Fama - Embrace passive management already

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matjen
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Fama - Embrace passive management already

Post by matjen » Sat Dec 02, 2017 9:31 am

Semantics aside as to what passive actually is, a great article with many concise snippets of wisdom from Eugene Fama.
On factor investing
Forget timing factors. That’s ridiculous. A company that I’m involved with [Dimensional Fund Advisors] does it passively. They just buy the whole value segment of the market, or the whole small segment of the market. They’re not trying to pick winners or losers. Timing is even more subject to error than picking individual securities.
http://review.chicagobooth.edu/finance/ ... nt-already
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Re: Fama - Embrace passive management already

Post by garlandwhizzer » Sat Dec 02, 2017 2:06 pm

Great post. Thanks for posting it, matjen. Fama has not only depth of knowledge but also extensive experience. He sees through peddling noise analysis as insight. Refreshing.

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mickeyd
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Re: Fama - Embrace passive management already

Post by mickeyd » Sat Dec 02, 2017 2:08 pm

Timing is even more subject to error than picking individual securities.
Can't mention this too darn often.
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David Jay
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Re: Fama - Embrace passive management already

Post by David Jay » Sat Dec 02, 2017 2:13 pm

mickeyd wrote:
Sat Dec 02, 2017 2:08 pm
Timing is even more subject to error than picking individual securities.
Can't mention this too darn often.
Yup, I like the way Bernstein puts it in "Deep Risk":
"...mistiming the market is probably the most frequent and severe form of permanent capital loss."
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: Fama - Embrace passive management already

Post by Robert T » Sat Dec 02, 2017 9:02 pm

.
Thanks for the link.
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nisiprius
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Re: Fama - Embrace passive management already

Post by nisiprius » Sat Dec 02, 2017 9:44 pm

matjen wrote:
Sat Dec 02, 2017 9:31 am
Semantics aside as to what passive actually is, a great article with many concise snippets of wisdom from Eugene Fama.
On factor investing
Forget timing factors. That’s ridiculous. A company that I’m involved with [Dimensional Fund Advisors] does it passively. They just buy the whole value segment of the market, or the whole small segment of the market. They’re not trying to pick winners or losers. Timing is even more subject to error than picking individual securities.
http://review.chicagobooth.edu/finance/ ... nt-already
Please explain to me how DFA can do "patient trading" without doing any "timing."

Please explain to me how DFA can be buying "the whole value segment of the market" or "the whole small segment of the market" while also using momentum and profitability screens, and excluding utilities.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Fama - Embrace passive management already

Post by Theoretical » Sat Dec 02, 2017 10:00 pm

What he's talking about is saying factor X is expensive so we won't buy it (or as much) or saying Y is cheap so we'll buy it/more of it). It's the difference between a consistent factor load and the variable level load of a RAFI fund.

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Re: Fama - Embrace passive management already

Post by DaufuskieNate » Sun Dec 03, 2017 5:30 pm

nisiprius wrote:
Sat Dec 02, 2017 9:44 pm
Please explain to me how DFA can do "patient trading" without doing any "timing."
This is about being a provider of liquidity. If one is concerned about tracking error and slavishly following an index, trades can be forced into a market when liquidity is lacking, increasing market impact costs. This issue can be especially pronounced in small cap markets. One of DFA's initial insights was that patient trading allowed them to cost effectively provide small cap funds.

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Re: Fama - Embrace passive management already

Post by nisiprius » Mon Dec 04, 2017 8:08 am

DaufuskieNate wrote:
Sun Dec 03, 2017 5:30 pm
nisiprius wrote:
Sat Dec 02, 2017 9:44 pm
Please explain to me how DFA can do "patient trading" without doing any "timing."
This is about being a provider of liquidity. If one is concerned about tracking error and slavishly following an index, trades can be forced into a market when liquidity is lacking, increasing market impact costs. This issue can be especially pronounced in small cap markets. One of DFA's initial insights was that patient trading allowed them to cost effectively provide small cap funds.
I don't understand what you're saying at all. My understanding is that patient trading means not, "slavishly" as you call it, following an index. That means you are not getting an accurate replica of the market portfolio. Surely the hope is that one will be getting results that are better than the market portfolio--which just what active managers try to do. Both are judgement-based departures from the market portfolio. And the departure consists of waiting for an opportune time to make the trade. That's timing, to me. If DFA's timing strategy works and other firms' strategies don't, that is certainly interesting, but it is still timing.

Are you saying that, to you that it is only timing if the trader is waiting for a valuation-based opportunity, but that if you are waiting for a liquidity-based opportunity that no longer counts as "timing?"

Or that it doesn't matter because it's not very far from passive?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Fama - Embrace passive management already

Post by Random Walker » Mon Dec 04, 2017 9:01 am

I think patient trading and provider of liquidity are not market timing. The DFA funds are sort of their own indexes; they certainly aren’t interested in mirroring any external index. If the fund has certain metrics (six, value, # stocks, etc), is totally agnostic as to which stocks it has as long as the fund is meeting it’s metrics, and has rules based buy and hold ranges, then I think it’s pretty passive. It can then take advantage of other funds who need to sell quickly.

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Re: Fama - Embrace passive management already

Post by Theoretical » Mon Dec 04, 2017 12:42 pm

nisiprius wrote:
Mon Dec 04, 2017 8:08 am
DaufuskieNate wrote:
Sun Dec 03, 2017 5:30 pm
nisiprius wrote:
Sat Dec 02, 2017 9:44 pm
Please explain to me how DFA can do "patient trading" without doing any "timing."
This is about being a provider of liquidity. If one is concerned about tracking error and slavishly following an index, trades can be forced into a market when liquidity is lacking, increasing market impact costs. This issue can be especially pronounced in small cap markets. One of DFA's initial insights was that patient trading allowed them to cost effectively provide small cap funds.
I don't understand what you're saying at all. My understanding is that patient trading means not, "slavishly" as you call it, following an index. That means you are not getting an accurate replica of the market portfolio. Surely the hope is that one will be getting results that are better than the market portfolio--which just what active managers try to do. Both are judgement-based departures from the market portfolio. And the departure consists of waiting for an opportune time to make the trade. That's timing, to me. If DFA's timing strategy works and other firms' strategies don't, that is certainly interesting, but it is still timing.

Are you saying that, to you that it is only timing if the trader is waiting for a valuation-based opportunity, but that if you are waiting for a liquidity-based opportunity that no longer counts as "timing?"

Or that it doesn't matter because it's not very far from passive?
I think what they're doing is a lot closer to how Vanguard's tax exempt "active" funds have far more issues in them than the actual indexes themselves.

The proof in the pudding is the fact that DFA has ultra-low turnover, including for highly volatile asset subclasses, so they're active but in a lower transaction fee sense than a lot of traditional style indexes.

Passive management to me in the DFA sense says "we must own these 1000 stocks" but we don't have to execute the trades at the same time. It's not a question of timing price so much as it is timing spreads and trading volume.

When you're at as low of turnover as the DFA ones are, it really doesn't matter if it's "active" or "passive."

But in the context of what Fama's criticizing, it's about not doing dynamic factor tilts.

DaufuskieNate
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Re: Fama - Embrace passive management already

Post by DaufuskieNate » Tue Dec 05, 2017 7:01 am

Real world fund managers are more interested in results and common sense than semantics. Large funds can get in their own way by cramming trades into an illiquid security. Even Vanguard understands this and doesn't slavishly follow an index. TSM and TBM both employ index sampling. They avoid stocks and bonds that are in the indexes they track that are too illiquid to cost effectively trade. They acknowledge index sampling error in these funds as a potential risk factor. They still refer to both funds as passively managed index funds as do most Bogleheads I would think.

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Re: Fama - Embrace passive management already

Post by Ron Scott » Tue Dec 05, 2017 12:25 pm

I'm familiar with Fama and the Larry portfolio etc., but I'm not understanding the recommendation.

While history isn't a good guide to the future lets just use it for this case:

Have investors with significant tilts toward small company stocks--using widely available small cap funds from Vanguard, Schwab, Fidelity et al--beaten funds holding the capital-weighted total market indexes?
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Re: Fama - Embrace passive management already

Post by Solo Prosperity » Tue Dec 05, 2017 6:53 pm

Ron Scott wrote:
Tue Dec 05, 2017 12:25 pm
Have investors with significant tilts toward small company stocks--using widely available small cap funds from Vanguard, Schwab, Fidelity et al--beaten funds holding the capital-weighted total market indexes?
Over the last ~25 years the Vanguard Small-Cap Index fund has beaten the Vanguard Total Stock Market fund by ~1% per year.
nisiprius wrote:
Sat Dec 02, 2017 9:44 pm
Please explain to me how DFA can do "patient trading" without doing any "timing."

Please explain to me how DFA can be buying "the whole value segment of the market" or "the whole small segment of the market" while also using momentum and profitability screens, and excluding utilities.
I do not own any DFA funds and I do not plan on buying any either, but let's be honest here, we are timing the market one way or another. None of us hold the global market portfolio and never re-balance.

The "patient trading" that DFA does is what most everyone does in some fashion, including passive market-weighted funds. The CRSP Total Stock Market Index re-balances quarterly. For ever quarterly re-balance, they re-balance over a 5-day period. They do this for liquidity reasons. This is their version of "patient trading". DFA may have more discretion in their "patient trading" decisions, but it is simply a "best practice" when investing large sums of money. It is timing, but so is re-balancing annually.

As for DFA buying "the whole value segment of the market" comment, I would go with something like this: Either one, Fama did not want to bother with getting into the additional screens and/or rules they use to exclude certain sectors in this interview and wanted to keep it easy, or two, when Fama says the "whole value segment", he means the "whole value segment" after the additional screens they use. Fama might say that if you tried to hand-pick after those screens, that would be active to him (In reality DFA is already active...so is everyone).

Bottom line, there is only one way to be completely passive and none of us do it. There are degrees of active for sure, Vanguard TSM would be comparable to the lowest active you can find, while DFA would probably be mid-spectrum, and something like a concentrated value fund would be high active.

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Re: Fama - Embrace passive management already

Post by lack_ey » Tue Dec 05, 2017 7:00 pm

nisiprius wrote:
Mon Dec 04, 2017 8:08 am
I don't understand what you're saying at all. My understanding is that patient trading means not, "slavishly" as you call it, following an index. That means you are not getting an accurate replica of the market portfolio. Surely the hope is that one will be getting results that are better than the market portfolio--which just what active managers try to do. Both are judgement-based departures from the market portfolio. And the departure consists of waiting for an opportune time to make the trade. That's timing, to me. If DFA's timing strategy works and other firms' strategies don't, that is certainly interesting, but it is still timing.

Are you saying that, to you that it is only timing if the trader is waiting for a valuation-based opportunity, but that if you are waiting for a liquidity-based opportunity that no longer counts as "timing?"

Or that it doesn't matter because it's not very far from passive?
If I may jump in here...

The point is that it's not very far from passive (close enough in theory, spirit, and implementation), and the deviations especially with respect to trading are not really about strong views on individual securities or trying to market time based on figuring out when they're going to go up or down, but rather about cost.

Let's imagine that it cost $50 to place trades or mutual fund orders on Mondays, and you found a $100 bill on the ground on a Monday. You want to invest it in stocks. So if you wait until Tuesday to place the order, that's market timing, in some sense. But the reason is to avoid the cost of transacting on Monday, not that you have some idea that you're predicting that the market is going to crash on Monday. The overall criticism is that timing the market is hard and generally unproductive. The actions of DFA in terms of their trading are not inconsistent with that.

I do think you have something of a point here, though, more generally.

I think most active managers would look at what they're doing and say that DFA is not doing all the work of being actually active like they are.

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Re: Fama - Embrace passive management already

Post by TimeRunner » Tue Dec 05, 2017 7:21 pm

QuietProsperity wrote:
Tue Dec 05, 2017 6:53 pm
None of us hold the global market portfolio and never re-balance.
Some of us are trying to get close to that goal by owning Vanguard Total World (net assets $9.8B) and/or ACWI (net assets $8.2B) as our equity holding. It's the ultimate Boglehead equity holding. There's always some of us oddballs out there. :beer
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Re: Fama - Embrace passive management already

Post by Solo Prosperity » Tue Dec 05, 2017 9:27 pm

TimeRunner wrote:
Tue Dec 05, 2017 7:21 pm
QuietProsperity wrote:
Tue Dec 05, 2017 6:53 pm
None of us hold the global market portfolio and never re-balance.
Some of us are trying to get close to that goal by owning Vanguard Total World (net assets $9.8B) and/or ACWI (net assets $8.2B) as our equity holding. It's the ultimate Boglehead equity holding. There's always some of us oddballs out there. :beer
You can get close in one public asset class like stocks or bonds, but even with just stocks AND bonds, the largest asset class is international bonds...I doubt many (if any) bogleheads have international bonds as their largest holding :D

Then you have to consider currencies, commodities, private business, real estate, etc. My point is that it is virtually impossible to own the global portfolio, thus, we are all active in some sense. As you pointed out, some less than others, but it's a degree thing.

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