Bill Sharpe: "Smart beta makes me sick"

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Erwin
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Bill Sharpe: "Smart beta makes me sick"

Post by Erwin » Mon Jun 01, 2015 2:22 pm

Sorry if this has been discussed already since it is over a year old.
I quote:
"The question Sharpe posed for a smart beta portfolio is whether it can be good for everyone. If so, then that would imply that he and his friends are dumb, because they hold the market portfolio. Other investors who underweight those stocks that are overweighted by the smart-beta strategies must be “really dumb. The market must therefore be divided between smart, dumb and really dumb investors.
The market must therefore be divided between smart, dumb and really dumb investors. “If that’s your story,” Sharpe said, “then smart beta is a way to exploit stupidity.”
“If so, then I would suggest that before too long, the really dumb ones will at least begin to choose index funds,” he said. “Maybe some of the Index-fund people will try to move in your direction,” at which point the advantage of smart-beta funds would be eliminated."

For the article:
http://www.advisorperspectives.com/acti ... harpe2.php
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Browser » Mon Jun 01, 2015 3:07 pm

If someone is able to beat the total market by means of this or that investment strategy, then someone on the other side of that trade must be underperforming the market. It is a zero-sum game. Is there any reason to believe that any particular "smart beta" strategy will reliably be on the winning side of the game?
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by JoMoney » Mon Jun 01, 2015 4:08 pm

Buying the market at a .05% ER seems pretty "smart", but I don't know that I believe "beta" is a good representation of the risk/return of these businesses. Plenty of reason to believe buying it could reliably have an advantage of at least the difference in expenses when compared to some other fund, and just about guaranteed to perform better than half the money chasing active strategies over whatever period one looks at.
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by matjen » Mon Jun 01, 2015 4:56 pm

Any deviation from market cap can be problematic if enough people follow the same strategy. Moreover, since the average investor has to, by definition, own the market, not everyone can be tilted toward the same risk factors. That is, for every value investor, there has to be a growth investor. If money managers continue to push value on everyone, then prices for value stocks will have to rise and will eventually eliminate the value premium.
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by DVMResident » Mon Jun 01, 2015 6:08 pm

mpt follower wrote:Index-fund people will try to move in your direction,” at which point the advantage of smart-beta funds would be eliminated."
Is this true? :confused

The stock premium hasn't disappeared (I hope) despite everyone "knowing" stocks are good for the long-term. It seems to me that premiums can survive discovery.

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by JoMoney » Tue Jun 02, 2015 3:54 am

DVMResident wrote:
mpt follower wrote:Index-fund people will try to move in your direction,” at which point the advantage of smart-beta funds would be eliminated."
Is this true? :confused

The stock premium hasn't disappeared (I hope) despite everyone "knowing" stocks are good for the long-term. It seems to me that premiums can survive discovery.
It's far from proven that
(A) the market is efficiently pricing "risk premiums", and
(B) these newly popularized factors actually measure "risk"
But if you have a strong faith in the EMH, and that these new measures will stand up within the real world investment universe, and that an investor with the right "risk preference" will be lucky enough such that whatever "risk" everyone else is supposedly pricing doesn't actually show up, ...then maybe it will work out.

There's at least a handful of EMH proponents who back in 1999-2000 certainly made comments contrary to the idea that the market was efficiently pricing an "equity risk premium".
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by nisiprius » Tue Jun 02, 2015 7:09 am

DVMResident wrote:
mpt follower wrote:Index-fund people will try to move in your direction,” at which point the advantage of smart-beta funds would be eliminated."
Is this true? :confused

The stock premium hasn't disappeared (I hope) despite everyone "knowing" stocks are good for the long-term. It seems to me that premiums can survive discovery.
That's an interesting point. It bears repeating that the entire premise of Glassman and Hassett's year-2000 book, Dow 36,000 was, very explicitly, that the equity risk premium was about to disappear, thanks to diffusion of knowledge of Jeremy Siegel's research, and stock prices would rise to a "perfectly reasonable price" reflecting the "undeniable historic fact" that stocks are no riskier than bonds.

So, no, the equity risk premium persists despite universal knowledge of it. But in my opinion that's because it is exactly that: reward for risk.

The claim is that "smart beta" in its various forms is not merely reward for risk, it is, in fact, a free lunch of some kind. (It's possible that Fama does not claim this. Some of his statements can be interpreted to mean it is purely reward for risk, there is no optimal choice, and it is entirely a personal decision as to the amount, shape, and texture of risk one likes best).

As for smart beta and the factor zoo, there is of course endless debate. Nobody ever will acknowledge that any factor has been discredited. Instead you get shifting definitions (small really means micro-cap, small really means small value, small value really means small value ex-utilities, value really means some combination of RMW and CMA...) and revisionism of claims (nobody ever said small company stocks had higher risk-adjusted return...) When confronted by conspicuous problems like Vanguard Small-Cap Growth Index Fund and Vanguard Small-Cap Value Index Funds having nearly identical performance, we are told that Vanguard's index providers aren't using the right definitions, etc.

Nevertheless, I don't see many people claiming that the size factor, as originally defined, is very important--the main debate is whether it has gone away or whether it was never really there. So much for small. As for value, we are starting to see articles with titles like Swedroe: Value Premium Goes Missing
I’ve been getting a lot of questions about the recent disappearance of the value premium... there has been, on average, no realized value premium over the last 10 calendar years.
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by matjen » Tue Jun 02, 2015 7:20 am

nisiprius wrote: As for value, we are starting to see articles with titles like Swedroe: Value Premium Goes Missing
I’ve been getting a lot of questions about the recent disappearance of the value premium... there has been, on average, no realized value premium over the last 10 calendar years.
From the same article it should be pointed out what a few extra years means. "As a footnote, for the 14-year period from 2000 through 2013, Fama-French small value stocks (ex-utilities) returned 12.7 percent, outperforming the S&P 500 Index by 9.1 percentage points per year. "

I am also compelled to repost a very recent Robert T. performance comparison between a SCV tilted portfolio (his) and Vanguard's Lifestrategy. Again, I guess the couple extra years makes all the difference. But it is substantial. Both on the upside and downside.

"Out of interest I just checked my portfolio performance since inception (at start of 2003) against the Vanguard lifestrategy growth funds. I have a 75:25 stock:bond portfolio with global small cap and value tilt. A combined 75:25 Vanguard Lifestrategy Growth:Moderate Growth mix provides a 75% stock:25% bond comparison.

Over last 12 years: Annualized return (%)
Lifestrategy fund combination = 8.3% (2008 return = -32.4%)
Own portfolio = 10.3% (2008 return = -28.7)

The 2008 downside would have been matched with a 35% bond allocation among the Lifestrategy fund combination for an annualized return over the last 12 years of 7.8%. In addition, using the lifestrategy funds would likely have been less tax efficient, as would need to hold some bonds in taxable account.

Obviously no guarantees.

Robert"

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Morik » Tue Jun 02, 2015 7:34 am

Browser wrote:If someone is able to beat the total market by means of this or that investment strategy, then someone on the other side of that trade must be underperforming the market. It is a zero-sum game. Is there any reason to believe that any particular "smart beta" strategy will reliably be on the winning side of the game?
Just as a thought experiment...

Lets say the whole world holds a whole-world index fund. Ok--so that is the balanced position of the game; no one is gaining or losing anything over anyone else.

Now lets say one investor decides to hold just a small-cap index fund, and small-cap returns 2x as much as the rest of the market that year. Who did this investor take those extra gains from? The market? (Would everyone else have made a little bit more that year if this investor didn't do that? Why?)

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by longinvest » Tue Jun 02, 2015 7:46 am

matjen wrote:
nisiprius wrote: As for value, we are starting to see articles with titles like Swedroe: Value Premium Goes Missing
I’ve been getting a lot of questions about the recent disappearance of the value premium... there has been, on average, no realized value premium over the last 10 calendar years.
From the same article it should be pointed out what a few extra years means. "As a footnote, for the 14-year period from 2000 through 2013, Fama-French small value stocks (ex-utilities) returned 12.7 percent, outperforming the S&P 500 Index by 9.1 percentage points per year. "
I like it when one has to exclude subsets to show outperformance, as in "Fama-French small value stocks (ex-some losing segment)...". Didn't the Total Stock Market (ex-losing subset)* outperform Fama-French small value stocks (ex-utilities)?

* I would have to dig through historical data until I found the right segments to exclude. :wink:
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Erwin » Tue Jun 02, 2015 8:35 am

Morik wrote:
Browser wrote:If someone is able to beat the total market by means of this or that investment strategy, then someone on the other side of that trade must be underperforming the market. It is a zero-sum game. Is there any reason to believe that any particular "smart beta" strategy will reliably be on the winning side of the game?
Just as a thought experiment...

Lets say the whole world holds a whole-world index fund. Ok--so that is the balanced position of the game; no one is gaining or losing anything over anyone else.

Now lets say one investor decides to hold just a small-cap index fund, and small-cap returns 2x as much as the rest of the market that year. Who did this investor take those extra gains from? The market? (Would everyone else have made a little bit more that year if this investor didn't do that? Why?)
If the system is a closed system, meaning nothing has been created, just transformed, whoever bought the Smal cap fund (individual A), in essence bought it from someone (individual B) that sold it and now has the whole world market MINUS the stocks that the individual A now owns. So, B lost what A gained. Do I make sense?
Erwin

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Maynard F. Speer » Tue Jun 02, 2015 8:56 am

I think it's fair to say, until the whole world owns the same index - by which point markets cease to function, and indexes would really have to become "smart" - the best returns will always be made by buying where the market isn't ..

e.g. If you always bought the least popular US sector, every year, you'd be (I believe) beating the market by 7% annually since the 1970s .. You'll always be buying cheaper than the market - and sectors don't stay down forever

Alice Handy - Yale and Harvard-beating endowment investor - wouldn't touch an S&P 500 tracker with a barge pole at the moment .. Last I heard she was buying mining stocks and beaten down mortgage securities .. In the early 90s she was buying technology VCTs .. In 2007 she was shorting the US market .. Where there's a crowd, there can't be a discount .. Who loses where she gains? Everyone buying any security above fair value

From what I've seen, smart beta strategies are arbitrary - you can weight by whatever you want (e.g. board members who wear bow ties) - all you're really doing is buying a bit more of where the market isn't

I don't think the terms should reflect the investor at all - but "dumb" money surely follows .. Herd animals don't have to be as smart as solitary animals .. From what I read, there's still a lot more money following into conventional indexes
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by in_reality » Tue Jun 02, 2015 9:18 am

Morik wrote: Just as a thought experiment...

Lets say the whole world holds a whole-world index fund. Ok--so that is the balanced position of the game; no one is gaining or losing anything over anyone else.

Now lets say one investor decides to hold just a small-cap index fund, and small-cap returns 2x as much as the rest of the market that year. Who did this investor take those extra gains from? The market? (Would everyone else have made a little bit more that year if this investor didn't do that? Why?)
Why is that you view that one investor as taking anything from anyone?

All of the whole-world index fund holders will receive market returns. It's as simple as that.

Time A: Say this group of whole-world holders bought when small-caps were worth $1
Time B: Say you bought small-cap stocks at $1.01 (from whom -- maybe a market maker who broke down a block of whole-world for some fee)
Time C: Say whole-world holders are now buying a group of small-cap stocks for $1.02 (again the market makers have costs)

So both Time A and Time C will receive market returns, but A will return more because they bought at a time when the price was lower. Your return will will fall in between Time A and Time C returns. I mean if small jumps to $1.50, time A gets $.50, you $.49 and C $.48. Your returns would be higher because the stocks you hold did well relative to those that you did not hold (for example large caps only go to $1.25 for a $.25 gain).

Do you doubt this? If you bought total market at a market top around 2008, and someone bought near a low, the net returns will be different but they will both receive the market returns corresponding to when they bought.

In any case, you are not taking returns from anyone. If anything, you simply took the opportunity to buy small at a certain price, and passed on buying large. Total market holders received market returns based on when they bought.

Since there were no other small stock buyers here and they return 2x, then that increase must have been due to their dividends.

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Morik » Tue Jun 02, 2015 9:49 am

in_reality wrote:
Morik wrote: Just as a thought experiment...

Lets say the whole world holds a whole-world index fund. Ok--so that is the balanced position of the game; no one is gaining or losing anything over anyone else.

Now lets say one investor decides to hold just a small-cap index fund, and small-cap returns 2x as much as the rest of the market that year. Who did this investor take those extra gains from? The market? (Would everyone else have made a little bit more that year if this investor didn't do that? Why?)
Why is that you view that one investor as taking anything from anyone?
The stock market isn't a 0-sum game. But deviations from average market returns are; so one investor's gain (or loss) compared to the market average is someone else's loss (or gain).
All of the whole-world index fund holders will receive market returns. It's as simple as that.

Time A: Say this group of whole-world holders bought when small-caps were worth $1
Time B: Say you bought small-cap stocks at $1.01 (from whom -- maybe a market maker who broke down a block of whole-world for some fee)
Time C: Say whole-world holders are now buying a group of small-cap stocks for $1.02 (again the market makers have costs)

So both Time A and Time C will receive market returns, but A will return more because they bought at a time when the price was lower. Your return will will fall in between Time A and Time C returns. I mean if small jumps to $1.50, time A gets $.50, you $.49 and C $.48. Your returns would be higher because the stocks you hold did well relative to those that you did not hold (for example large caps only go to $1.25 for a $.25 gain).

Do you doubt this? If you bought total market at a market top around 2008, and someone bought near a low, the net returns will be different but they will both receive the market returns corresponding to when they bought.

In any case, you are not taking returns from anyone. If anything, you simply took the opportunity to buy small at a certain price, and passed on buying large. Total market holders received market returns based on when they bought.

Since there were no other small stock buyers here and they return 2x, then that increase must have been due to their dividends.
My question does have some flaws. The real answer is that someone would have had to be buying and selling those stocks. So someone would have to break out just the small caps for that buyer to buy, and then someone else later would have to accept just small caps for the small cap holder to sell to. At that point it isn't true anymore that everyone else holds total market index.
So the question is non-sensical. Sorry :).

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Runalong » Tue Jun 02, 2015 10:01 am

I agree with Speer.

OTOH: "If money managers continue to push value on everyone, then prices for value stocks will have to rise and will eventually eliminate the value premium." This seems to be the common misconception. People who buy Growth stocks are generally swinging for the fences, they want that "four-bagger", the next incipient Wal-Mart or Google or Amazon or Apple. They aren't going to go away and all convert to settling for walks and singles. And they are going to strike out a lot and end up with a lower batting average than Value investors.

If you buy a full market index you are betting (yes) that high P/E (P/B, P/S, EV/EBITDA, whatever measure you prefer) stocks will do just as well in the long run as value stocks. You are swinging for singles half the time and swinging for the fence the other half and assuming that is a better long-term strategy for success than playing "small ball".

I believe that the EMH applies fully to the larger stocks, but one can still find alpha in those companies that are too small for the big boys to buy. And I believe this will persist. Even Buffet says he could do a lot better if he could focus on smaller companies.

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Erwin » Tue Jun 02, 2015 10:15 am

Runalong wrote:I agree with Speer.

OTOH: "If money managers continue to push value on everyone, then prices for value stocks will have to rise and will eventually eliminate the value premium." This seems to be the common misconception. People who buy Growth stocks are generally swinging for the fences, they want that "four-bagger", the next incipient Wal-Mart or Google or Amazon or Apple. They aren't going to go away and all convert to settling for walks and singles. And they are going to strike out a lot and end up with a lower batting average than Value investors.

If you buy a full market index you are betting (yes) that high P/E (P/B, P/S, EV/EBITDA, whatever measure you prefer) stocks will do just as well in the long run as value stocks. You are swinging for singles half the time and swinging for the fence the other half and assuming that is a better long-term strategy for success than playing "small ball".

I believe that the EMH applies fully to the larger stocks, but one can still find alpha in those companies that are too small for the big boys to buy. And I believe this will persist. Even Buffet says he could do a lot better if he could focus on smaller companies.
So, in essence, you believe that the market is NOT sufficiently efficient? I would agree with you on the very bottom of the market in terms of capitalization, where the market is not liquid. But is the small cap market not efficient?
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Maynard F. Speer » Tue Jun 02, 2015 10:29 am

mpt follower wrote:So, in essence, you believe that the market is NOT sufficiently efficient? I would agree with you on the very bottom of the market in terms of capitalization, where the market is not liquid. But is the small cap market not efficient?
Swensen (in his Yale lecture) says he believes the small-cap market is less efficient .. So you get a greater dispersal - people over-paying for what they believe to be the next Google or Microsoft, and under-paying for the boring companies that sell office stationary or make rubber bushes for washing machines

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by JoMoney » Tue Jun 02, 2015 3:35 pm

mpt follower wrote:...So, in essence, you believe that the market is NOT sufficiently efficient? I would agree with you on the very bottom of the market in terms of capitalization, where the market is not liquid. But is the small cap market not efficient?
Whether it's "efficient" or not, it's very difficult to beat. Active small-cap pickers as a group can't beat themselves within the universe of small caps, and the empirical studies reflect this. If one believes there is more opportunity in the small-cap space, they still have to demonstrate an "above average" ability to pick better stocks, or at least pick better stock picking managers, and this is not as simple as some purport.

Most of us aren't going to get more than a couple 10 year periods to invest in, if some strategy turns out miserably you're not going to get that time back, and deciding to double-down and stick it out another decade hoping things will turn around may just compound a problem - or you might change course and find that you gave up on the strategy at the wrong time.
Whatever strategy you go with, I think it has to mesh with your own philosophy in such a way that whether or not it beat some benchmark isn't the deciding factor on whether or not you would have done anything differently.
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Erwin » Tue Jun 02, 2015 4:23 pm

JoMoney wrote:
mpt follower wrote:...So, in essence, you believe that the market is NOT sufficiently efficient? I would agree with you on the very bottom of the market in terms of capitalization, where the market is not liquid. But is the small cap market not efficient?
Whether it's "efficient" or not, it's very difficult to beat. Active small-cap pickers as a group can't beat themselves within the universe of small caps, and the empirical studies reflect this. If one believes there is more opportunity in the small-cap space, they still have to demonstrate an "above average" ability to pick better stocks, or at least pick better stock picking managers, and this is not as simple as some purport.

Most of us aren't going to get more than a couple 10 year periods to invest in, if some strategy turns out miserably you're not going to get that time back, and deciding to double-down and stick it out another decade hoping things will turn around may just compound a problem - or you might change course and find that you gave up on the strategy at the wrong time.
Whatever strategy you go with, I think it has to mesh with your own philosophy in such a way that whether or not it beat some benchmark isn't the deciding factor on whether or not you would have done anything differently.
I so much agree with you. I have read extensively on SV investing, specially Swedroe's work, but I am not able to get myself to follow the strategy. I cannot afford to be on the losing side for the many years that SV is underperfoming. Thus, my portfolio is very simple and neutral, all equities are in one global equity fund plus a small tilt towards emerging markets. This way, if equities are performaning, I can guarantee that my portfolio also will.
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by Runalong » Tue Jun 02, 2015 4:36 pm

"I cannot afford to be on the losing side for the many years that SV is underperforming... This way, if equities are performaning, I can guarantee that my portfolio also will."

No one is recommending 100% US SV or even 50%. If you buy an index, half of it's holdings are going to underperform each year.

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Re: Bill Sharpe: "Smart beta makes me sick"

Post by nisiprius » Tue Jun 02, 2015 4:40 pm

longinvest wrote:
matjen wrote:
nisiprius wrote:As for value, we are starting to see articles with titles like Swedroe: Value Premium Goes Missing
I’ve been getting a lot of questions about the recent disappearance of the value premium... there has been, on average, no realized value premium over the last 10 calendar years.
From the same article it should be pointed out what a few extra years means. "As a footnote, for the 14-year period from 2000 through 2013, Fama-French small value stocks (ex-utilities) returned 12.7 percent, outperforming the S&P 500 Index by 9.1 percentage points per year."
I like it when one has to exclude subsets to show outperformance, as in "Fama-French small value stocks (ex-some losing segment)...". Didn't the Total Stock Market (ex-losing subset)* outperform Fama-French small value stocks (ex-utilities)?

* I would have to dig through historical data until I found the right segments to exclude. :wink:
Yes, I'd like to know more about that "ex-utilities" business.

I just double-checked Eugene F. Fama and Kenneth R. French, "The Cross-Section of Expected Stock Returns", The Journal of Finance, Vol. 47, No. 2 (Jun., 1992), pp. 427-465 and as I expected, the word "utilities" does not appear in it. "Ex-utilities" is not part of the original definition of small-cap value. So, when did it get added... and why?
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Re: Bill Sharpe: "Smart beta makes me sick"

Post by matjen » Tue Jun 02, 2015 4:59 pm

Nisi and Longinvest,

The no REITS and Utilities is just the way DFA constructs its portfolios. Same with no IPOs for example. The difference between pure academia and applied I suppose.

From Morningstar's Process Pillar:

http://analysisreport.morningstar.com/f ... ctcode=MLE

"Process Pillar: Positive | Alex Bryan 08/12/2014
The fund starts with stocks smaller than the 1,000th-largest U.S. stock by market cap or those representing the smallest 10% of the U.S. market, whichever breakpoint is largest. It then filters out highly regulated utilities, REITs, stocks with less than $10 million in market capitalization, and companies in bankruptcy. Until recently, the fund targeted the cheapest fourth of this universe, using book value/price. However, it expanded its reach to target the cheapest 35% and started to exclude the least-profitable companies."

From a Cloning DFA article:

http://www.etf.com/publications/journal ... nopaging=1

"DFA excludes certain asset classes, such as real estate investment trusts and highly regulated utilities that enjoy large value coefficients, so investors who replicate DFA using traditional index funds will appear to have the same HML as DFA, but they really don’t, because utilities and REITs are pretty sluggish sectors. Since DFA attains high factor loadings and deeper value exposure without these sectors, the clone should compensate by having slightly higher “value” (HmL) beta coefficients than the DFA target fund."
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