which factors matter to investors?

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larryswedroe
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which factors matter to investors?

Post by larryswedroe » Wed Nov 30, 2016 9:46 am

http://www.etf.com/sections/index-inves ... -investors

An interesting study on retail investor behavior/knowledge. Perhaps more should read my new book (:-))

Best wishes
Larry

Random Walker
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Re: which factors matter to investors?

Post by Random Walker » Wed Nov 30, 2016 10:33 am

In addition to all the often cited reasons to have a factor tilted portfolio, this essay makes me want to minimize CAPM beta market exposure to avoid the trappings of following the crowd.

Dave

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Portfolio7
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Re: which factors matter to investors?

Post by Portfolio7 » Wed Nov 30, 2016 11:53 am

The results of the study really aren't that surprising to me. Not only do many people not accept the evidence for factors, many people work off of instinct as much or more than statistics and theory; and many high income people are not mathematically nor statistically inclined (nor exceptional savers or investors). CAPM is more than just a theory, it's ingrained in the investment world in a lot of ways, in our basic assumptions about how to go about the process of investing. Additionally, professional investing seems to favor action. Many clients will pull money from a fund/manager that's declining with no sign of turn-around (sometimes they are right to do so). Some newer factor funds are over-bought as people jump into the latest fad, which tends to make many value-oriented types to want to wait until the funds crash before considering buying in. Also, factor investing is newer.... and it's easy enough to dismiss factors as anomalies (though I personally believe the evidence enough to dip my toe in the water - I tilt to value and size in my 401(k), as these are the only factors I really have access to with my fund choices.)

It would be interesting to see how many Bogleheads.com visitors employ factors, and which factors they use. For sure, many may be limited as I am by their investment vehicle(s).
"An investment in knowledge pays the best interest" - Benjamin Franklin

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nisiprius
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Re: which factors matter to investors?

Post by nisiprius » Wed Nov 30, 2016 12:27 pm

Just for laughs... and to explore the extent to which "factor-based investing" is generally accepted... it occurred to me to take a quick peek at what mutual fund companies are doing in their target retirement funds. I haven't done this yet, except for Vanguard. In order to give scope for a long holding period, I think I'll look at... let's see... 2015 minus 25 plus 65... year-2055 funds.

Target-date funds are intended for unsophisticated investors most of whom don't know about factors and wouldn't care about the factor composition, therefore mutual fund companies, who know they will be judged by results, are free to act as "sophisticated investors."

Let's start with Vanguard Target Retirement 2055, VFFVX. Since we know it uses only total market funds for U.S. and international, this is an example of a fund that ignores factors completely and a good fund to compare others against.
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For comparison, here's what a typical "factor-aware" portfolio looks like. This is the Bill Schultheis "Coffeehouse portfolio."
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Fidelity Freedom 2055, FDEEX. "Large blend" category. A distinct tilt away from value (!)
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Virtus DFA 2055 Target Date Retirement, VTITX. "Large blend" category. Just the faintest trace of small and value tilts compared to Vanguard.
Virtus has partnered with Dimensional Fund Advisors to develop the Virtus DFA Target Date Retirement Income Funds.

The Funds are grounded in Dimensional’s extensive lifecycle research in financial economics and strive to effectively manage the tradeoff between investments expected to grow and those that may help manage risk around retirement income—both while an individual is working and throughout retirement.
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T. Rowe Price Retirement 2055, TRRNX. "Large blend" category. A definite tilt away from value.
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JPMorgan SmartRetirement® 2055 Fund, JFFIX. "Large blend" category. Not only is it tilted away from value, there's a tiny tilt away from small- and mid-caps, too.
Image

My conclusions: when building target retirement mutual funds, the fund companies do not employ either the size or value factors--at least not to the extent that most "factor" advisors recommend--and, if anything, seem to tilt slightly away from value.
Last edited by nisiprius on Wed Nov 30, 2016 7:24 pm, edited 1 time in total.
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Re: which factors matter to investors?

Post by triceratop » Wed Nov 30, 2016 1:06 pm

nisiprius wrote:Just for laughs... and to explore the extent to which "factor-based investing" is generally accepted... it occurred to me to take a quick peek at what mutual fund companies are doing in their target retirement funds. I haven't done this yet, except for Vanguard. In order to give scope for a long holding period, I think I'll look at... let's see... 2015 minus 25 plus 65... year-2055 funds.

Target-date funds are intended for unsophisticated investors most of whom don't know about factors and wouldn't care about the factor composition, therefore mutual fund companies, who know they will be judged by results, are free to act as "sophisticated investors."

<snip>
Target Date (and others) funds are intended to do total market investing: they target the market beta, term, and default (to the extent that corporate issues are in VBTLX) factors. So it isn't true that they aren't looking at factors.

But I think your humorous jab at factor investing points to the precise reason there is no exposure to the value or size factor: they're targeting unsophisticated investors! Since the unsophisticated investors cannot be relied upon to know about periods of underperformance or the academic research, they'll benchmark against the S&P500 + bonds and may not stick to the same long-term strategy.

It seems unfair to ding factor-based investing because Vanguard is looking out for unsophisticated investors unaware of this approach to investing, who rightfully shouldn't believe in the approach. Isn't that what you're doing here?
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: which factors matter to investors?

Post by Aptenodytes » Wed Nov 30, 2016 1:18 pm

I didn't read the article as advocating that investors should design portfolios with respect to all identified factors, but rather that many investors appear to be inferring the presence of a "secret sauce" on the part of active managers when what they really see are known factor effects. To quote the conclusion:
they end up attributing to skill what is really nothing more than exposure to common factors, exposure that can be obtained far more cheaply through low-cost index mutual funds and ETFs
I realize Larry does think most investors would be better off utilizing size, value and momentum factors, but that's not what this piece is arguing. You might disagree that we should all be using all these factors in our portfolios, but you can still accept the conclusion of this piece.

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Re: which factors matter to investors?

Post by saltycaper » Wed Nov 30, 2016 2:01 pm

nisiprius wrote:
Target-date funds are intended for unsophisticated investors most of whom don't know about factors and wouldn't care about the factor composition, therefore mutual fund companies, who know they will be judged by results, are free to act as "sophisticated investors."
I think they know their "unsophisticated" customers will judge them by their short-term results, which I believe you hinted at before when discussing how Vanguard changed the composition of some of their TD funds, making them more stock-heavy, possibly for fear that investors would see their peers outperform with similar-sounding TD funds. But, we don't even have to go that far in making assumptions. Just witness the occasional post on this forum about how someone's portfolio is underperforming the market, with the poster not realizing a 100% US stock index is not the appropriate benchmark for a portfolio that includes bonds or international stocks. And as Larry says, if you can't stand tracking error, don't tilt. I think many "unsophisticated" investors might have trouble with tracking error, and the fund families know this.
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Re: which factors matter to investors?

Post by Theoretical » Wed Nov 30, 2016 2:25 pm

Actually, if Small/Value is a risk story, then a slight tilt to megacap growth means lower expected returns but somewhat lower risk (and FAR lower volatility risk than significant small cap holdings), which makes sense for an all-things-for-all people fund.

A tilted TDF would be a potential nightmare both because of tracking error and the dilemma of whether to increase, shrink, or maintain the tilts as the investor gets older.

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Re: which factors matter to investors?

Post by asif408 » Wed Nov 30, 2016 3:41 pm

saltycaper wrote:Just witness the occasional post on this forum about how someone's portfolio is underperforming the market, with the poster not realizing a 100% US stock index is not the appropriate benchmark for a portfolio that includes bonds or international stocks. And as Larry says, if you can't stand tracking error, don't tilt. I think many "unsophisticated" investors might have trouble with tracking error, and the fund families know this.
I tried to point this out to one of the posters you're referring to. The poster mentioned wanting to get rid of international stocks because they had underperformed US for the last couple of years. I then asked him if in 2010 he sold all his US stocks and put them in international, because from 2002-2009 International beat US stocks every year except 2008, so based on his current reasoning that's what he should have done. That seemed to click with him.

It just seems to be difficult for many people to view investing as a long-term process (more than a few years). A good chunk of Bogleheads do, but this group is a minority. Just witness the plethora of posts recently asking why anyone should own international stocks at all. I would imagine in 2006 no one would have been saying that if this forum existed then (maybe it did, I'm not sure).

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Re: which factors matter to investors?

Post by Theoretical » Wed Nov 30, 2016 4:17 pm

nisiprius wrote:My conclusions: when building target retirement mutual funds, the fund companies do not tilt employ either the size or value factors--at least not to the extent that most "factor" advisors recommend--and, if anything, seem to tilt slightly away from value.
I actually think that's a perfectly rational decision for a product oriented towards unsophisticated investors, because (1) domestic large caps are MUCH less volatile than small caps (not so much the case for international, developed or emerging), and (2) growth has expected lower returns but also lower expected risk aside from the small cap world. Honestly, I bet that's a big part of why DFA's TDFs aren't tilted either.

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Re: which factors matter to investors?

Post by larryswedroe » Wed Nov 30, 2016 9:11 pm

Theoretical
Exactly right on the DFA issue.
Larry

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