tech bubble burst? What has happened the last 15 years? Take a look at the Morningstar charts posted above.

Hey I love Vanguard. I love your Three Fund and the Core Four. Behaviorally, I love finagling with my portfolio as well. It is for those reasons that I have settled on factor investing and DFA-ish strategies moving forward. Because with DFA you can get all that factor goodness and new screens and qauntiness (my new word) and have everything automatically balanced and efficient. I can have a Larry Portfolio with 3 Funds and all my factors remain consistent. I can have a tilted portfolio with 3 funds and all my factors remain consistent. I can have a tilted Core 4 portfolio with 4 funds and all my factors remain consistent. I can have the latest acadmic theories that are applicable incorporated in my portfolio. Best of the Taylor world and the Swedroe world IMHO. One can also do much of it without DFA but requires a bit more work. Will it give me better returns moving forward? Hope so. Who knows. I am confident that I won't suffer (do significantly worse) compared to traditional indexing.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by larryswedroe »

Richard
When they first wrote their paper Fama and French actually said they did not know the source of the premiums, leaving that to further research, though they called them risk premiums --if my memory serves me correctly. And of course while DFA believes in the EMH as a good model that helps think about how markets work and what the right strategy is, they obviously don't believe it's perfectly efficient or they would not have incorporated MOM into portfolios long ago.

Taylor

This is bit dated but easily updated if someone interested. Show M* ranking for 10/15 years.

Note that in real world both much higher ranking because M* doesn't take into account survivorship bias--and on AT basis would look even better

Morningstar Percentile Ranking (as of December 24, 2013)
Fund 10 Years 15 Years
Domestic
Vanguard 500 Index (VFINX) 34 51
DFA U.S. Large (DFUSX) 31 n/a
Vanguard Value Index (VIVAX) 41 60
DFA U.S. Large Value III (DFUVX) 7 4
Vanguard Small Cap Index (NAESX)21 63
DFA U.S. Small (DFSTX) 22 33
DFA U.S, Micro Cap (DFSCX) 35 18
Vanguard Small Cap Value Index (VISVX) 42 70
DFA U.S. Small Value (DFSVX) 30 24
Vanguard REIT Index (VGSIX) 39 41
DFA Real Estate (DFREX) 43 30
International
Vanguard Developed Markets Index (VDMIX) 51 n/a
DFA International Large (DFALX ) 48 53
DFA International Value III (DFVIX) 15 22
DFA International Small (DFISX) 29 15
DFA International Small Value (DISVX) 12 1
Vanguard Emerging Markets Index (VEIEX) 44 50
DFA Emerging Markets II (DFEMX) 16 27
DFA Emerging Markets Value (DFEVX) 10 9
DFA Emerging Markets Small (DEMSX) 9 8
Average Vanguard Ranking 39 56
Average DFA Ranking 24 20

Note both fund families IMO do great job. DFA funds tend to perform better over the long term MOSTLY due to higher loadings on factors---with some additional benefits from other things



Best wishes
Larry
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by berntson »

stlutz wrote:
As you can see, the US is now in the middle of the longest and worst downturn for value stocks in 30 years. If you believe in the value premium, this looks like a golden time to be buying value stocks
I'm not seeing this in real-world index fund returns. When I look at the last 5 or 10 years, at both small and large cap stocks, I see growth winning by just a bit, and I definitely don't see that value is some sort of massive downturn. Value stocks have done just fine over the past 5/10 years.
The value premium has been the value discount for seven long years. You may not have noticed because we're in an overall bull market. Everyone is making money.

Since 2007, Vanguard Small Value has trailed Vanguard Small Growth by a total of 30 percentage points. The story is similar, but less dramatic, for large caps and mid caps. Here's the link for those who want to see the returns.

The value premium has done much better internationally. This suggests that the market has not found some new way to kill the value premium. If it had, it would have killed the value premium overseas as well. Arbitrage works as well there as it works here.
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Re: CORRECTION

Post by dkturner »

Taylor Larimore wrote:
virtually ALL of the major DFA equity funds have performed amazingly well since inception.
In May, 2000, Morningstar's Research Director, John Rekenthaler, conducted an 18 year comparative study of DFA vs. Vanguard. He concluded: "Vanguard in a landslide."

Why Investing Isn't Engineering

Best wishes.
Taylor
Wow! Timing is everything, isn't it?
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by heyyou »

Should make for an interesting discussion.
May as well move along as there is nothing new here, same debate, same hardened positions, just a couple of new labels to stir with, as though those labels would forecast what the market will do in the future. That is hidden in the arguments, our greed for choosing which will do better going forward.

In the near future, the Ford/Chevy debate will be having a centennial, but our ancestors probably argued about which breeds of horses were better.

It saddens me to see the he-said, she-said and the "mine is better than yours" responses here instead of broad acceptance of "many roads to Dublin." Choose the one that suits you, knowing that something different may suit others.
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Re: CORRECTION

Post by Taylor Larimore »

dkturner wrote:
Taylor Larimore wrote:
virtually ALL of the major DFA equity funds have performed amazingly well since inception.
In May, 2000, Morningstar's Research Director, John Rekenthaler, conducted an 18 year comparative study of DFA vs. Vanguard. He concluded: "Vanguard in a landslide."

Why Investing Isn't Engineering

Best wishes.
Taylor
Wow! Timing is everything, isn't it?
Attempting to time the stock market is one of the biggest mistakes an investor can make.

Market Timing. What Experts Say.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by steve_14 »

berntson wrote:As you can see, the US is now in the middle of the longest and worst downturn for value stocks in 30 years. If you believe in the value premium, this looks like a golden time to be buying value stocks. The time to buy into a strategy is when that strategy is out of favor.
Yes, this is how I view my portfolio, which consists only of stocks based in Dallas. When it outperforms, I congratulate myself of picking up the "Dallas premium". When it lags, I tell myself that Dallas stocks are now cheap, and I'm lucky to own them. I'm a long term investor, which means somehow I'll win in the end :) .
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by staythecourse »

heyyou wrote:It saddens me to see the he-said, she-said and the "mine is better than yours" responses here instead of broad acceptance of "many roads to Dublin." Choose the one that suits you, knowing that something different may suit others.
I agree 100%. I will actually come out and say TSM vs. slice dice based on whatever makes NO difference to success or failure. Sometimes I feel folks on here think they are in academia defending their thesis papers.

For retail investors (which we all are) it does not matter which approach one takes. Pick a diversified, low cost plan and stay the course is more important. Many of us are definitely guilty of "losing sight of the forest through the trees".

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by berntson »

steve_14 wrote:
berntson wrote:As you can see, the US is now in the middle of the longest and worst downturn for value stocks in 30 years. If you believe in the value premium, this looks like a golden time to be buying value stocks. The time to buy into a strategy is when that strategy is out of favor.
Yes, this is how I view my portfolio, which consists only of stocks based in Dallas. When it outperforms, I congratulate myself of picking up the "Dallas premium". When it lags, I tell myself that Dallas stocks are now cheap, and I'm lucky to own them. I'm a long term investor, which means somehow I'll win in the end :) .
I would love to see an out-of-sample, international test of the Dallas premium! For some reason, I'm imagining cowboys running cafés in France... :beer
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by matjen »

heyyou wrote:
Should make for an interesting discussion.
May as well move along as there is nothing new here, same debate, same hardened positions, just a couple of new labels to stir with, as though those labels would forecast what the market will do in the future. That is hidden in the arguments, our greed for choosing which will do better going forward.

In the near future, the Ford/Chevy debate will be having a centennial, but our ancestors probably argued about which breeds of horses were better.

It saddens me to see the he-said, she-said and the "mine is better than yours" responses here instead of broad acceptance of "many roads to Dublin." Choose the one that suits you, knowing that something different may suit others.
I actually think of it as more a Corvette/911 debate. Mine is just as fast as yours and cheaper! Guilty as charged on the greed part but must say that humility as to my ability to follow a path correctly, appreciation of simplicity, and flat out laziness also play roles for me. :-)
A man is rich in proportion to the number of things he can afford to let alone.
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Re: Fama/French Factors: "A Come-to-Buffet Moment" (from M*)

Post by steve_14 »

staythecourse wrote:
heyyou wrote:It saddens me to see the he-said, she-said and the "mine is better than yours" responses here instead of broad acceptance of "many roads to Dublin." Choose the one that suits you, knowing that something different may suit others.
I agree 100%. I will actually come out and say TSM vs. slice dice based on whatever makes NO difference to success or failure.
Oh agreed. It's just fun to argue about :) . Well "no difference" ignoring any extra fees you might pay. Clearly a 1% fee drag would be devastating over time, given our low return world.
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