investing with style

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investing with style

Postby larryswedroe » Fri Feb 08, 2013 2:17 pm

http://www.cbsnews.com/8301-505123_162-57567939/how-to-invest-with-style/

The authors of the paper cited are IMO among the top financial economists. Illmanen is the author of what I consider a must read book for those interested in modern financial theory Expected Returns, and Toby Moskowitz is professor at Chicago and has produced a lot of quality research. He is also the author of a great non investment book Scorecasting. A must read for sports fans

Both are at AQR which has collection of top academics including Cliff Asness, one of the founders.

Hope you find this helpful

Larry
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Re: investing with style

Postby Rick Ferri » Fri Feb 08, 2013 2:31 pm

Good article.

I find it disconcerting that what people know as investment strategy is now being relabeled as investment styles. This will become confusing to people who think of small, large, value and growth as styles and hedge funds as investment strategy.

It's no different than ETF companies calling every sophisticated trading strategy they come up with as "passive indexing" because it follows a highly quantitative set of rules that's labelled an "index" by AQR, S&P, Russell and every other "index provider" on the street.

While I'm not arguing for or against these strategies, oops, I mean styles, the marketing of them is just more mud in the water of passive management.

Rick Ferr
Mutual fund investing is simple. There is risk, there is return, and there are costs. All else is marketing.
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Re: investing with style

Postby Rosco » Fri Feb 08, 2013 2:40 pm

Glad all the money I've lost in the past was actually called the Momentum style of investing. SS
Edit: thought that was funny. Just sounds snarky. Sorry.
Last edited by Rosco on Fri Feb 08, 2013 2:43 pm, edited 1 time in total.
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Re: investing with style

Postby larryswedroe » Fri Feb 08, 2013 2:41 pm

Rick
Not debating your point because I think you have a valid issue
We certainly agree that things like hedge funds are not styles of investing but strategies

On other hand the carry trade is a style IMO, well known for decades, and of course it can be done passively. DFA has a fund that partially uses the "strategy", in long only way

Then you can debate about other issues like MOM, whether it's a strategy or style. Certainly is or has been a factor in explaining returns. In fact almost all academic papers now use the Carhart 4 factor model when doing research on explaining returns, evaluating performance. That has been the case basically since 1998 when Carhart published the paper (if memory serves).

The "quality" or defensive one now seems to be an important style like value and size. It contains information about future returns--though IMO it's totally a behavioral phenomenon and doesn't seem to add much if any value (except reducing tracking error risk) to portfolios that are diversified across the other factors/styles

The important thing is that investors be aware of the research and then they can decide if they want to invest based on the findings or not.

Best wishes and congratulations on being chosen for the WSJ
Larry
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Re: investing with style

Postby larryswedroe » Fri Feb 08, 2013 2:51 pm

Roscoe
Perhaps you did not know that
a) momentum is short term (4-5) positive and long term mean reverting. Perhaps you forgot the RTM part. (:-))). Or that like any style it doesn't always work, all the time. You have to be disciplined, patient investor--a Boglehead (:-))
b) MOM style, (long/short anyway) is subject to big "crashes" like in March of 2009.

Best wishes
Larry
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Re: investing with style

Postby michaelsieg » Fri Feb 08, 2013 3:39 pm

Larry
Thanks for the interesting link. Would you have any links to their original work? From reading the article I am not sure how they backtested these seemingly conflicting strategies - it would be an interesting read. Or would that information be in the book you mention?
Thanks
Michael
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Re: investing with style

Postby larryswedroe » Fri Feb 08, 2013 4:01 pm

michael
I had copy of early draft of the paper before it was officially released so no link to share
What I can tell you for what it's worth these are among the top academics in the world of modern financial theory. You won't see anything but high quality stuff from them
Don't know if it will be a published paper or just for their internal use. I got permission to write it up
Larry
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Re: investing with style

Postby Random Walker » Fri Feb 08, 2013 4:56 pm

Momentum and defense seem like they would make a value tilted portfolio more growthy. Is the key to incorporate these styles as a seperate asset class within a portfolio to rebalance against? I think I remember reading that value and momentum mixed particularly well in a portfolio.

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Re: investing with style

Postby mwgr5 » Sat Feb 09, 2013 10:04 am

Larry

Have you looked at the tax efficiency of momentum funds. I'm assuming it is higher turnover and would need to not be held in a taxable account ideally.

Also, for your clients that incorporate momentum what percent of their equities allocation does it typically represent?

Thank you
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Re: investing with style

Postby larryswedroe » Sat Feb 09, 2013 11:20 am

Dave
Yes. And that is actually a plus in this case. The reasons are momentum and value are negatively correlated, as you would expect intuitively. So combining them reduces tracking error vs. market. The profitability stocks just happen to be more growthy, but have the same type of premium as value. So while you don't get much difference in returns, you do reduce tracking error. IMO that's a positive.

MWGR5
Yes and no. First, better to combine MOM within a fund rather than separate fund. Also not as tax inefficient as you might think as have lots of opportunities to harvest losses as well. But you can run a fund in a tax aware way.

As to clients, DFA and Bridgeway both incorporate momentum into strategies but it's long only, avoiding buying stocks with negative momentum until that ceases. So it's 100% incorporated in that way. Long only also avoids the crashes MOM can have. Finally, for taxable accounts we tax managed funds where they exist in that asset class.

Best wishes
Larry
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Re: investing with style

Postby stlutz » Sat Feb 09, 2013 12:19 pm

Larry--Just to make sure I'm reading correctly: Are the strategies discussed long/short? If so, how does the paper account for the costs of shorting?

Thanks,
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Re: investing with style

Postby Random Walker » Sat Feb 09, 2013 2:05 pm

Larry,
So if a value fund incorporates momentum by patient buying and hold ranges , will its value loading factor be lower than one might think? Would the fund actually in a sense be more valuey than represented by that single number? Thanks,

Dave
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Re: investing with style

Postby larryswedroe » Sat Feb 09, 2013 3:14 pm

stlutz
Studies don't typically look at the frictions. So you have to look at the premiums and decide if they are large enough to overcome the frictions. So momentum clearly would work better in large caps than in microcaps, given the larger spreads and the high turnover of MOM strategies. And you have to be able to trade very efficiently, using algorithmic trading strategies. I've seen the data and am convinced that a well run firm that focuses on trading costs can capture it well. But I would not own a long short fund, only long only.

Dave
Yes once you add momentum (and tax management) you tend to lose bit of value exposure---the hold ranges lower the exposure and avoiding negative momentum stocks will lower it (but that is good thing).

Larry
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Re: investing with style

Postby Random Walker » Sat Feb 09, 2013 4:04 pm

Larry,
So do you advocate incorporating these styles only into current asset class funds or do you recommend investors add new "asset classes" to their portfolios. For example, should an investor think about adding a momentum fund or just take advantage of currently held funds that now incorporate momentum? Thanks

Dave
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Re: investing with style

Postby JimInIllinois » Sat Feb 09, 2013 5:15 pm

Antti Ilmanen, Ronen Israel and Tobias J. Moskowitz of AQR Capital Management studied the period 1990-2011 and found...

Whatever theoretical explanation is offered, this is an analysis of what strategies paid off over the last two decades. I have great respect for Larry, but this seems more like "fashion" than style, and tilting your portfolio towards strategies that have done well recently is not "diversifying across styles". If they found the same effects in 1950-1970 and 1970-1990 they might be on to something, but we won't be sure until everybody knows about this and it still works in 2030 or 2050.
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Re: investing with style

Postby larryswedroe » Sat Feb 09, 2013 5:59 pm

Jim
The data holds up all over the world and for periods lot longer than that. MOM and carry trade have been well known phenomenons for many decades. The profitability factor is the only new one, with Novy-Marx "discovering" it. MOM also exists not only all around the globe (with if memory serves Japan being the exception) but across asset classes. There's no recency here or fashion.

Dave
The best way is to incorporate it into existing funds or creating (as AQR is doing) a core fund that combines say value and MOM in one strategy. That cuts frictions and improves tax efficiency.


Hope that is helpful

Larry
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Re: investing with style

Postby JimInIllinois » Sat Feb 09, 2013 6:54 pm

larryswedroe wrote:Jim
The data holds up all over the world and for periods lot longer than that. MOM and carry trade have been well known phenomenons for many decades. The profitability factor is the only new one, with Novy-Marx "discovering" it. MOM also exists not only all around the globe (with if memory serves Japan being the exception) but across asset classes. There's no recency here or fashion.


Thanks for the reply. I wish your article had cited a peer-reviewed academic journal rather than a mutual fund company. It read like this had only just been discovered by AQR.
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Re: investing with style

Postby larryswedroe » Sun Feb 10, 2013 10:22 am

Jim
FWIW, what these guys write is at least as good as anything you'll find in a peer reviewed journal. They are among the top financial economists in world.
Larry
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Re: investing with style

Postby larryswedroe » Sun Feb 10, 2013 10:22 am

Jim
FWIW, what these guys write is at least as good as anything you'll find in a peer reviewed journal. They are among the top financial economists in world.
Larry
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