Larry Swedroe: Patience And Diversification Crucial

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Random Walker
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Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Wed Jan 03, 2018 10:38 am

http://www.etf.com/sections/index-inves ... nopaging=1

This is an excellent short summary of the basis for Larry’s approach to investing. Larry shows that the market, size, value factors can each underperform for long periods. He shows how volatile each factor is by comparing its premium to its standard deviation. He reviews a November 2017 Fama French paper on premium volatility. The article recreates most of the most important chart from Larry’s factor book. Although Larry emphasizes the importance of diversifying across factors at the end of the article, he doesn’t recreate the rows from the above mentioned chart that show the benefit of diversifying across factors. Readers should definitely follow up this short read by checking out Chapter 9 of Your Complete Guide To Factor Based Investing.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Wed Jan 03, 2018 9:50 pm

This is a great article, so thought I’d give it a bump. Although the market, small, and value premiums are substantial, their standard deviations are much larger! From the article
negative equity premiums occur in 29% of three-year and 23% of five-year simulation runs. Even for 10- and 20-year periods, negative premiums occur in 16% and 8% of simulation runs
This article is an excellent introduction to the potential significance of diversifying across factors/sources of return.

Dave

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by nedsaid » Wed Jan 03, 2018 11:40 pm

A big reason for factor investing is that the market is not a monolith. The US Total Stock Market fund advanced by 21.15% in 2017 but there were areas of the stock market that did worse and others that did better. We are in a Large Growth stock market both here in the United States and Internationally. It is tough being a Value guy nowadays, indeed I drowned my sorrows in root beer floats over the New Year's Day weekend. Small-Cap also underperformed.

In the aftermath of the bursting of the high tech bubble in 2000, Value looked awfully good after having been ignored during the 1990's. Mid-Cap/Small-Cap also performed relatively well during that time period. Needless to say, Growth did not do well during that time period. 2000-2007 was almost the inverse of the 1990's.

At some point, Value will come back.
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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Robert T » Thu Jan 04, 2018 4:19 am

.
From the Fama-French paper: https://papers.ssrn.com/sol3/papers.cfm ... id=3081101

Percent of premiums that were negative
(based on simulations with uncertain expected premiums)

1 yr / 3 yr / 5 yr / 10 yr / 20 yr / 30 yr periods

36.2 / 29.1 / 24.5 / 17.8 / 11.2 / ..8.0 = Equity premium
33.2 / 23.9 / 18.3 / 10.9 / ..5.2 / ..3.1 = Market value over market
39.3 / 33.1 / 28.7 / 22.4 / 16.0 / 12.6 = Big value over market
29.8 / 18.6 / 12.8 / ..6.1 / ..2.1 / ..1.0 = Small value over market
40.6 / 34.5 / 30.5 / 24.4 / 18.3 / 15.0 = Small over market

For alignment of expectations ...

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by iceport » Thu Jan 04, 2018 4:54 am

^^^Wow, those are some big percentages, even for longer periods. Thanks Robert T.

I'm not a factor investor (well, a minor small cap tilt), but the core message — even minus the multi-factor diversification — applies to all investors:
The lesson I’ve taken from this knowledge is that investment discipline—the ability to adhere to a well-thought-out strategy (asset allocation)—is likely to prove far more important for helping investors meet their goals than the specific asset allocation decision itself.
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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Top99% » Thu Jan 04, 2018 8:06 am

Certainly international and value investors have required patience over the last decade. For the former that patience is finally being rewarded but for the latter the waiting continues. I find periodically peeking at the Callan table https://www.bogleheads.org/wiki/Callan_ ... nt_returns helps.
Adapt or perish

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by bgf » Thu Jan 04, 2018 8:08 am

Top99% wrote:
Thu Jan 04, 2018 8:06 am
Certainly international and value investors have required patience over the last decade. For the former that patience is finally being rewarded but for the latter the waiting continues. I find periodically peeking at the Callan table https://www.bogleheads.org/wiki/Callan_ ... nt_returns helps.
novelinvestor puts out excellent tables as well.

https://novelinvestor.com/2017-year-returns/
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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Top99% » Thu Jan 04, 2018 8:18 am

bgf wrote:
Thu Jan 04, 2018 8:08 am
Top99% wrote:
Thu Jan 04, 2018 8:06 am
Certainly international and value investors have required patience over the last decade. For the former that patience is finally being rewarded but for the latter the waiting continues. I find periodically peeking at the Callan table https://www.bogleheads.org/wiki/Callan_ ... nt_returns helps.
novelinvestor puts out excellent tables as well.

https://novelinvestor.com/2017-year-returns/
Wow. These are some excellent tables and worthy of linking on the Collective Wisdom thread in my opinion.
https://novelinvestor.com/asset-class-returns/ in particular is interesting.
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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Robert T » Thu Jan 04, 2018 9:41 am

Top99% wrote:
Thu Jan 04, 2018 8:06 am
Certainly international and value investors have required patience over the last decade. For the former that patience is finally being rewarded but for the latter the waiting continues.
Small value relative to market has been positive over last 10 years for both Intl and US markets.

10 year annualized return (%) according the M*

2.04 = iShares MSCI EAFE (EFA)
2.51 = Vanguard Developed Markets (VTMGX)
6.11 = PowerShares FTSE RAFI Developed Markets ex-U.S. Small-Mid Portfolio (PDN)
5.95 = DFA International Small Cap Value (DISVX)

9.02 = Vanguard Total Stock Market (VTI)
10.25 = Vanguard MidCap Value (VOE)
10.27 = iShares S&P600 Value (IJS)

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by QuietProsperity » Thu Jan 04, 2018 4:41 pm

Robert T wrote:
Thu Jan 04, 2018 9:41 am
Top99% wrote:
Thu Jan 04, 2018 8:06 am
Certainly international and value investors have required patience over the last decade. For the former that patience is finally being rewarded but for the latter the waiting continues.
Small value relative to market has been positive over last 10 years for both Intl and US markets.

10 year annualized return (%) according the M*

2.04 = iShares MSCI EAFE (EFA)
2.51 = Vanguard Developed Markets (VTMGX)
6.11 = PowerShares FTSE RAFI Developed Markets ex-U.S. Small-Mid Portfolio (PDN)
5.95 = DFA International Small Cap Value (DISVX)

9.02 = Vanguard Total Stock Market (VTI)
10.25 = Vanguard MidCap Value (VOE)
10.27 = iShares S&P600 Value (IJS)

Robert
.
This seems to be almost entirely attributed to the size factor, not the value factor. If controlled for size and we use Large Value in the comparison, the numbers change quite a bit:

10 year annualized return (%) according the M*

2.04 = PowerShares FTSE RAFI Developed Markets ex-U.S. Portfolio (PXF)

6.97 = iShares S&P500 Value (IVE)

"Value" investors have had a tough decade. "International" investors have had a tough decade relative to U.S. stocks. "Small Value" investors have had it easier thanks to the size factor being positive over the decade.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by linenfort » Thu Jan 04, 2018 5:35 pm

I learned a new word: leptokurtic.
Thanks Random Walker & Larry.
Is it too early for an all-bond-portfolio thread?

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by MindTheGAAP » Thu Jan 04, 2018 6:23 pm

Top99% wrote:
Thu Jan 04, 2018 8:18 am
bgf wrote:
Thu Jan 04, 2018 8:08 am
Top99% wrote:
Thu Jan 04, 2018 8:06 am
Certainly international and value investors have required patience over the last decade. For the former that patience is finally being rewarded but for the latter the waiting continues. I find periodically peeking at the Callan table https://www.bogleheads.org/wiki/Callan_ ... nt_returns helps.
novelinvestor puts out excellent tables as well.

https://novelinvestor.com/2017-year-returns/
Wow. These are some excellent tables and worthy of linking on the Collective Wisdom thread in my opinion.
https://novelinvestor.com/asset-class-returns/ in particular is interesting.
Agree with you - really interesting to see how they stack up each year. REITs surprised me specifically.
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Re: Larry Swedroe: Patience And Diversification Crucial

Post by GibsonL6s » Thu Jan 04, 2018 7:39 pm

I am somewhat new here, but factor investing seems very un Bogle like. Picking a factor feels like looking in the rearview mirror and hoping a class of asset will repeat past performance / outperformance. I thought the idea is to own the market as a part of an asset allocation you can live with, keep investing and hang on. Am I not seeing this?

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Thu Jan 04, 2018 9:19 pm

Hi GibsonL6s,
I think all Bogleheads believe markets are efficient, can’t be timed, individual stock selection assumes uncompensated risk, and costs (including taxes) matter a lot. There is obviously serious variation between individuals though. Most recently the board seems dominated by total markets enthusiasts. But there is potentially plenty more to passive investing than just that. I think passive investing (index investing is a subset of passive investing) implies no market timing and no individual security selection. One can passively invest in multiple drivers of returns beyond the one factor found in a TSM fund, the market factor. Academics have identified other independent sources of equity returns: size, value, momentum, profitability/quality. These can all be accessed in a passive formulaic fashion. Accessing these factors does involve increased cost compared to TSM, but cost alone is not what matters, it’s cost per unit value added that matters. And different investors will draw the line on costs at different points. Note that the individual who invests in these factors is not purely relying on past historical performance. There are also strong risk based or behavioral based rationale for these factors to persist in the future. I do not think factor investors would dare invest in such a way without strong forward looking intuitive reasons to expect the premia to exist in the future.
Perhaps note that even John Bogle holds some equity funds with a value tilt to them and he pays attention to market valuations as well.

Dave

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by GibsonL6s » Thu Jan 04, 2018 11:10 pm

Dave

Thanks for the detailed reply!

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Top99% » Fri Jan 05, 2018 8:11 am

GibsonL6s wrote:
Thu Jan 04, 2018 7:39 pm
I am somewhat new here, but factor investing seems very un Bogle like. Picking a factor feels like looking in the rearview mirror and hoping a class of asset will repeat past performance / outperformance. I thought the idea is to own the market as a part of an asset allocation you can live with, keep investing and hang on. Am I not seeing this?
Dave covered it very well. The only thing I have to add is I view things more as a continuum:
Continuum 1: Pure Total Market Cap based asset allocaion (IE TSM) on --> Individual stocks
Continuum 2: Pick an asset allocation and never change it (IE stay the course) --> Active market timing
Some Bogleheads are on the far left side of one or both contiuums while others tend more towards the right but never all the way to the far right.
And as Dave said costs *always* matter. I personally favor a mix of TSM and factor tilts and will adjust my allocations within bands based on valuations. For example, I was overweight in REITs in the 2000s when they were screaming cheap and am at market weight now. As several people say there are many roads to Dublin,
Adapt or perish

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by packer16 » Fri Jan 05, 2018 8:26 am

Has any one tested the premise that factor diversification adds value over time. Has a portfolio of factor based ETFs/mutual funds been tested against more market weighted benchmarks to see if this actually provides a benefit (esp, since 2012)? From the discussion I have been hearing, there is alot of assumptions about benefits & backtests based upon theoretical portfolios. This real factor based portfolios have been around for at least 5 years & if the benefits are as discussed we should see some benefit of a diversified factor fund versus a stock index.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by azanon » Fri Jan 05, 2018 8:30 am

GibsonL6s wrote:
Thu Jan 04, 2018 7:39 pm
I am somewhat new here, but factor investing seems very un Bogle like. Picking a factor feels like looking in the rearview mirror and hoping a class of asset will repeat past performance / outperformance. I thought the idea is to own the market as a part of an asset allocation you can live with, keep investing and hang on. Am I not seeing this?
I think you've got it. Yes, one of the Boglehead philosophy tenants is to "invest with simplicity" (reference: Boglehead Investment Philosophy), and by that, the narrative goes on to discuss using total market indexes. There's certainly nothing simple about certain aspects of factor investing (like momentum), and the difficulty of living with tracking error (I didn't read the article, but I know that's a hurdle). What I've observed in practice, is that you have many people that subscribe and apply some or even most of the Boglehead tenants, but not necessarily every one of them.

But this is a pretty open-minded bunch so if you stray a little bit, most are ok with that. That's just my observation. Be careful though and keep that radar up when folks are straying, even if they aren't willing to acknowledge it.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by grog » Fri Jan 05, 2018 9:12 am

GibsonL6s wrote:
Thu Jan 04, 2018 7:39 pm
I am somewhat new here, but factor investing seems very un Bogle like. Picking a factor feels like looking in the rearview mirror and hoping a class of asset will repeat past performance / outperformance. I thought the idea is to own the market as a part of an asset allocation you can live with, keep investing and hang on. Am I not seeing this?
Bogle’s view is that subsets of the market like large, small, growth, value, sectors, etc. will all have their day in the sun, but trying to guess what that will be and chase after it adds complexity and introduces the risk that you will underperform the market. So Jack advocates total market because you can guarantee yourself the market return with very low management fees, trading commissions, timing problems, and tax costs. There is a lot of wisdom in what Jack says because the market return is there for the taking, but few investors manage to earn it!

That said, nowadays you can invest in things other than total market also for very low cost, and it might not be unreasonable to focus on certain types of equities depending on the portfolio, although you do face the risk of underperforming the broad market.

As you go further down the factor investing rabbit hole you soon find it goes well beyond buying an extra small cap fund. You’ll read about a half dozen factors from “the literature,” many of which are pitched as passive in the sense that they are rules-based and algorithmic, but which are quite active in that your there is sometimes constant trading, long-short strategies, etc. That more extreme stuff is pretty much anti-Bogle imo.
Last edited by grog on Fri Jan 05, 2018 1:33 pm, edited 1 time in total.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by triceratop » Fri Jan 05, 2018 9:40 am

packer16 wrote:
Fri Jan 05, 2018 8:26 am
Has any one tested the premise that factor diversification adds value over time. Has a portfolio of factor based ETFs/mutual funds been tested against more market weighted benchmarks to see if this actually provides a benefit (esp, since 2012)? From the discussion I have been hearing, there is alot of assumptions about benefits & backtests based upon theoretical portfolios. This real factor based portfolios have been around for at least 5 years & if the benefits are as discussed we should see some benefit of a diversified factor fund versus a stock index.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by livesoft » Fri Jan 05, 2018 9:53 am

packer16 wrote:
Fri Jan 05, 2018 8:26 am
Has any one tested the premise that factor diversification adds value over time. Has a portfolio of factor based ETFs/mutual funds been tested against more market weighted benchmarks to see if this actually provides a benefit (esp, since 2012)? From the discussion I have been hearing, there is alot of assumptions about benefits & backtests based upon theoretical portfolios. This real factor based portfolios have been around for at least 5 years & if the benefits are as discussed we should see some benefit of a diversified factor fund versus a stock index.

Packer
It seems that mere humans can try to have a portfolio of factor based ETFs/mutual funds, but most of them cannot manage it in a way to capture all the stuff that backtesting says they should benefit from. That is, real investors screw it up whenever they try. This is probably why Larry Swedroe has to write these articles all the time and the DFA guys have to "manage expectations", too.
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Re: Larry Swedroe: Patience And Diversification Crucial

Post by DallasGuy » Fri Jan 05, 2018 2:52 pm

Random Walker wrote:
Wed Jan 03, 2018 10:38 am
http://www.etf.com/sections/index-inves ... nopaging=1

This is an excellent short summary of the basis for Larry’s approach to investing. Larry shows that the market, size, value factors can each underperform for long periods. He shows how volatile each factor is by comparing its premium to its standard deviation. He reviews a November 2017 Fama French paper on premium volatility. The article recreates most of the most important chart from Larry’s factor book. Although Larry emphasizes the importance of diversifying across factors at the end of the article, he doesn’t recreate the rows from the above mentioned chart that show the benefit of diversifying across factors. Readers should definitely follow up this short read by checking out Chapter 9 of Your Complete Guide To Factor Based Investing.

Dave
Thanks for sharing. Very good article!

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by garlandwhizzer » Fri Jan 05, 2018 3:17 pm

Very interesting post. A Baron's article on multi-factor is worth reading.
Some historical perspective in order. When Fama and French first described the small and value factors, factor investing seemed simple. Just load up on small cap weight stocks with low book to market values and the magic happened. Few if any SCV funds these days do that. SCV funds now screen out things like junk, negative MOM, positive profitability, etc., in their SCV stock selection, likely because the simple formula doesn't work so reliably anymore. Too easy to replicate. Clearly if B/M and cap weight alone were sufficient to produce robust outperformance there wouldn't be this many approaches to trying to harvest the SCV bonus seen in academic backtesting.

The factor rage now is multi-factor funds. SCV alone is a bit out of style like wearing bell bottoms. Multi-factor in theory offers the incredible combination of higher returns with lower volatility. With that lower volatility we wouldn't expect to have to wait 10 or 15 years to harvest the premium as we do sometimes with SCV. 5 - 10 years should be an adequate time frame to assess success or lack of it because, according to theory, when one factor goes negative another picks up the slack. The only thing unaccounted for in the models is alpha, which can be quite considerable either positive (Vanguard PrimeCap) or negative (AQR's MOM funds).

A lot of money, now approaching a trillion dollars, has poured into factor based investment approaches, and recently much of it goes into multi-factor. At some point there is likely to be a limiting capacity restraint for each factor. Many experts recently agreed that the Low Vol strategy was overbought and hence that future Low Vol outperformance for the foreseeable future was likely to disappear. Isn't it possible that at some point in time the same problem might occur as the tidal wave of incoming money saturates all these factors. It could turn out in a decade or two that there will be a brand new factor approach, that current multi-factor approaches will largely have been abandoned just as simple B/M measures of SCV have gone out of style now. There is strong motivation for academics (who get promoted in universities from publishing newer and better factor research) and those in the financial industry (who create and market these new investment products and derive their income is this way) to keep cranking out more and more research and products. The optimal factor approach is a moving target and I don't suspect that will change going forward.

Academic backtesting creates investing models based what worked over long time frames in the past, most of which was done when factor funds and efts didn't comprise a significant percentage of investment volume in the market. It may be overreaching IMO to assume that this backtesting derived model is going to fully predictive of the future when that backtesting was based largely on factor-naive market participants setting asset prices. The market is dynamic and ever-changing as money rushes instantly to sources of perceived future outperformance. I suspect that factors are not immune saturation by this rush. Time will tell, but IMO the jury is still out.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by grog » Fri Jan 05, 2018 9:30 pm

garlandwhizzer wrote:
Fri Jan 05, 2018 3:17 pm
Some historical perspective in order. When Fama and French first described the small and value factors, factor investing seemed simple. Just load up on small cap weight stocks with low book to market values and the magic happened. Few if any SCV funds these days do that. SCV funds now screen out things like junk, negative MOM, positive profitability, etc., in their SCV stock selection, likely because the simple formula doesn't work so reliably anymore. Too easy to replicate. Clearly if B/M and cap weight alone were sufficient to produce robust outperformance there wouldn't be this many approaches to trying to harvest the SCV bonus seen in academic backtesting.
I remember getting Ben Graham's Intelligent Investor when I was right out of high school. In the book, he lays out some rather precise recommendations for security selection and price-to-book was one of his key screens. Whereas Graham would have had to go through investment publications and manually screen his stocks, I could get on the computer and run those stock screens within minutes. I noticed pretty quickly that the various screens I tried tended to give very clustered results, like lots of bank stocks, or oil stocks, or utility companies. And then when I looked into things a little more, it became clear that you just couldn't rely on a single metric like price-to-book in isolation, that it might mean different things depending on the accounting and on other variables (like debt) and the company's industry and situation. Price-to-book is fairly meaningless for a lot of companies and it just isn't as relevant as it would have been in the 1930s when the stock market was far more industrial. Price-to-book probably skews toward certain industries, corporate finance structures, etc., and sure it's not unbelievable that whatever it might be that price-to-book selects for might outperform over extended periods, but I don't see any reason why that simple screen would be consistent gold across decades, even through accounting changes and the transitions toward a service economy.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Buttery Lobster » Sat Jan 06, 2018 3:55 pm

I found the Odds of Negative Premium chart interesting, particularly the Momentum row showing that once you get out to a 5+ year time frame, your odds of a negative premium should be 10% or less.



Image



Most of the ETFs on the market seem to struggle to capture the momentum premium. I pulled total returns from StockCharts and compared their performance from when they launched to now. Other than MTUM (U.S.) over the past 4 1/2 years and PIZ (Developed Markets ex-U.S.) over the past 10, most have lagged index funds, often spectacularly. Does this just have to do with the timing of the past few years? Are trading costs eating away the entire premium (and more)? The academic probabilities seem completely at odds with existing products.



U.S. Large/Total Market



(3/1/07 to 1/5/18)

144.99% VTI - Vanguard Total Stock Market ETF

128.11% PDP - PowerShares DWA Momentum Portfolio



(9/7/11 to 1/5/18)

159.81% SPY - SPDR S&P 500 ETF Trust

-3.27% MOM - AGFiQ US Market Neutral Momentum Fund (long/short)



(10/25/12 to 1/5/18)

115.07% VTI - Vanguard Total Stock Market ETF

113.75% MMTM - SPDR S&P 1500 Momentum Tilt ETF



(4/18/13 to 1/5/18)

94.12% VTI - Vanguard Total Stock Market ETF

122.31% MTUM - iShares Edge MSCI USA Momentum Factor ETF



(12/3/15 TO 1/5/18)

39.30% SPY - SPDR S&P 500 ETF Trust

21.64% QMOM - MomentumShares U.S. Quantitative Momentum ETF

36.69% ONEO - SPDR Russell 1000 Momentum Focus

38.82% SPMO - PowerShares S&P 500 Momentum Portfolio



(FDMO Fidelity Momentum underperformed SPY by about 1% in roughly 15 months, SPVM is under a year old, essentially identical to SPY, DWTR PowerShares DWA Tactical Sector Rotation Portfolio underperformed by about 26% in a little over 2 years)



U.S. Small Cap



(7/19/12 to 1/5/18)

127.04% IJR - iShares Core S&P Small Cap ETF

110.21% IWM - iShares Russell 2000 ETF

99.60% DWAS - PowerShares DWA SmallCap Momentum Portfolio



Nasdaq



(5/1/03 to 1/5/18)

552.38% QQQ - PowerShares QQQ Trust

281.20% DWAQ - PowerShares DWA NASDAQ Momentum Portfolio



International Developed



(12/27/07 to 1/5/18)

24.54% EFA - iShares MSCI EAFE ETF

34.09% PIZ - PowerShares DWA Developed Markets Momentum Portfolio



(It should be noted that PIZ's average market cap is much smaller than EFA - something like Schwab's SCHC has performed about 15% better over the past 8 years)



(2/24/12 to 1/5/18)

56.96% EFA - iShares MSCI EAFE ETF

28.14% IDMO - PowerShares S&P International Developed Momentum Portfolio



(IMTM outperformed EFA by about 0.5% during the roughly three years it's existed, IMOM underperformed EFA by about 3% during the couple of years it's been around)



Emerging Markets



(12/27/07 to 1/5/18)

24.54% EEM - iShares MSCI Emerging Markets ETF

-7.13% PIE - PowerShares DWA Emerging Markets Momentum Portfolio



(2/24/12 to 1/5/18)

25.88% EEM - iShares MSCI Emerging Markets ETF

-2.45% EEMO - PowerShares S&P Emerging Markets Momentum Portfolio

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by midareff » Sat Jan 06, 2018 4:02 pm

It is interesting but at 70 years old I'm not interested in anything that could under perform for long periods.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Sat Jan 06, 2018 7:13 pm

Midareff wrote
It is interesting but at 70 years old I'm not interested in anything that could under perform for long periods.
I believe diversifying across factors is perhaps more important the SHORTER the time frame. All factors, including market beta, can underperform at any given time. I think it’s fair to assume market beta will pay off in 50 years, but it’s a coin flip what will happen next year. Moreover, I believe that a portfolio diversified across factors will underperform by little when it underperforms, and outperform significantly when it outperforms.

Dave

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by pop77 » Sat Jan 06, 2018 8:12 pm

bgf wrote:
Thu Jan 04, 2018 8:08 am
Top99% wrote:
Thu Jan 04, 2018 8:06 am
Certainly international and value investors have required patience over the last decade. For the former that patience is finally being rewarded but for the latter the waiting continues. I find periodically peeking at the Callan table https://www.bogleheads.org/wiki/Callan_ ... nt_returns helps.
novelinvestor puts out excellent tables as well.

https://novelinvestor.com/2017-year-returns/
Wow this is very cool. I am looking for a periodic table across asset classes and Callan tables do not cover asset classes like REIT. Novel comes closer. Still looking or more comprehensive tables with EM Bond, International Real Estate, Real Estate etc

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Mel Lindauer » Sat Jan 06, 2018 8:41 pm

Robert T wrote:
Thu Jan 04, 2018 9:41 am

Small value relative to market has been positive over last 10 years for both Intl and US markets.

10 year annualized return (%) according the M*

9.02 = Vanguard Total Stock Market (VTI)
10.25 = Vanguard MidCap Value (VOE)
10.27 = iShares S&P600 Value (IJS)

Robert
.
Looks like Mel's Unloved Mid Caps are still doing very well compared to the traditional slice-and-dice portfolio of 50% LC and 50% SC.
Best Regards - Mel | | Semper Fi

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by naha66 » Sun Jan 07, 2018 6:55 am

Random Walker wrote:
Sat Jan 06, 2018 7:13 pm
Midareff wrote
It is interesting but at 70 years old I'm not interested in anything that could under perform for long periods.
I believe diversifying across factors is perhaps more important the SHORTER the time frame. All factors, including market beta, can underperform at any given time. I think it’s fair to assume market beta will pay off in 50 years, but it’s a coin flip what will happen next year. Moreover, I believe that a portfolio diversified across factors will underperform by little when it underperforms, and outperform significantly when it outperforms.

Dave
You just lost all credibility. The guys 70 like he's going to wait 50 year. You even say in the 1st post in this thread that it might under perform for a long time.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Sun Jan 07, 2018 12:27 pm

Naha66 wrote
You just lost all credibility. The guys 70 like he's going to wait 50 year. You even say in the 1st post in this thread that it might under perform for a long time.
I strongly disagree. I think you may be misunderstanding my point. My point is that one should diversify across all the known equity factors: market, size, value, momentum, profitability/quality. Each on its own can underperform at any given time and for long periods. But the likelihood of underperformance for the portfolio decreases lots when diversified across all the factors. See the 1/N portfolios at the bottom of table in Chapter 9 of Larry’s factor book. Hopefully he will follow up this article with one showing the value of factor diversification: the bottom 3 rows of the chart he excluded from this article.

Dave

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by rfowler » Sun Jan 07, 2018 2:22 pm

Hello all,

Very interesting article by Swedroe -- thanks for posting.

I would appreciate comments on Swedroe's concluding lines in the article -- I am scratching my head a bit:
"Thus, the prudent strategy (the one most likely to allow you to achieve your goals) is to diversify across various factors, not concentrating risk in any single factor (which is typical of most “conventional” marketlike 60% equity/40% bond portfolios that have as much as 85-90% of their total risk in the market beta factor). Diversification reduces the risk of having too many of your eggs in the one basket that draws the short straw over your investment horizon."
What do you think he is referring to as the "typical 60/40" portfolio? Is he implying that for investors who have a 60/40 allocation (whether Boglehead advised or financial advisor guided), the equity portion is probably NOT diversified? i.e. Would the Boglehead 3-fund portfolio be a "typical" (non-diversified) portfolio compared to a 10-fund slide and dice?

I've reread the article and not sure what his conclusion means.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Sun Jan 07, 2018 2:31 pm

Rfowler,
Yes I think he is saying the typical 60/40 portfolio has overwhelmingly total market or large cap growth type funds. I think he would say that the typical TSM equity portfolio is diversified by number of stocks and minimization of single stock risk. But the equity portion is not diversified from the standpoint of the factors known to drive equity returns. A TSM portfolio only has exposure to one factor, the market factor. One can potentially diversify across factors: market, size, value, profitability, momentum.

Dave

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The total market contains all factors

Post by Taylor Larimore » Sun Jan 07, 2018 2:55 pm

A TSM portfolio only has exposure to one factor, the market factor. One can potentially diversify across factors: market, size, value, profitability, momentum.
Random Walker:

It seems to me that a total market portfolio by definition must already contain market factors. Factor proponents simply overweight the factors they think will outperform.

Best wishes.
Taylor
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Re: Larry Swedroe: Patience And Diversification Crucial

Post by betablocker » Sun Jan 07, 2018 5:25 pm

The market write large contains all the risk factors in a way but they cancel each other out. What we are trying to do is own the factors that are distinct, have positive expected returns and get the benefit of diversifying across them. Why would you want to own risk factors with negative expected returns?

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by grog » Sun Jan 07, 2018 5:58 pm

betablocker wrote:
Sun Jan 07, 2018 5:25 pm
The market write large contains all the risk factors in a way but they cancel each other out. What we are trying to do is own the factors that are distinct, have positive expected returns and get the benefit of diversifying across them. Why would you want to own risk factors with negative expected returns?
“Canceling out” is diversification. The “factors” aren’t actual things that you can own. They are just statistical abstractions. The companies on the S&P 500 in contrast are real, investable businesses and they do not have negative expected returns. If beta (i.e., the whole stock market) sinks, small cap value will not be much of a life raft.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by betablocker » Sun Jan 07, 2018 7:43 pm

The companies a value fund owns are just as real and investable as the ones that any fund owns.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Toons » Sun Jan 07, 2018 7:48 pm

I agree.
Tend to your portfolio
Like You would a
Cactus Plant :mrgreen:
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by in_reality » Sun Jan 07, 2018 9:02 pm

betablocker wrote:
Sun Jan 07, 2018 5:25 pm
The market write large contains all the risk factors in a way but they cancel each other out. What we are trying to do is own the factors that are distinct, have positive expected returns and get the benefit of diversifying across them. Why would you want to own risk factors with negative expected returns?
Your positive expected returns (for your favored factors) are derived from theoretical long-short portfolios that don't have trading costs. Some of the trades are impossible in real life (you just can't find a stock to short), some of the trades have market impact, and the trades have cost. And some of the theoretical returns are from stocks that wouldn't make it into an index in the first place (very awful small growth stocks).

Most of us use long only portfolios.
Random Walker wrote:
Sat Jan 06, 2018 7:13 pm
Midareff wrote
It is interesting but at 70 years old I'm not interested in anything that could under perform for long periods.
I believe diversifying across factors is perhaps more important the SHORTER the time frame. All factors, including market beta, can underperform at any given time. I think it’s fair to assume market beta will pay off in 50 years, but it’s a coin flip what will happen next year. Moreover, I believe that a portfolio diversified across factors will underperform by little when it underperforms, and outperform significantly when it outperforms.

Dave
Looking at the actual returns of real multi factor funds over their short lifetimes, you'll see diversification over factors doesn't really help.

CAGR for Large/Mid Cap funds: Oct 2015 - Dec 2017 (lifetime of JPUS and GSLC)
17.05% SCHX Schwab [large cap, market weighting]
16.98% SCHV Schwab [large cap value]
16.46% LRGF iShares [quality, value, size and momentum - large and mid caps]
16.31% JPUS JPMorgan [value, quality and momentum factors]
15.18% QCELX AQR [value, momentum and quality]
15.29% GSLC Goldman Sachs [value, momentum, quality and low volatility]

CAGR for Small Cap funds: May 2015 - Dec 2017 (lifetime of SMLF)

13.13% SMLF iShares Edge [value, quality, momentum, and low size - small cap stocks]
10.40% VBR Vanguard [small cap value]
9.93% VB Vanguard [small cap, market weighting]
7.94% QSMLX AQR [value, momentum and quality - small cap stocks]

Looking at the fund loadings and premiums doesn't really explain much given that the Annual Alphas range from -0.54% (SCHX) to -5.83% (QSMLX).

In general, funds with poorer performance have worse negative alpha. To me it seems the implementations are not able to match the exposure of academic long/short portfolios, and that mismatch shows up in alpha. Or the data is just too noisy which raises the question of how these funds select stocks if the underlying exposures are noisy.

It looks to me like maybe the difference between SMLF and QSMLX is the implementation of momentum measures. We can see this in iShares' and AQR's straight momentum funds. iShare funds seem to have done better in this environment.

It leads me wonder if multi-factor funds aren't rather like active managed ones in that some will outperform in a particular environment during a particular time, but it's difficult to choose them in advance.

To the best of my knowledge, I have seen no-one recommending SMLF. I am not recommending it either since perhaps choosing it now based on past performance will give you the same results as choosing active funds based on past performance.

Perhaps over a long time, the returns of various multi-factor funds will converge and trend towards exceeding market cap weighting. I don't see that now though over the short life of these types of funds.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by naha66 » Sun Jan 07, 2018 9:30 pm

Random Walker wrote:
Sun Jan 07, 2018 12:27 pm
Naha66 wrote
You just lost all credibility. The guys 70 like he's going to wait 50 year. You even say in the 1st post in this thread that it might under perform for a long time.
I strongly disagree. I think you may be misunderstanding my point. My point is that one should diversify across all the known equity factors: market, size, value, momentum, profitability/quality. Each on its own can underperform at any given time and for long periods. But the likelihood of underperformance for the portfolio decreases lots when diversified across all the factors. See the 1/N portfolios at the bottom of table in Chapter 9 of Larry’s factor book. Hopefully he will follow up this article with one showing the value of factor diversification: the bottom 3 rows of the chart he excluded from this article.

Dave

I think you miss my point. How many 60+ year old want to get that deep into factors, oh but pay me 1% or more and I will do it for you. I doubt if the cost pays back over the long term. It just a different type of active investing for FA's. Yes you use mostly index funds but that doesn't change the fact that it not cheap or simple which is the backbone of Bogleheads. You are trying too hard to prove a point, maybe you might eke out a slight out performance but is it worth the time or money, I doubt it.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Sun Jan 07, 2018 9:40 pm

Naha66,
You bring up a good point. Costs are certain, and the benefits are only potential. Cost may or may not be worth it over the long term. No one knows, and we all individually make our best estimates. I strongly feel individual investors should understand the trade offs involved in the decisions they are making though. I think the simplicity argument is way over played. If one can maintain a 3 fund portfolio with appropriate rebalancing and tax loss harvesting, he can do the same for 8-10 funds. The additional work is negligible.

Dave

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Sun Jan 07, 2018 9:47 pm

In reality,
Not sure what point your data makes. We need to look at whole portfolios not individual funds. Moreover the last few years have been a short period dominated by large growth. And of course we know that the best long only equity funds can achieve is about half the factor exposure seen in academic long-short portfolios.

Dave

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by in_reality » Sun Jan 07, 2018 10:02 pm

Random Walker wrote:
Sun Jan 07, 2018 9:47 pm
In reality,
Not sure what point your data makes. We need to look at whole portfolios not individual funds. Moreover the last few years have been a short period dominated by large growth.
I see a benefit in looking at actual returns instead of assuming real funds will mirror hypothetical academic returns.

That's why I compared multi-factor funds to value funds. You had suggested that targeting multiple factors was "more important the SHORTER the time frame".

It doesn't seem adding additional factors had benefit short term. Certainly not for the large caps and only depending on implementation for the smaller ones.
Random Walker wrote:
Sun Jan 07, 2018 9:47 pm
And of course we know that the best long only equity funds can achieve is about half the factor exposure seen in academic long-short portfolios.

Dave
Well what I am seeing in real long funds is that they have factor exposure. They also have negative alpha. So even if a fund loads on size, it's been suggested the negative alpha arises from the mismatch between what the fund holds and the academic returns in hypothetical long/short portfolios.

And again if you missed the point, this raises the question of whether simply choosing a multi-factor fund will provide you the returns promised by hypothetical long/short portfolios, or whether it's more like active investing where it's difficult to know which fund will outperform in advance.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Random Walker » Sun Jan 07, 2018 10:17 pm

I’m not looking for one factor fund to outperform versus another. I’m just looking for the purest factor exposures achieved in a passive formulaic manner. I guess there is some alpha achieved (patient trading, tax management, securities lending), but for the most part just looking for returns explained by factor exposures.

Dave

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by QuietProsperity » Mon Jan 08, 2018 1:32 am

in_reality wrote:
Sun Jan 07, 2018 9:02 pm
It leads me wonder if multi-factor funds aren't rather like active managed ones in that some will outperform in a particular environment during a particular time, but it's difficult to choose them in advance.
The problem of course is the varying factor exposures of these new multi-factor funds. One year they might lean heavier on one factor versus the next. They essentially seem to be "timing" factors. When most academics use a back-test to prove the validity of a "multi-factor" approach, they typically have constant weights to each factor. Obviously in the real world, that is impossible, but by using multi-factor funds, you have no chance to get anything close to constant factor exposure.



As great as a multi-factor approach sounds in a whitepaper, the reality is that they have not paid off so far. They seem to have some pretty wild tracking error and the performance has been awful.

in_reality wrote:
Sun Jan 07, 2018 10:02 pm


That's why I compared multi-factor funds to value funds. You had suggested that targeting multiple factors was "more important the SHORTER the time frame".

If we use a single-factor blend approach instead of the multi-factor funds, Random Walker's thesis at least has a chance...



Image

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UA

Post by in_reality » Mon Jan 08, 2018 2:29 am

QuietProsperity wrote:
Mon Jan 08, 2018 1:32 am
in_reality wrote:
Sun Jan 07, 2018 9:02 pm
It leads me wonder if multi-factor funds aren't rather like active managed ones in that some will outperform in a particular environment during a particular time, but it's difficult to choose them in advance.
The problem of course is the varying factor exposures of these new multi-factor funds. One year they might lean heavier on one factor versus the next. They essentially seem to be "timing" factors. When most academics use a back-test to prove the validity of a "multi-factor" approach, they typically have constant weights to each factor. Obviously in the real world, that is impossible, but by using multi-factor funds, you have no chance to get anything close to constant factor exposure.



As great as a multi-factor approach sounds in a whitepaper, the reality is that they have not paid off so far. They seem to have some pretty wild tracking error and the performance has been awful.

in_reality wrote:
Sun Jan 07, 2018 10:02 pm


That's why I compared multi-factor funds to value funds. You had suggested that targeting multiple factors was "more important the SHORTER the time frame".

If we use a single-factor blend approach instead of the multi-factor funds, Random Walker's thesis at least has a chance...



Image
The single-factor blend you cite has a negative loading on value and size (since Aug 2013 or inception of QUAL). During that time value and size premiums were negative. Isn't the premise of factor investing that value and size will return a premium over time, so you want a portfolio that loads positively on value and size? Most factor investors aren't using portfolios with negative value and size loadings, so I am not sure of how much evidence that really is.



It's an interesting point though because the multi-factor funds have often been touted as being more efficient. Perhaps using the single combination simply allowed you create a portfolio with characteristics more typical of large growth.



Anyway, my point was about the difficulty in fund selection. If you had chosen AQR's AMOMX (AQR is often recommended by Larry Swedroe) in the single-factor blend then the CAGR drops (from 13.87% with MTUM) to 12.84% vs 13.05% for SCHX. They load quite similarly on size.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by packer16 » Mon Jan 08, 2018 8:38 am

One possibility here is that factor investing is more akin to active investing than passive investing. In this case, the early adopters will reap the gains until the factor premium is arbed away. The assumption made in factor investing is the underlying characteristics of firms associated with a factor do not change materially over time & thus you can rely on reversion to the mean to get returns. However, this is at odds with the EMH. As time goes on securities should be priced better and any factor premium should be arbed away. If this is happening then value stocks should be getting crappier and growth stocks higher quality. Without seeing if this is going on in the underlying stocks you cannot be sure your factor portfolio has consistent characteristics.

If factors are more akin to active than passive, then diversification will not help either. Once the factor premium is arbed away all you will have is at most marker returns with more volatility, which is what I think we are seeing. You are also betting against the wisdom of the crowd which should set prices based upon the factors so by deviating from the market you are saying you know more than the market, a very bog assumption.


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Re: Larry Swedroe: Patience And Diversification Crucial

Post by Robert T » Mon Jan 08, 2018 8:42 am

.
The word 'multifactor' seems to have different meanings to different people, confused further by financial industry 'marketing'. Multifactor is simply more than one factor (multi = more than one). By extension - large cap value and small cap are multi-factor (exposure to two 'risk factors' each), as is small cap value (exposure to three 'risk factors'). The Fama-French three factor equity model explains on average about 95% of the variability of returns across a spectrum of different equity portfolios (re: https://www.ifa.com/academic-papers/mul ... a_2006.pdf ) - so there is not much benefit in explanatory power from adding additional factors ( https://papers.ssrn.com/sol3/papers.cfm ... id=2509529 ). And the higher the number of 'risk factors' added to a portfolio, the more portfolio construction/design seems to matter, and the more costs seem to increase. IMO it is better to focus time/energy on the "95%" (getting 'purest' exposure to Fama-French three equity risk factors - i.e. alpha closest to zero with highest R^2), than focusing that time/energy on the "5%".

Robert
.

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Re: Larry Swedroe: Patience And Diversification Crucial

Post by QuietProsperity » Mon Jan 08, 2018 3:26 pm

Robert T wrote:
Mon Jan 08, 2018 8:42 am
.
The word 'multifactor' seems to have different meanings to different people, confused further by financial industry 'marketing'. Multifactor is simply more than one factor (multi = more than one). By extension - large cap value and small cap are multi-factor (exposure to two 'risk factors' each), as is small cap value (exposure to three 'risk factors'). The Fama-French three factor equity model explains on average about 95% of the variability of returns across a spectrum of different equity portfolios (re: https://www.ifa.com/academic-papers/mul ... a_2006.pdf ) - so there is not much benefit in explanatory power from adding additional factors ( https://papers.ssrn.com/sol3/papers.cfm ... id=2509529 ). And the higher the number of 'risk factors' added to a portfolio, the more portfolio construction/design seems to matter, and the more costs seem to increase. IMO it is better to focus time/energy on the "95%" (getting 'purest' exposure to Fama-French three equity risk factors - i.e. alpha closest to zero with highest R^2), than focusing that time/energy on the "5%".

Robert
.
Robert, out if curiosity, when you run something like MTUM through a 3 factor analysis, does it still explain close to 95%? Momentum is really the only factor that disaudes me from the fama french 3 factor framework. I am indifferent to most other factors, but I have a strong belief in momentum (both relative and absolute) and for that reason, I have always felt like the 4 factor model is more inclusive, but maybe I am blowing it out of proportion. If momentum really only explains 0-5% after the first 3 factors, I need to rethink some things :confused

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FundX Momentum Fund

Post by Taylor Larimore » Mon Jan 08, 2018 4:13 pm

Bogleheads:

I became interested in "momentum" investing many years ago as I watched the first momentum fund called "Fund X" which started-out by outperforming most mutual funds. From their website:
"The Funds employ an “Upgrading” strategy whereby investment decisions are based on near-term performance . ."
http://performance.morningstar.com/fund ... ture=en-US

Fortunately, I did not invest. During the past 15 years FUNDX fund has significantly under-performed Vanguard Total Market Index Fund in The Three-Fund Portfolio

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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