DFA Growth funds?

[lorneabramson]

[Posting a naked link is a violation of forum policy and it was removed]

[larryswedroe]

They are based on the research that got Fama the most excited he's been in very long time on profitability or quality

I wrote about it here http://www.cbsnews.com/8301-505123_162-57524029/how-warren-buffett-beats-the-market/

hope that helps
Larry

[lorneabramson]

So, does their website need to be updated (now that Fama has apparently identified four, instead of three factors)?

http://www.dfaus.com/philosophy/dimensions.html

[Rick Ferri]

We used to call this GARP in the old days (growth at a reasonable price).

GARP was hot in the early 1990s. Earlier this month I was telling the folks as S&P that I thought GARP would make a comeback.. DFA just confirmed my belief.

Rick Ferri

[Blue]

Is this the same as Grantham's High Quality?

[umfundi]

... in the old days ... in the early 1990s ...
Rick Ferri

[cheapskate]

I read the "PRINCIPAL INVESTMENT STRATEGIES" section of the Large Cap Growth Fund. It does not shed any light at all on how/why this fund is different.

1) How is this Large Cap Growth Fund different from say a Vanguard S&P500 Growth (Style) fund ? How different is this going to be from a vanilla S&P500 index fund ?
2) Isn't it well known that "small cap growth" is the black hole of investing ? Why bother with Small Cap Growth Funds ?

At least a quick read of the prospectus doesn't tell me that this is GARP, where high valuation equities are weeded out.

[larryswedroe]

• Profitability, Investment and Average Returns by Eugene Fama and Kenneth French
• The Other Side of Value: The Gross Profitability Premium by Robert Novy-Marx


These are the two papers you want to read if you're interested.

It's basically what I wrote about in that Buffett's Alpha paper.

I believe DFA will be incorporating this finding in lots of their funds, not just the four new ones.

The folks at AQR are also working on this factor for use in funds

Best wishes
Larry

[wintermute]

Its funny how DFA is becoming more active (that is, selective), albeit at low costs and using defined rules. Research (from my limited, casual viewing) appears to be moving toward security selection. That's fine, as long as the fees don't consume all this alpha laying around. Or maybe there's so little, people publish what was trade secret, after its lost its own excess return. Maybe they trickle out just enough to keep people in their funds, as needed.

Essentially, advocating for these new factors is advocating for open trade strategies (which require a plauseble risk story to be sustainable). That way you can know an active fund is doing something sensible. Looking at only returns doesn't give you enough to decide between managers (Larry's "don't confuse outcome with strategy").

I expect whether price setting or indexing pays better, to oscillate around an equilibrium, as pricing itself is priced. Is there a greek for that? Maybe one can rebalance between them.

[Blue]

Is this the same as Grantham's High Quality?

Granthams Definition of Quality

GMO's definition is more substantive, including firms with high and stable profitability, low debt levels and shares that exhibit comparatively low volatility.

Sounds very much like,

http://www.cbsnews.com/8301-505123_162- ... he-market/

High-quality companies, which have historically provided higher returns, especially in down markets, tend to have the following characteristics:

Low earnings volatility
High margins
High asset turnover (indicating efficiency)
Low financial and operating leverage (indicating a strong balance sheet and low macroeconomic risk)
Low specific stock risk (volatility unexplained by macroeconomic activity)

[Blue]

In 2010 we looked at GMO High Quality Stocks - Portfolio Allocation/Best Vehicle.

Two of the standouts from the discussion were Vanguard Dividend Appreciation Index (VDAIX) and GMO Quality III (GQETX) (institutional). Both have performed very well and strikingly similarly within the Large Blend category over the past 3 and 5 years.

Ever since Granthams favoring "Quality", I've been tempted to set aside a quality allocation within our portfolio. Learning Fama's excitement for it adds that much more temptation.

OTOH, TSM includes significant % of "quality stocks" so I'm not convinced splitting out an allocation to quality (whether with DFA, Vanguard, or GMO) adds much incremental return?

[larryswedroe]

wintermute
It's not active at all. The research has uncovered a powerful factor that explains returns --though IMO there is no logical risk story for the premium, it's all behavioral

This is no more active than a fund that screens for market cap or BtM. It's just screening for the profitability factor, ranking them and then market cap weighting them

Best wishes
Larry

[Rick Ferri]

In today's quatitative drive to find "factors" that define stock prices, every alpha is eventually commoditized into a beta and every active strategy is eventually renamed as a passive one. This is how active managers have been competing in an increasingly savy index world.

The question is where to draw the line between active and passive, quant and indexing. The water has become very, very muddy.

Rick Ferri

[cheapskate]

• Profitability, Investment and Average Returns by Eugene Fama and Kenneth French
• The Other Side of Value: The Gross Profitability Premium by Robert Novy-Marx
These are the two papers you want to read if you're interested.

It's basically what I wrote about in that Buffett's Alpha paper.

I believe DFA will be incorporating this finding in lots of their funds, not just the four new ones.

The folks at AQR are also working on this factor for use in funds

Best wishes
Larry

Thanks Larry. It will be interesting to see these new strategies do and how they stack up against the S&P 500 and the S&P 600 in actual realized returns.

I am surprised that the prospectuses make absolutely no mention of "High Quality, relatively low valuation" and so on. Maybe DFA will be adding more information on their website over time.

I hope this is not performance chasing on their part (given than growth has outperformed value handily in recent years).

[hafius500]

Rules-based investments (quantitative, technical, fundamental strategies) are active strategies by definition even if they select exposure to certain (risk) "factors".

If behavioral or structural factors (agency problems) explain the historical performance of high-quality or low-volatility stocks, the alpha may not be sustainable if lots of money is invested in these strategies. You may add MSCI and SocGen to DFA:

Indexuniverse, December 19, 2012

The MSCI quality index methodology has three main components...“The indices are designed to reflect a quality growth investment strategy by identifying stocks with high scores based on three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth and low financial leverage.”...
MSCI’s move increases competition for French bank Société Générale, which earlier this year launched a quality income index.

Société Générale’s index includes between 25 and 75 global equities, selected according to their dividend yields and subject to an additional quantitative screening for profitability, leverage, liquidity and operating efficiency. The bank's exchange-traded fund (ETF) arm, Lyxor, has subsequently launched several ETFs on the bank’s index.

DFA prospectus:

In assessing expected profitability, the Advisor may consider different ratios, such as that of earnings or profits from operations relative to book value or assets

[Robert T]

.
Interesting. From the Fama-French paper on Profitability, Investment and Average Returns

more profitable firms have higher expected returns, as do firms with higher Bt/Mt

The spreads in realized average returns are large, but the lion’s share is absorbed by the book-to-market ratio, with an assist from size. The average high minus low portfolio returns from cross-section regressions that use size and Bt/Mt to explain returns are 5% to 6% per year. Adding lagged profitability and growth to the regressions increases the average return spreads by less than 1% per year. When we add accruals to these regressions, the incremental return is again less than 1% per year, and most of this seems to be due to small growth stocks.

This may explain the negative alpha's on value indexes and positive alphas on growth indexes (in general) - if a 'profitability' variable were added to the three factor model then perhaps the alphas would all be closer to zero. It may also explain the more negative alphas on the Russell 2000 value index relative to the S&P 600 Value (for example). Russell includes both lower price-to-book and lower forecasted growth in their value index sorts, the latter may add to the negative alpha (lower return). S&P includes some measure of financial viablity in its S&P600 which may reduce the negative alpha (in relative terms). And selecting indexes with closest to zero alpha's may just mean those in which 'profitability' is not under or overweighted in index construction. In any event, the effect relative to price-to-book and size sorts seems relatively small (re: Fama-French quote above). FWIW - the value load on the GMO Quality Fund since inception has been -0.14 (suggesting considerations of profitability may lead to a 'growth' tilt). [my earlier take on high quality).

Robert
.

[larryswedroe]

hafius
That point is a key one, no different than for momentum as neither has a rational explanation, purely behavioral. So at very least premium might shrink.
Best wishes
Larry

[FinancialDave]

• Profitability, Investment and Average Returns by Eugene Fama and Kenneth French
• The Other Side of Value: The Gross Profitability Premium by Robert Novy-Marx


I believe DFA will be incorporating this finding in lots of their funds, not just the four new ones.

The folks at AQR are also working on this factor for use in funds

Best wishes
Larry

In other words, whatever seems to be the hottest research of the moment is going to turn into an investing idea - isn't that what active managers do?

fd

[larryswedroe]

FD
So Dave what do smart people do> They look at the evidence and when they discover something has value in terms of explaining returns, a new insight, do they ignore it or incorporate that knowledge?
The data here, having seen it, is very powerful. Should one ignore it, or change their views?
I don't know about you but when I learn something new I change my opinions to incorporate that new knowledge.
The question here IMO is do you ignore the evidence because there is not a good risk story (in fact it's the opposite IMO) or incorporate it?
Here's one way to think about it. If it is going to go away because you think people will pounce on the idea and it will become crowded or arbitraged away then you should pounce on it immediately, not ignore it. You want to be the first on that bandwagon as prices of these stocks would take a one time jump.

Here's another thought. MOM has been known for decades, well publicized in the literature. But there's only a behavioral story so you would think once it's discovered it would disappear, but it hasn't happened. It appears human behavior is too hard to change and there are limits to arbitrage that seem to prevent it from disappearing. Even the most ardent of efficient market theorists, Fama, finally through in the towel and DFA began incorporating a negative MOM screen in 2003, after seeing what not doing so did to one of funds in 2002.

BTW-I'm surprised they called them growth funds as they are buying stocks with relatively high profitability relative to assets which just happen to be growth stocks.

Hope that is helpful

Best wishes
Larry

[lorneabramson]

The original link I provided was removed, so I am including it here. Sorry, but I apparently misunderstood the forum's policy about "naked" links. I thought the post was relatively self-explanatory; either way, I just thought DFA's launch of growth funds was interesting in the context of what they are traditionally known for (i.e., FF 3 factor)

http://www.dfaus.com/pdf/prospectuses/growth_pros.pdf

[FinancialDave]

Does anyone bother to read a prospectus and digest what it means.

Does anyone else find the below quote from the prospectus quite comical?

The Advisor may modify market capitalization weights after considering such factors as free float, momentum, trading strategies, liquidity management and other factors that the Advisor determines to be appropriate, given market conditions.

To me this means DFA can change the AA of the fund whenever and however they want based on their perceived "market conditions."

[larryswedroe]

financialdave
Prospectuses are written to give the fund manager flexibility to address almost any condition that might happen. Otherwise when you have an unusual/unanticipated situation (like financial crises, liquidity drying up, etc) the fund could be forced into trades that would be very expensive just in order to stick to the prospectus (like must keep market cap weighting exact).
There is nothing "shady" here at all.
Larry

[FireProof]

Don't let the salesmen bamboozle you into thinking this isn't active. Of course all active strategies have (past) research to back them - that's the whole allure. Hedge funds don't pick stocks by feeling, they have complex quantitative screens based on historical patterns that they've discovered.

Now, that doesn't mean you can't believe in active funds (even Vanguard has Wellesley etc.), but don't imagine you're doing anything different than most people picking active funds because they think "THIS manager is better."

[nisiprius]

financialdave
Prospectuses are written to give the fund manager flexibility to address almost any condition that might happen. Otherwise when you have an unusual/unanticipated situation (like financial crises, liquidity drying up, etc) the fund could be forced into trades that would be very expensive just in order to stick to the prospectus (like must keep market cap weighting exact).
There is nothing "shady" here at all.
Larry

I have to take exception here. If "read the prospectus" is to mean anything at all, it means "read the prospectus and believe what it says." It doesn't mean "check off the checkbox that says you've read it, but don't look over there, look over here at the shiny brochure. No, no, no, don't worry about the prospectus, it's just lawyer stuff, they would never really do anything like that. Pay no attention to the prospectus behind the curtain."

A mutual fund is what the prospectus says it is, not something else.

[umfundi]

A mutual fund is what the prospectus says it is, not something else.

Well, it is also not what the shiny brochure says it is. Remember when fund names and descriptions often had nothing to do with their square on the Morningstar Style Box?

Also, at Bogleheads 11 it was repeatedly noted that many "active" mutual funds have actually become index funds.

Keith

[larryswedroe]

Nisiprius
You can take all the exception you want, but that is how prospectuses are written.
Now some people/funds use that large flexibility all the time--which is what active managers do. Like say PIMCO with its collateral for the TIPS fund
Not the case here.
Larry

[danieljquirk]

I apologize if I missed it, but can anyone point to the actual study that shows the data? Or if there is a link to an understandable interpretation of the data, that would be even better.

My gut instinct is to be skeptical of this fund and the behavioral story, but I'd like to look at the data for myself. Thanks.

[larryswedroe]

http://scholar.google.com/citations?view_op=view_citation&hl=en&user=3SJnQ6wAAAAJ&citation_for_view=3SJnQ6wAAAAJ:qxL8FJ1GzNcC

Here is the paper by Robert Novy Marx

[boglety]

Perhaps cost and turnover is more important instead of the definition active or passive. Vanguard has quite a few good active bond funds with low turnover which perform like a passively managed index.

[larryswedroe]

Boglety
With investment grade, especially high investment grade, bonds you need far less diversification, and you have far less tracking error when do sampling. Almost all of the risks are INTEREST RATE, not credit. That is why it's so hard for active bond funds to outperform, far less differentiation say between Microsoft and Johnson &Johnson bonds than their stocks. So it's basically pretty much about costs (and of course turnover involves costs, especially at lower credits)

Larry

[lorneabramson]

FYI, Jason Zweig discusses these new funds in his Intelligent Investor column in this weekend's Wall Street Journal.

[Ketawa]

Thanks for the pointer, interesting article. If you don't have a WSJ subscription, enter "Have Investors Finally Cracked the Stock-Picking Code?" into Google and you'll be able to access it.

William Bernstein quoted in the article:

"There's something there, and I don't think it can be ignored," says William Bernstein, a money manager and investment theorist at Efficient Frontier Advisors in Eastford, Conn. "We don't know exactly why it works, but it works."

[umfundi]

FYI, Jason Zweig discusses these new funds in his Intelligent Investor column in this weekend's Wall Street Journal.

http://online.wsj.com/article/SB1000142 ... _Investing

Keith

[FinancialDave]

It tells me a lot about a group who thinks they have found the next "mouse trap."

I think the correct quote in this article should have been -- "We don't know exactly why it has worked, but it worked." Unless of course they own a time machine -- which would be something to invest in!

The other key here is "We don't know why.."

A very old saying is that if you don't know why some investment works (ie you can't understand it) you should not be investing in it.



fd

[Blue]

William Bernstein quoted in the article:

"There's something there, and I don't think it can be ignored," says William Bernstein, a money manager and investment theorist at Efficient Frontier Advisors in Eastford, Conn. "We don't know exactly why it works, but it works."

How is this not Skating Where the Puck Was?