New AQR/Asness Paper on Factor Timing

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matjen
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New AQR/Asness Paper on Factor Timing

Post by matjen » Wed Jun 22, 2016 5:51 pm

Cliff Asness' latest in the ongoing disagreement he has with Arnott on this topic. Last sentence of the Abstract could have been written by our own Robert T. " Instead, investors are better off identifying factors they believe in, and staying diversified across them, unless we see far more extreme pricing than we do today."

http://papers.ssrn.com/sol3/papers.cfm? ... id=2799441


Abstract:
Arnott, Beck, Kalesnik, and West (2016) (ABKW) study smart beta or factor-based strategies and come to the following conclusions: (1) Aside from value, most popular factor strategies currently look expensive. (2) These expensive factor valuations portend lower future returns and a strong possibility of a future “factor crash” in which they go “horribly wrong.” And (3) many of these non-value factors were never real to start with because their historical performance was due to factor richening. That is, researchers mistook the one-time returns from factor richening for truly repeatable “structural alpha.” ABKW’s implied bottom line (their many protestations to only making modest recommendations aside): stick with value, dump the other factors. This essay elaborates on my response in Asness (2016). In summary: (1) I find non-value factor valuations moderately expensive, but not as expensive as ABKW. (2) I argue that ABKW exaggerate the power of factor timing by improperly using long-horizon regression techniques. More proper short-horizon regressions suggest some weak factor timing ability and given this predictability, I construct value-based tactical factor timing strategies to test them. Unfortunately, these strategies add little to portfolios that are already invested in the value factor. It turns out that this “newly” discovered timing tool is, yet again, mostly just a version of regular old value investing. And (3) I examine ABKW’s claim that factor richening drives much of non-value long-term factor performance and find that this very serious allegation about other researchers’ work is totally without merit. Overall, these results suggest that one should be wary of aggressive factor timing. Instead, investors are better off identifying factors they believe in, and staying diversified across them, unless we see far more extreme pricing than we do today.
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Angst
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Re: New AQR/Asness Paper on Factor Timing

Post by Angst » Wed Jun 22, 2016 9:41 pm

Thank you matjen for the link. I do enjoy Asness' writing style and look forward to reading this latest "Philippic" on Rob Arnott sometime tomorrow. And in my book, anything that can be favorably compared to the likes of Robert T deserves my attention.

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GreatOdinsRaven
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Re: New AQR/Asness Paper on Factor Timing

Post by GreatOdinsRaven » Thu Jun 23, 2016 1:43 am

Matjen,
Thanks for the link. Extremely entertaining- particularly the footnotes.

Asness pulls no punches!

GOR
"The greatest enemies of the equity investor are expenses and emotions." -John C. Bogle, Little Book of Common Sense Investing. | | "Winter is coming." Lord Eddard Stark.

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Rick Ferri
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Re: New AQR/Asness Paper on Factor Timing

Post by Rick Ferri » Thu Jun 23, 2016 4:27 am

The multi-factor "smart beta" space is becoming increasing crowded as investment companies trip over each other to introduce me-too products. There are now dozens of mutual funds and ETFs following known factors of value, momentum, quality and size. Given so much competition, the next step was for factor timing strategies to be introduced by index providers - and that's what this is all about.

While this stuff is theoretically interesting, it's not important. You can skip it.

Rick Ferri
The views expressed by Rick Ferri are strictly his own as a private investor and author and do not reflect the views of any entity or other persons.

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SimpleGift
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Re: New AQR/Asness Paper on Factor Timing

Post by SimpleGift » Thu Jun 23, 2016 6:15 am

While I find the dueling papers and ongoing dialogue between Mr. Arnott and Mr. Asness fascinating to read, I can’t help but be bothered by the fact that these are not unbiased, disinterested financial researchers. In other words, since both parties are managers of commercial investment funds that are founded upon their own factor-based theories and strategies, they are to some degree arguing in their own financial interest.

In short, how much of this work is a quest for truth, and how much is a quest for increased assets-under-management?
Cordially, Todd

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matjen
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Re: New AQR/Asness Paper on Factor Timing

Post by matjen » Thu Jun 23, 2016 11:26 am

Rick Ferri wrote:While this stuff is theoretically interesting, it's not important. You can skip it.

Rick Ferri


Which is basically what Asness is saying. Pick the factors/strategy exposure that you can stick with and stick with it. For three-funders that may be just beta which is fine of course.
A man is rich in proportion to the number of things he can afford to let alone.

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Re: New AQR/Asness Paper on Factor Timing

Post by lack_ey » Thu Jun 23, 2016 11:51 am

Simplegift wrote:While I find the dueling papers and ongoing dialogue between Mr. Arnott and Mr. Asness fascinating to read, I can’t help but be bothered by the fact that these are not unbiased, disinterested financial researchers. In other words, since both parties are managers of commercial investment funds that are founded upon their own factor-based theories and strategies, they are to some degree arguing in their own financial interest.

In short, how much of this work is a quest for truth, and how much is a quest for increased assets-under-management?

I see those things as largely complementary here. Their reputations are built in large part from their publishing background, which is bolstered by lines of inquiry that challenge norms as well as attempts to get things right and figure out the world. It's not all about supporting their product lines, current or future. And they may get more AUM over the long term contributing better research, wherever that leads, which can also help with attracting better talent too.

All in all, there's a deep and obvious conflict of interest, but it's not like researchers in academia and others away from the asset management business don't have biases too, even if they don't have additional motivations regarding AUM. Any researcher's work is influenced by her background, familiarity with her previous work, desire for advancement (which is usually not about admitting previous work was wrong or assuming current work is not significant, for example), sources of funding in particular, the usual politics, etc. You have to treat everything with a skeptical eye anyway.

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Re: New AQR/Asness Paper on Factor Timing

Post by garlandwhizzer » Thu Jun 23, 2016 1:02 pm

Simplegift wrote:

In short, how much of this work is a quest for truth, and how much is a quest for increased assets-under-management?


1+

This is an important question. Many robust salaries are created by financial/investment research and the products they spawn. I don't believe that because Arnott and Asness are universally agreed to be experts that one should automatically design a portfolio around what they are touting. The fact that experts often vehemently disagree on factors or asset allocation decisions makes this point abundantly clear. When it comes to financial research (and much research in general) skepticism seems to me an appropriate attitude. In medicine, my former occupation, when there are many different treatments advocated for a disease, what that usually meant was that none of them worked very well. The same may be true in the financial arena. Find one approach you like and believe in and stick with it. Any low cost broadly diversified portfolio--2 fund, 3 fund, 4 fund, or various factor approaches--will work out if maintained in the long run. It is probably more important to stick to your plan through thick and thin than it is to find the perfect plan. Finding something that outperformed beautifully over a given time frame in the past is a simple exercise in arithmetic. Finding something that will outperform beautifully in the future is a very different and problematic matter.

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quantAndHold
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Re: New AQR/Asness Paper on Factor Timing

Post by quantAndHold » Thu Jun 23, 2016 1:19 pm

garlandwhizzer wrote: In medicine, my former occupation, when there are many different treatments advocated for a disease, what that usually meant was that none of them worked very well. The same may be true in the financial arena.

...

Garland Whizzer


I think this is an important point. I've heard interviews with Asness, who is indeed a very smart man, where he was explaining that this or that "works, for some definition of 'works'". Essentially, there are things you can do that will probably get you better than market returns, but it's a competitive, tough space, and even if you find something that beats the market in the long run, it's not going to beat it all the time, and it's not going to beat it by much.

I think a lot of the current discussion and disagreement, especially between these guys, is in trying to explain why certain factors outperform. Because if we understand why they outperform, then we might understand whether or not the factor will outperform in the future. But at this point, it's all pretty weak sauce.

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Re: New AQR/Asness Paper on Factor Timing

Post by Angst » Thu Jun 23, 2016 1:49 pm

Asness seems to have presented some very specific, pointed criticisms of Arnott, et al. I'm not really qualified to comment much but I'd love to hear from someone who is; as Arnott might say, a "referee". But most of the posts above seem to skirt the content of both of their complaints. Is it all then just an overblown spat between equals? Dancing on the head of a pin? Or does one of them make more sense than the other? Asness speaks and writes so well, I'm wary of falling for his persuasiveness without adequately understanding each side of the argument. And I'm not inclined to just cynically chalk it up to dueling impresarios. Larry?

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