Factor Investing - A convincing article

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Always passive
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Factor Investing - A convincing article

Post by Always passive » Tue Apr 10, 2018 9:40 am


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jhfenton
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Re: Factor Investing - I convincing article

Post by jhfenton » Tue Apr 10, 2018 9:52 am

5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.

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Re: Factor Investing - I convincing article

Post by Always passive » Tue Apr 10, 2018 10:07 am

jhfenton wrote:
Tue Apr 10, 2018 9:52 am
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
We do not live forever. Using decades to try to reach a conclusion is great for the academic world, but in the life span of an investor is a very long time.
But that was not the main reason I liked the article. It was the justification for sticking with a total market strategy.

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Re: Factor Investing - I convincing article

Post by goingup » Tue Apr 10, 2018 10:18 am

I do wonder if investors here were able to stick with factor bet strategies. The original Larry Portfolio had 30% SC Value and 70% Int Treasuries, if I'm recalling correctly. Holding that for the last few years would have been tough. I'd have needed to meditate on the mantra, "Do not confuse outcome with strategy".

Allan Roth seems very optimistic about SC Value in the future. Reversion to mean?

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Re: Factor Investing - I convincing article

Post by pkcrafter » Tue Apr 10, 2018 10:34 am

Always passive wrote:
Tue Apr 10, 2018 9:40 am
I am convinced!

https://www.advisorperspectives.com/art ... went-wrong

Any comments?
Thanks, excellent article from Allan Roth.

There are a few investors on the board that have the knowledge and experience to actually capture some of these now you see 'em, now you don't factors, but it takes great patience and understanding. Most investors who read about these "smart beta" strategies will commit to them after they've had a good run, noting that their costs have gone up. They will squirm for two or three years realizing their new winners have not only not outperformed, they are lagging their old, lower cost portfolio. And they bail out. If all investors who get into smart beta strategies actually stayed with them, there would be no premium at all. It's only because they are sporadic that they work...sometimes

jhfenton wrote:
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
Come on, don't leave us in suspense, what is your secret overperformance strategy?

For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html



Paul
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Re: Factor Investing - I convincing article

Post by Portfolio7 » Tue Apr 10, 2018 11:01 am

goingup wrote:
Tue Apr 10, 2018 10:18 am
I do wonder if investors here were able to stick with factor bet strategies. The original Larry Portfolio had 30% SC Value and 70% Int Treasuries, if I'm recalling correctly. Holding that for the last few years would have been tough. I'd have needed to meditate on the mantra, "Do not confuse outcome with strategy".

Allan Roth seems very optimistic about SC Value in the future. Reversion to mean?
Certainty in investing is a pipedream, and I continue to waver on the wisdom of factor-based investing. My short and incomplete list of worries:
- I figure the market has changed over time. The mean may change with it.
- I suppose there is still a risk premium story to SCV and EM even if factors fail, but....
- it's also now far easier to invest in those historical sources of higher returns than it used to be.
- Maybe factor benefits still exist, but maybe they will be muted compared to the past?
- Even if they still exist in full, fund construction realities may limit actual outperformance.
- How factors are defined to construct an Index Fund may mean making a sector bet, or some other skew that isn't obvious.

I still tilt... but I suspect I'll refine my portfolio approach to reduce factor tilts over time as I approach retirement and recognize that my investing timeline has dropped from roughly 60 years to roughly 30 years, with luck. That means there is less time for factor trends to reverse meaningfully, and I trust the earning power of stocks in general far more than I trust the earning power of factor influences.

Anyways, this topic made me think of Yoda's comment: "Difficult to see. Always in motion is the future..."
An investment in knowledge pays the best interest.

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Re: Factor Investing - I convincing article

Post by jhfenton » Tue Apr 10, 2018 12:10 pm

pkcrafter wrote:
Tue Apr 10, 2018 10:34 am
jhfenton wrote:
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
Come on, don't leave us in suspense, what is your secret overperformance strategy?

For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html
It's not rocket science, nor is it a secret:

1. Buy your first non-401(k) investments in June or July of 1998.
2. Choose small cap value and emerging markets funds.
3. Maintain a well-balanced portfolio for the next 20+ years rebalancing from over-performing assets into under-performing assets.
4. Win!

We were 100% equities until 2015. We're currently about 80/20. We have always been heavily tilted to small cap value and emerging markets. I can't imagine why I would ever change that.

Actually, you haven't even had to rebalance small cap value or emerging markets to outperform over the last 20 years. Both VSIAX and VEMAX have significantly outperformed VTSAX since the summer of 1998:

Since July 1, 1998, Growth of $10,000

VEMAX $55,764.10
VSIAX $53,596.64
VTSAX $36,232.52

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Re: Factor Investing - I convincing article

Post by Mezzanine » Tue Apr 10, 2018 1:35 pm

Interesting maybe, but not sure I've been convinced of anything. Maybe I read through it too quickly, but it felt like a rehash of a classic argument, with a reminder that one period of 5 year returns isn't enough to evaluate a strategy:

Factor investing = higher volatility = increased probability of higher returns*
*When viewed on a LONG term time scale (not remotely close to 5 years)

If you have the time and risk tolerance to weather the variance then smart factor tilting theoretically should increase the probability of your cumulative return ending up higher. But for most investors / discrete investment goals, the risk isn't worth the reward given that the risk/return slope isn't linear. i.e. you have to take on alot more risk to increase your median probability of hitting a 14% vs a 12% return than you do to get a 12% vs. a 10% return.

I really like the RTM charts in the Bogle article pkcrafter posted
For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html
After looking at those I think I actually think Bogle's charts reinforce the conclusion that small and value factors are real and have, over more time periods than not, led to superior returns relative to simply levering up the S&P 500 to have the same variance as the small/value portfolios. The takeaway of "total market portfolio is > slice and dice" might be true for most investors but is a bit of an oversimplification IMO and neglects to acknowledge that for some people Slice and Dicing is indeed the superior choice.

I think this quote from the article sums it up:
I've been excoriated for my views, but I'm comforted by this reported exchange between Dr. Fama and a participant at a recent investment conference: "What do you say to otherwise intelligent people like Jack Bogle who examine this same data and conclude that there is no size or value premium?" His response: "How far are they from the slide? If I get far enough away, I don't see it either . . . Whether you decide to tilt towards value depends on whether you are willing to bear the associated risk . . . The market portfolio is always efficient . . . For most people, the market portfolio is the most sensible decision." Amen!
I actually get a bit irritated by the whole argument sometimes. I think the way Bogle is sometimes imprecise and overarching in his denouncement of SMB and HML complicates real understanding of Fama/French factors.

Aren't Fama and Bogle essentially agreeing, but somewhat just talking past eachother? Bogle isn't saying that factor investing doesn't work but is pointing out the fact that the returns delta is very small and it's very hard to make an argument that the additional risk is worth the reward for normal investors. Fama's research isn't concerned with whether or not it makes sense for most investors, but is simply pointing out that statistically it does work if implemented correctly over long periods of time.

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Re: Factor Investing - I convincing article

Post by pkcrafter » Tue Apr 10, 2018 3:15 pm

jhfenton wrote:
Tue Apr 10, 2018 12:10 pm
pkcrafter wrote:
Tue Apr 10, 2018 10:34 am
jhfenton wrote:
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
Come on, don't leave us in suspense, what is your secret overperformance strategy?

For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html
It's not rocket science, nor is it a secret:

1. Buy your first non-401(k) investments in June or July of 1998.
2. Choose small cap value and emerging markets funds.
3. Maintain a well-balanced portfolio for the next 20+ years rebalancing from over-performing assets into under-performing assets.
4. Win!



We were 100% equities until 2015. We're currently about 80/20. We have always been heavily tilted to small cap value and emerging markets. I can't imagine why I would ever change that.

Actually, you haven't even had to rebalance small cap value or emerging markets to outperform over the last 20 years. Both VSIAX and VEMAX have significantly outperformed VTSAX since the summer of 1998:

Since July 1, 1998, Growth of $10,000

VEMAX $55,764.10
VSIAX $53,596.64
VTSAX $36,232.52
Thank you, and that's how it's done. :!:

Paul
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Re: Factor Investing - I convincing article

Post by Doc » Tue Apr 10, 2018 6:32 pm

Mezzanine wrote:
Tue Apr 10, 2018 1:35 pm
Factor investing = higher volatility = increased probability of higher returns*
If you look at Larry Swedroe's "Black Swans" book he advocates changing your overall AA ratio to compensate for the added risk. The idea is to eiliminate or at least reduce the "fat tails" in the (both + & - ) in the distribution of returns.

In theory if you can reduce the variance you can can increase long term returns. (On average.)
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Re: Factor Investing - I convincing article

Post by triceratop » Tue Apr 10, 2018 6:52 pm

Always passive wrote:
Tue Apr 10, 2018 10:07 am
jhfenton wrote:
Tue Apr 10, 2018 9:52 am
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
We do not live forever. Using decades to try to reach a conclusion is great for the academic world, but in the life span of an investor is a very long time.
But that was not the main reason I liked the article. It was the justification for sticking with a total market strategy.
Is it though? Young investors starting out on this site are looking at a horizon of possibly 60-70 investing years.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Factor Investing - A convincing article

Post by CULater » Tue Apr 10, 2018 7:01 pm

Doesn't it sound like we are replacing one kind of risk with other risks when pursuing factor investing? The risk of not pursuing it is that all of your equity risk is riding on beta and not diversified across different factors. But the risk of pursuing it is that the findings are wrong, the risk of ineffective implementation, and/or you are skating to where the puck was and all the juice has been squeezed. If you ride the factor pony and it doesn't pay off for 5 years, 10 years, what will you do -- dismount or continue to ride? It's a risk tradeoff. Which risk is your flavor?
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Re: Factor Investing - A convincing article

Post by Good Listener » Tue Apr 10, 2018 7:21 pm

I think it's a fad and I would just go with broad indices. It's just a way for some people to sell something. We won't know for 20 years if that soon and I would bet it underperformed or adds little.

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Re: Factor Investing - A convincing article

Post by Dominic » Tue Apr 10, 2018 7:23 pm

I've flip-flopped on factors a number of times. I understand the concept. Much like it's intuitive that high-yield bonds are riskier than Treasury bonds, it is intuitive that some classes of stocks are riskier than others. Value stocks are treated by the stock market the same way high-yield bonds are treated by the bond market: they have lower valuations because they're riskier. And, if you believe equities outperform bonds, you should also believe that riskier assets should outperform less risky assets. Therefore, we expect a value premium going forward.

My issues arise when the other factors come into the mix. Why is the size premium measured by splitting the market 50/50, instead of the value/growth methodology of splitting the market into 30/40/30 and ignoring the middle 40%? Why hasn't the value premium shown up in large caps for ~25 years? Why is there a quality/profitability premium if these companies are intuitively less risky? Moreover, if we've identified 600 factors, or something to that effect, shouldn't we have expected ~5 factors to consistently appear, assuming a significance threshold of 5%?

Personally, I haven't invested in factor funds. I mostly trust the analysis, but not enough to risk my index funds' guarantee of market returns.

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Re: Factor Investing - I convincing article

Post by privatefarmer » Wed Apr 11, 2018 3:07 am

triceratop wrote:
Tue Apr 10, 2018 6:52 pm
Always passive wrote:
Tue Apr 10, 2018 10:07 am
jhfenton wrote:
Tue Apr 10, 2018 9:52 am
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
We do not live forever. Using decades to try to reach a conclusion is great for the academic world, but in the life span of an investor is a very long time.
But that was not the main reason I liked the article. It was the justification for sticking with a total market strategy.
Is it though? Young investors starting out on this site are looking at a horizon of possibly 60-70 investing years.
bingo. I'm 34 years old.

I had the pleasure of speaking to paul merriman a few years back and he broke it down very plainly : the reason we expect an equity premium is the exact same reason we would expect a small/value premium: increased risk. If you believe stocks will outperform bonds over the long-term then you should believe that riskier stocks will outperform safer stocks over the long-term, otherwise nobody would own them.

a 2%/year premium or whatever it turns out to be may not seem like much but over 30+ years we all know what kind of difference it would make.

For me, I have to either bet on large caps/growth or small caps/value. If you own the market you are betting on the former. One could reasonably put half their money in large/growth and half in small/value. I tilt as hard as I can to small/value, while still owning thousands of companies in a low-cost fund, and intend to hold that for many decades.

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Re: Factor Investing - A convincing article

Post by jalbert » Wed Apr 11, 2018 3:30 am

From the article:
Over the next five years, I’m at least 95% certain small-cap-value will do better relative to large-cap growth than the shortfall size and value have had over the past five years.
This is an odd statement. Small-cap value certainly could underperform or overperform large-cap growth over the next 5 years. I believe it underperformed from 1983 to 1998, so underperformance over another 5 years is hardly unprecedented.

I have no idea how Mr. Roth determined the 95% or greater certainty, and I'm highly skeptical that anybody knows that probability.
Risk is not a guarantor of return.

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Re: Factor Investing - A convincing article

Post by Lauretta » Wed Apr 11, 2018 4:58 am

I understand the argument that when a smart beta strategy gets crowded, prices increase and thus future returns are likely to be lower, though I am not sure how it can apply to the value strategy, since by definition the strategy regularly invests in the cheapest stocks.

Mr Roth also rightly notes that value stocks 'have a lower historic standard deviation than the broader market', so in sofar as risk is measured by beta they cannot be considered riskier. Yet it is usually postulated that they must have some other kind of risk (otherwise EMH would not be valid). For me this seems a bit of a circular argument and it's not very clear where that risks resides. A stock like Amazon, trading at at PE of more than 300, seems to have a huge way to fall if/when there is a negative surprise, so I don't understand why a value stock should be riskier. I like Warren Buffett's quote on Value investing: something along the lines of 'buying 1 dollar's worth for 50 cents is less risky than buying it for 80 cents.' Finally, if one looks at risk in terms of fat tails, this article actually shows that value strategies have positive skewness:
https://arxiv.org/pdf/1409.7720.pdf
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Re: Factor Investing - A convincing article

Post by Random Walker » Wed Apr 11, 2018 7:14 am

One way to view the extra risk of value stocks is when they do poorly. Value stocks may get hit harder in a recession than safer growth stocks. The extra risk is the stock does poorly at the same time I lose my job: doing badly in bad times.

Dave

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Re: Factor Investing - A convincing article

Post by Lauretta » Wed Apr 11, 2018 7:23 am

Random Walker wrote:
Wed Apr 11, 2018 7:14 am
One way to view the extra risk of value stocks is when they do poorly. Value stocks may get hit harder in a recession than safer growth stocks. The extra risk is the stock does poorly at the same time I lose my job: doing badly in bad times.

Dave
Thanks Dave, that's an interesting point.
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Re: Factor Investing - A convincing article

Post by Doc » Wed Apr 11, 2018 7:34 am

Dominic wrote:
Tue Apr 10, 2018 7:23 pm
My issues arise when the other factors come into the mix. Why is the size premium measured by splitting the market 50/50, instead of the value/growth methodology of splitting the market into 30/40/30 and ignoring the middle 40%?
I think you are misinformed. Maybe that's what the referenced author used but I recall the that the small effect for example is concentrated in the lowest few deciles. The problem comes when we try to use funds which are not that concentrated.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Re: Factor Investing - A convincing article

Post by Random Walker » Wed Apr 11, 2018 8:00 am

Also, I believe when companies are divided into deciles, the return rises monotonically with decreasing size decile.

Dave

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Re: Factor Investing - A convincing article

Post by Elysium » Wed Apr 11, 2018 8:02 am

I concur with the conclusion of the article:

Factor tilting is an active strategy and active investors keep markets efficient. That efficiency allows cap-weighted indexes to have the true free lunch.

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Re: Factor Investing - A convincing article

Post by Random Walker » Wed Apr 11, 2018 9:28 am

I actually thought it was a very poor article. Obviously, from my factor junkie point of view, there is some serious confirmation bias at work here. Nonetheless, here’s what I felt was wrong with the article. I know Alan is one of the good guys, but even from my naive, non financial point of view, this article has big problems.

1. The size and value factors can be accessed with cap weighted index funds
2. Describing size and value as potential free lunch is straw man argument. We all agree they represent risk factors. In fact the point of the F-F work is that they are independent and unique risk factors from market beta
3. Not all risk is reflected by SD, but depending on time period I believe value does have higher SD than market
4. 5 year returns are way too short to be meaningful
5. Who cares about the 300 published factors. What counts are the 5 or 6 that meet the persistent, pervasive, robust, intuitive, investable criteria
6. “Money pouring into factor strategies”. Despite the popularity, I believe the value - growth spread is pretty much at historical norms. Supposed increased purchase of value funds has not narrowed the valuation spread.
7. Yes data mining is potentially a huge problem! But the problem is substantially eliminated when a factor is shown to exist with out of sample data: different time period, different geographic market, even different asset class.
8. By the end of the article, the reader doesn’t even know what factors he’s talking about! He has lumped everything into “smart beta”
9. One can access factors in a passive formulaic fashion: no market timing and agnostic as to what securities are bought and sold. Factor investing is not necessarily active by definition. Guess it depends on the definition!
10. Sharpe’s Arithmetic of Active Management requires that you compare the same asset classes managed actively versus passively
11. “I tell clients owning the entire market is enough risk and there is no need to take even more”. The point of factor investing is to diversify one’s risks! How about less market beta exposure, and more exposure to non correlated risks. This is the free lunch: Diversification!

In fact, as I’ve written these points, I’ve become increasingly frustrated that this is a very poor article! I know Alan Roth is definitely one of the good guys in the financial advisory world. Perhaps he just tried to lump way too much in a very short article.

Dave

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Re: Factor Investing - A convincing article

Post by Dottie57 » Wed Apr 11, 2018 9:51 am

Random Walker wrote:
Wed Apr 11, 2018 7:14 am
One way to view the extra risk of value stocks is when they do poorly. Value stocks may get hit harder in a recession than safer growth stocks. The extra risk is the stock does poorly at the same time I lose my job: doing badly in bad times.

Dave
Why would value stocks do worse in a recession? I would think investors would flock to value.
Last edited by Dottie57 on Wed Apr 11, 2018 10:01 am, edited 1 time in total.

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Re: Factor Investing - A convincing article

Post by Lauretta » Wed Apr 11, 2018 9:58 am

Dottie57 wrote:
Wed Apr 11, 2018 9:51 am
Random Walker wrote:
Wed Apr 11, 2018 7:14 am
One way to view the extra risk of value stocks is when they do poorly. Value stocks may get hit harder in a recession than safer growth stocks. The extra risk is the stock does poorly at the same time I lose my job: doing badly in bad times.

Dave
What would value stocks do worse in a recession? I would think investors would flock to value.
My understanding is that if there is a recession value seems indeed to have larger DD, as shown e.g. here:
https://www.msci.com/documents/10199/68 ... 2e0ba81c86

(On the other hand on the previous occasion when the US market had a large DD, after the dotcom bubble burst, value did of course very well).
I hadn't thought of Dave's point because it doesn't apply to my situtation, but I think it can be a valid one for some investors.
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Re: Factor Investing - A convincing article

Post by Dottie57 » Wed Apr 11, 2018 10:08 am

Lauretta wrote:
Wed Apr 11, 2018 9:58 am
Dottie57 wrote:
Wed Apr 11, 2018 9:51 am
Random Walker wrote:
Wed Apr 11, 2018 7:14 am
One way to view the extra risk of value stocks is when they do poorly. Value stocks may get hit harder in a recession than safer growth stocks. The extra risk is the stock does poorly at the same time I lose my job: doing badly in bad times.

Dave
What would value stocks do worse in a recession? I would think investors would flock to value.
My understanding is that if there is a recession value seems indeed to have larger DD, as shown e.g. here:
https://www.msci.com/documents/10199/68 ... 2e0ba81c86

(On the other hand on the previous occasion when the US market had a large DD, after the dotcom bubble burst, value did of course very well).
I hadn't thought of Dave's point because it doesn't apply to my situtation, but I think it can be a valid one for some investors.
What is DD?

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Re: Factor Investing - A convincing article

Post by Lauretta » Wed Apr 11, 2018 10:18 am

Dottie57 wrote:
Wed Apr 11, 2018 10:08 am

What is DD?
drawdown
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Re: Factor Investing - A convincing article

Post by Random Walker » Wed Apr 11, 2018 10:35 am

At the limits of my knowledge here. I know the answer is in Antti Ilmanen’s book Expected Returns though. I know it’s one of the very best books, but I haven’t been able to make myself get through it. My understanding is that because value companies tend to be highly leveraged, have wide variability of their earnings, big fixed costs with potential for excess unused capacity when demand declines, they are especially hit hard in bad economic times. Conversely, when the economy improves, they can quickly take advantage of the excess capacity to come back strong.

Dave

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Re: Factor Investing - A convincing article

Post by jalbert » Wed Apr 11, 2018 1:23 pm

Random Walker wrote:
Wed Apr 11, 2018 8:00 am
Also, I believe when companies are divided into deciles, the return rises monotonically with decreasing size decile.

Dave
That is certainly not correct. Consider penny stocks as a counterexample.
Risk is not a guarantor of return.

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Re: Factor Investing - A convincing article

Post by Random Walker » Wed Apr 11, 2018 1:54 pm

Penny stocks I believe are a known anomaly, frequently screened out of SV funds.

Dave

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Re: Factor Investing - A convincing article

Post by dkturner » Wed Apr 11, 2018 2:00 pm

Dottie57 wrote:
Wed Apr 11, 2018 9:51 am
Random Walker wrote:
Wed Apr 11, 2018 7:14 am
One way to view the extra risk of value stocks is when they do poorly. Value stocks may get hit harder in a recession than safer growth stocks. The extra risk is the stock does poorly at the same time I lose my job: doing badly in bad times.

Dave
Why would value stocks do worse in a recession? I would think investors would flock to value.
They did in the last 3 major bear markets:
1973-1974 Large Growth -44.5%, Large Value -23.1%
2000-2002 Large Growth -55.5%, Large Value -14.6%
2008 Large Growth -38.4%, Large Value -36.9%

But not during the “Big One”:
1929-1932 Large Growth -65.2%, Large Value -78.4%

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Re: Factor Investing - A convincing article

Post by Taylor Larimore » Wed Apr 11, 2018 2:13 pm

Bogleheads:

Allan Roth is one of the good guys. He has been on our "Panel of Experts" at Boglehead Conventions. Allan is a CPA, CFA and author of "How a Second Grader Beats Wall Street." If I have a difficult question, I often go to Allan to get a good answer.

Allan's Second Grader Three-Fund Portfolio is currently leading all eight CBS MarketWatch Professional Portfolios for 1-year, 3-year, 5-year, and 10-year returns.

When Allan writes about Factor Investing and other subjects, I have learned it pays to listen.

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

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Re: Factor Investing - A convincing article

Post by fennewaldaj » Wed Apr 11, 2018 2:15 pm

I am not sure if there are any papers that explore this but it is also a possible risk that the new economy narrative will eventually be right. When we overweight value stocks we essentially bet that the new economy narrative is always wrong. Eventually it may be right and I would expect value to do very poorly in that case. That said I am still willing to bet on the new economy narratives always being wrong.

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Re: Factor Investing - A convincing article

Post by jalbert » Wed Apr 11, 2018 3:24 pm

Random Walker wrote:
Wed Apr 11, 2018 1:54 pm
Penny stocks I believe are a known anomaly, frequently screened out of SV funds.

Dave
So expected return is not a monotone function of size.
Risk is not a guarantor of return.

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Re: Factor Investing - A convincing article

Post by triceratop » Wed Apr 11, 2018 5:21 pm

Taylor Larimore wrote:
Wed Apr 11, 2018 2:13 pm
Bogleheads:

Allan Roth is one of the good guys. He has been on our "Panel of Experts" at Boglehead Conventions. Allan is a CPA, CFA and author of "How a Second Grader Beats Wall Street." If I have a difficult question, I often go to Allan to get a good answer.

Allan's Second Grader Three-Fund Portfolio is currently leading all eight CBS MarketWatch Professional Portfolios for 1-year, 3-year, 5-year, and 10-year returns.

When Allan writes about Factor Investing and other subjects, I have learned it pays to listen.

Best wishes.
Taylor
Once again, comparing equity-dominated portfolios to bond-dominated portfolios to prove something about the validity of the underlying ideas is suspect to put it mildly.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Factor Investing - A convincing article

Post by jalbert » Fri Apr 13, 2018 8:14 pm

Taylor Larimore wrote:
Wed Apr 11, 2018 2:13 pm
Bogleheads:

Allan Roth is one of the good guys. He has been on our "Panel of Experts" at Boglehead Conventions. Allan is a CPA, CFA and author of "How a Second Grader Beats Wall Street." If I have a difficult question, I often go to Allan to get a good answer.

Allan's Second Grader Three-Fund Portfolio is currently leading all eight CBS MarketWatch Professional Portfolios for 1-year, 3-year, 5-year, and 10-year returns.

When Allan writes about Factor Investing and other subjects, I have learned it pays to listen.

Best wishes.
Taylor
Taylor,

I’ve never met Mr. Roth, but my impression is that he is very knowledgeable of investment and tax issues, and provides his clients with a high quality service, so I have no reason to dispute your position.

I found two things in the article that I thought could be quite misleading to someone who is not knowledgeable about smart beta and/or factor investing.

First, if I’m understanding the article correctly, it conflates small-cap value with smart beta. It has the premise that Mr. Roth has been hearing the virtues of smart beta extolled for the last 5 years, and then claims it failed by presenting returns for small-cap value. I’m not aware of any investment products being marketed as smart beta that are in fact small-cap value portfolios.

Second, my understanding of the article is that Mr. Roth claims that a 5-year underperformance of small-cap value is significant and that he is 95% certain that small cap value will overperform large-cap growth in the next 5 years by a greater magnitude than the recent 5-year underperformance. Small-cap value underperformed for 14 years from 1984-1998 (15 years of you pick the correct start month). Nobody knows the probability of small-cap value overperforming for the next 5 years.

Factor tilting is not appropriate for all investors. I’m not enamored with the moderately heavy tilts I hear some investors espouse. A portfolio that may have 15-20 years of market tracking error is not my interest. I think that is the best motivation for rejecting factor investing in favor of a total market index for those who make that choice.
Last edited by jalbert on Fri Apr 13, 2018 10:59 pm, edited 1 time in total.
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Re: Factor Investing - I convincing article

Post by HomerJ » Fri Apr 13, 2018 8:53 pm

jhfenton wrote:
Tue Apr 10, 2018 12:10 pm
pkcrafter wrote:
Tue Apr 10, 2018 10:34 am
jhfenton wrote:
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
Come on, don't leave us in suspense, what is your secret overperformance strategy?

For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html
It's not rocket science, nor is it a secret:

1. Buy your first non-401(k) investments in June or July of 1998.
2. Choose small cap value and emerging markets funds.
3. Maintain a well-balanced portfolio for the next 20+ years rebalancing from over-performing assets into under-performing assets.
4. Win!

We were 100% equities until 2015. We're currently about 80/20. We have always been heavily tilted to small cap value and emerging markets. I can't imagine why I would ever change that.

Actually, you haven't even had to rebalance small cap value or emerging markets to outperform over the last 20 years. Both VSIAX and VEMAX have significantly outperformed VTSAX since the summer of 1998:

Since July 1, 1998, Growth of $10,000

VEMAX $55,764.10
VSIAX $53,596.64
VTSAX $36,232.52
Did you invest all your money in July 1, 1998 and not a cent since then? Because if not, you haven't gotten these results.

Emerging Markets did terrible compared to VTSAX these past 9 years.
Last edited by HomerJ on Fri Apr 13, 2018 8:56 pm, edited 1 time in total.

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Re: Factor Investing - I convincing article

Post by HomerJ » Fri Apr 13, 2018 8:56 pm

pkcrafter wrote:
Tue Apr 10, 2018 3:15 pm
jhfenton wrote:
Tue Apr 10, 2018 12:10 pm
pkcrafter wrote:
Tue Apr 10, 2018 10:34 am
jhfenton wrote:
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
Come on, don't leave us in suspense, what is your secret overperformance strategy?

For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html
It's not rocket science, nor is it a secret:

1. Buy your first non-401(k) investments in June or July of 1998.
2. Choose small cap value and emerging markets funds.
3. Maintain a well-balanced portfolio for the next 20+ years rebalancing from over-performing assets into under-performing assets.
4. Win!



We were 100% equities until 2015. We're currently about 80/20. We have always been heavily tilted to small cap value and emerging markets. I can't imagine why I would ever change that.

Actually, you haven't even had to rebalance small cap value or emerging markets to outperform over the last 20 years. Both VSIAX and VEMAX have significantly outperformed VTSAX since the summer of 1998:

Since July 1, 1998, Growth of $10,000

VEMAX $55,764.10
VSIAX $53,596.64
VTSAX $36,232.52
Thank you, and that's how it's done. :!:

Paul
What are you talking about? That's how it's done? Invest all your money at one moment in time, and pick the correct factors? That's how it's done?

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Re: Factor Investing - I convincing article

Post by pkcrafter » Fri Apr 13, 2018 11:09 pm

HomerJ wrote:
Fri Apr 13, 2018 8:56 pm
pkcrafter wrote:
Tue Apr 10, 2018 3:15 pm
jhfenton wrote:
Tue Apr 10, 2018 12:10 pm
pkcrafter wrote:
Tue Apr 10, 2018 10:34 am
jhfenton wrote:
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
Come on, don't leave us in suspense, what is your secret overperformance strategy?

For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html
It's not rocket science, nor is it a secret:

1. Buy your first non-401(k) investments in June or July of 1998.
2. Choose small cap value and emerging markets funds.
3. Maintain a well-balanced portfolio for the next 20+ years rebalancing from over-performing assets into under-performing assets.
4. Win!



We were 100% equities until 2015. We're currently about 80/20. We have always been heavily tilted to small cap value and emerging markets. I can't imagine why I would ever change that.

Actually, you haven't even had to rebalance small cap value or emerging markets to outperform over the last 20 years. Both VSIAX and VEMAX have significantly outperformed VTSAX since the summer of 1998:

Since July 1, 1998, Growth of $10,000

VEMAX $55,764.10
VSIAX $53,596.64
VTSAX $36,232.52
Thank you, and that's how it's done. :!:

Paul
What are you talking about? That's how it's done? Invest all your money at one moment in time, and pick the correct factors? That's how it's done?
Homer J, you're asking the wrong person. Ask jhfenton.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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Re: Factor Investing - I convincing article

Post by jhfenton » Sat Apr 14, 2018 7:39 am

HomerJ wrote:
Fri Apr 13, 2018 8:56 pm
pkcrafter wrote:
Tue Apr 10, 2018 3:15 pm
jhfenton wrote:
Tue Apr 10, 2018 12:10 pm
pkcrafter wrote:
Tue Apr 10, 2018 10:34 am
jhfenton wrote:
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
Come on, don't leave us in suspense, what is your secret overperformance strategy?

For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html
It's not rocket science, nor is it a secret:

1. Buy your first non-401(k) investments in June or July of 1998.
2. Choose small cap value and emerging markets funds.
3. Maintain a well-balanced portfolio for the next 20+ years rebalancing from over-performing assets into under-performing assets.
4. Win!



We were 100% equities until 2015. We're currently about 80/20. We have always been heavily tilted to small cap value and emerging markets. I can't imagine why I would ever change that.

Actually, you haven't even had to rebalance small cap value or emerging markets to outperform over the last 20 years. Both VSIAX and VEMAX have significantly outperformed VTSAX since the summer of 1998:

Since July 1, 1998, Growth of $10,000

VEMAX $55,764.10
VSIAX $53,596.64
VTSAX $36,232.52
Thank you, and that's how it's done. :!:

Paul
What are you talking about? That's how it's done? Invest all your money at one moment in time, and pick the correct factors? That's how it's done?
Way to beat up on that strawman.

It won't surprise you that I've continuously added money over the last twenty years, because that's the norm and no one ever said or implied otherwise. My first Roth IRA investment was also not $10,000. (The annual limit was $2,000.) I've also slowly increased my international exposure over the years, from 20% initially to 50% the last few years. The growth of $10,000 numbers also don't account for the benefit of rebalancing among less-than-perfectly-correlated volatile asset classes.

I also had other holdings! :shock:

In other words, you knew those were not representative of actual account balances or actual returns.

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Re: Factor Investing - I convincing article

Post by indexonlyplease » Sat Apr 14, 2018 7:57 am

pkcrafter wrote:
Tue Apr 10, 2018 10:34 am
Always passive wrote:
Tue Apr 10, 2018 9:40 am
I am convinced!

https://www.advisorperspectives.com/art ... went-wrong

Any comments?
Thanks, excellent article from Allan Roth.

There are a few investors on the board that have the knowledge and experience to actually capture some of these now you see 'em, now you don't factors, but it takes great patience and understanding. Most investors who read about these "smart beta" strategies will commit to them after they've had a good run, noting that their costs have gone up. They will squirm for two or three years realizing their new winners have not only not outperformed, they are lagging their old, lower cost portfolio. And they bail out. If all investors who get into smart beta strategies actually stayed with them, there would be no premium at all. It's only because they are sporadic that they work...sometimes

jhfenton wrote:
5 years of underperformance! I'm convinced. :oops:

Or perhaps, I'll stick with what has overperformed for me for more than 20 years.
Come on, don't leave us in suspense, what is your secret overperformance strategy?

For those who aren't familiar with John Bogle's classic Tell Tail Chart, here it is.

https://www.vanguard.com/bogle_site/sp20020626.html



Paul
This is what I think is the most important. Sticking with a investment plan. Most of us never do so we underperform the market. What I finalized realize when I decided the 3 fund was for me, was that I am willing to take what the market gives me. Yes, nice to be in a fund that outperformed the market last year but we never know until its to late.

Someone needs to keep reposting take what the market gives you and be happy. This is my thinking what the 3 fund is all about.

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Re: Factor Investing - A convincing article

Post by Rick Ferri » Sat Apr 14, 2018 8:34 am

Making you portfolio more complex than it needs to be provides one guarantee: it will increase cost. That being said, there is a chance a complex portfolio that’s maintained diligently for many years will generate a higher return.
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.

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Re: Factor Investing - A convincing article

Post by Kenkat » Sat Apr 14, 2018 9:23 am

I’ve been factor investing since 2000, so while value and small has indeed underperformed recently, over my time period it has done very well, so I don’t think a few bad years means factor investing is dead. In fact, when people start thinking factor investing is dead, I suspect the opposite.

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Re: Factor Investing - A convincing article

Post by Random Walker » Sat Apr 14, 2018 10:53 am

Kenkat wrote:
Sat Apr 14, 2018 9:23 am
I’ve been factor investing since 2000, so while value and small has indeed underperformed recently, over my time period it has done very well, so I don’t think a few bad years means factor investing is dead. In fact, when people start thinking factor investing is dead, I suspect the opposite.
I think this is an important point. When a portfolio diversified across factors underperforms, it’s generally not by very much. All of our portfolios have a lot of market beta in them. When the portfolio diversified across factors outperforms, it can be much more significant.

Dave

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Re: Factor Investing - A convincing article

Post by jalbert » Sat Apr 14, 2018 12:56 pm

When a portfolio diversified across factors underperforms, it’s generally not by very much
That may not be the case. Small-cap value with a quality screen greatly underperformed market beta during the dot-com boom.
Risk is not a guarantor of return.

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Re: Factor Investing - A convincing article

Post by heyyou » Sun Apr 15, 2018 12:56 am

In Roth's article, every one of those segment returns in the first chart, is okay to me. I am past wanting only whatever performed the best, so my slice and dice portfolio, with its somewhat equal exposures to various size and value stocks, has suited me just fine. My tilt is away from Large Growth, into smaller, more value stocks just by default.

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Re: Factor Investing - A convincing article

Post by randomizer » Sun Apr 15, 2018 1:00 am

I’ve managed to avoid falling for factor based investing yet. I read Swedroe, but I’d rather keep it simple.
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Re: Factor Investing - A convincing article

Post by comeinvest » Wed Apr 18, 2018 4:45 am

The article has little substance.
The author provides no justification for his assertion that smart beta will outperform over the next 5 years. The probability numbers seem made up. Furthermore, his "crowded" arguments have been studied many times before in greater detail, and proven false e.g. based on relative valuations.
Regardless of this easy to ignore article, what is the justification of deviation from the performance of the market cap portfolio being used as a risk measure? I could similarly argue that the risk of the market cap portfolio is to underperform a tilted portfolio. The fact that the market cap portfolio's performance is the average of the performance of all active portfolios (before fees) is no valid reason. If we assume that the theory that smart beta will (statistically/probabilistically) outperform is true, or that there exists evidence that this is the case, then I would have still "lost out" on risk-adjusted return based on my ex-ante knowledge if I invest in the market just to get the "average" return. The fact that there is a loser for every winner, is no good justification for not trying to be a winner (based on ex-ante knowledge).

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Re: Factor Investing - A convincing article

Post by CULater » Wed Apr 18, 2018 10:02 am

Listened to a podcast with Elroy Dimson, and he made an interesting point about evaluating "factors." There should be some convincing reasons that there are sellers of factor stocks if buyers are to benefit. For example, he mentions that with small cap value, there are sellers who prefer large cap stocks with high liquidity and growth stocks that can provide higher short term returns than value stocks. For these investors, it is sensible to avoid small value stocks, which can lag and might have long periods of poor returns compared to the market. I would add that it seems to me that it could be argued that the legions of index-hugging Bogleheads are also buyers of large cap growth, since these are the stocks that dominate the market index. Almost by definition, small cap value stocks are destined to not outperform the market except over long periods of time because there are investors who are unwilling to bear the low liquidity and tracking error they provide. If you own SCV, you should not expect a short term payoff. So, I'm not sure that 5 years of underperformance is a reason to avoid them, as much as it is the reason to own them -- IF you are a long term investor who does not require higher liquidity assets.
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

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Re: Factor Investing - A convincing article

Post by pkcrafter » Wed Apr 18, 2018 11:57 am

If factor investing works reliably it will become very popular and it will be reflected in total market profile. Ho hum.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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