The main motivation of our mentor Jack Bogle to start the first publicly available index fund was not the "efficiency" of total-market indexing; it was the simpler fact that it was a
cheap way (due to its minimal turnover*) to harvest the returns of the market. This is what he called the "Cost Matters Hypothesis". History has proven him right and continues to do so.
* Minimal turnover leads to fewer transactions which translates into less losses (relative to the market) due to transaction fees (visible), taxes on capital gains (semi-visible), and spreads (hidden).
For investors, there's something very comforting to be able to look at a Total Market index and see that his fund is tracking it very closely, given that the fund's day-to-day operations are quite opaque (e.g. how does it manage to stay in balanced despite all the subscriptions and redemptions).
The only factor which can easily be invested into is the
total market ("beta").
Total-market investing requires very little ongoing trading, and more importantly, there's little differences between definitions of what makes the total market. For example, some total-market index might include micro-caps or not; this represents a difference of less than 2%. There might be small differences in the definition of "free-float" or other inclusion criteria at the margin of investable stocks (e.g. buy stocks at their initial public offering or not? When to get rid of a penny stock?). Charts of the
real-life growth of different well-managed low-cost funds tracking total market indices show practically no differences (e.g. there's no significant difference between Vanguard's and Fidelity's total-market fund results).
Other factors, like value and small, can only be invested directly into when a fund does 2 things: it invest
long into value or small stocks, and it
shorts growth or large stocks, as if shorting was an easy thing to do (it's not, because you have to find another investor willing to lend you the stock to short) or free (it's obviously not, because the few investors who will lend you their stocks to short will charge you dearly for it). The worst part of it is that nobody seems to agree on the definition of what is a value stock, in the first place! Is book/price ratio the right definition?
Author Larry Swedroe, who published books about factors, wrote earlier in this thread that even FF don't recommend investing directly into a long/short fund. So, you end up with some weird definition of a value fund, which provides a hazy and probably unstable, given the dynamics of the market, exposure to a market factor. DFA funds, for example, don't even track an index, so you won't know if they have a tracking error. That's paradise for the fund manager, as he doesn't have to match a benchmark. Even better, DFA keeps part of its costs outside the ER by cleverly hiding them into advisor fees, as these funds are not available without paying for an advisor (or through workplace plans where the fess can be hidden). This helps keeping a part of the ongoing costs outside of comparative charts. That's really, really clever!
Back to the hazy definitions: Apparently, some real-life funds
have been more "valuey" than others. Even some of the few beloved "index" factor funds such as PXSV, on this forum (
Due diligence on RAFI Pure Small Value), don't seem to be able to stick to their choice of index, sometimes making controversial changes (
PXSV has changed indexes).
Author Larry Swedroe has been suggesting, on the forums, to invest into high-cost AQR offerings to get exposure to multi-factor funds, where the funds do provide a long/short exposure, but where the factor exposure is under ongoing change, based on the "taste" of the managers and whatever new factor is discovered. These are completely opaque funds doing all kinds of trading with no index whatsoever to track. One has to have utterly total faith into the fund manager and his traders when investing in such funds. There will be no way to compare the
outcome to anything, as apparently we should never "confuse strategy with outcome" according to author Larry Swedroe. The outcome could be either marvelous or disastrous, yet no simple investor like me will ever be able to know if it was due to luck, bad luck, cleverness/dumbness of the traders, or having succeeded to exactly match the followed factors, specially that the factor exposure is neither clearly disclosed (before hand) or even stable.
So, in summary, investing in anything other than the total market is making a huge leap of faith that the fund manager has made the "right" choice of factor definition (e.g. what is value?), partial factor exposure (for funds using long-only investments), that costs won't kill all benefits (for funds shorting stocks), and that one is not being fleeced by traders on the other side of the fund's ongoing transactions (higher turnover). It is really difficult for me to picture these investments as anything other than
active management, under any reasonable definition of "active" and "passive".
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)