Factor-based strategy is better (winer), OK. then who are the losers?

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zwzhang
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Factor-based strategy is better (winer), OK. then who are the losers?

Post by zwzhang » Thu Jun 14, 2018 2:43 pm

One of my basic beliefs is that all investors as a group in a market, must earn the average total return of that market before expenses. There are winners, there must be losers, so that they offset each other (zero-sum game before expense).

If the Factor-based strategy is better than the traditional Total Cap-weighted Market Index, as so many people believed here, (otherwise why bother?) then my question is who will be the losers?

No offense, I'm just curious.

MotoTrojan
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by MotoTrojan » Thu Jun 14, 2018 2:49 pm

People buying growth funds/stocks in the case of value factor. This is a weird question for me. If the guy who invests 100% Netflix is the winner, who is the loser?

alex_686
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by alex_686 » Thu Jun 14, 2018 2:50 pm

zwzhang wrote:
Thu Jun 14, 2018 2:43 pm
One of my basic beliefs is that all investors as a group in a market, must earn the average total return of that market before expenses. There are winners, there must be losers, so that they offset each other (zero-sum game before expense).
The stock market is not a zero sum game. Just because one person wins does not mean somebody else loses. That is why you use the language over-preform / under-preform. i.e., small caps can earn 10% and large caps can earn 8%. Nobody loses but SC does out preform LC by 2%.

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JoMoney
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by JoMoney » Thu Jun 14, 2018 3:04 pm

MotoTrojan wrote:
Thu Jun 14, 2018 2:49 pm
People buying growth funds/stocks in the case of value factor. This is a weird question for me. If the guy who invests 100% Netflix is the winner, who is the loser?
I believe in the context that the "losers" were the ones that under-performed the broad markets return, that was available to anyone at very low costs, at just accepting the markets consensus for what it was, the loser would be people that underweighted Netflix, like people who tilted to Value style funds which have underperformed the broad market
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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JoMoney
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by JoMoney » Thu Jun 14, 2018 3:10 pm

What type of wine do factor-based investors think is best?
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

columbia
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by columbia » Thu Jun 14, 2018 3:14 pm

JoMoney wrote:
Thu Jun 14, 2018 3:10 pm
What type of wine do factor-based investors think is best?
The VFVA crowd leans towards Two Buck Chuck.


:beer

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packer16
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by packer16 » Thu Jun 14, 2018 3:21 pm

IMO the loser are supposedly the non-factor investors. I think factor investing, like any other active strategy (based upon other than market derived weights or values), is subject to the same factors that eroded active investing, more people doing it.

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triceratop
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by triceratop » Thu Jun 14, 2018 3:24 pm

JoMoney wrote:
Thu Jun 14, 2018 3:10 pm
What type of wine do factor-based investors think is best?
Given the recent underperformance of the value factor I believe we’re in-the-red whine area. ;)
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Taylor Larimore
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Past Performance vs. Buy the Market

Post by Taylor Larimore » Thu Jun 14, 2018 3:34 pm

alex_686" wrote:Nobody loses but SC does out perform LC by 2%.
Not always.

I went to Morningstar.com to look at their famous 9-category matrix.

These are the 3-year average returns (longest period shown):

------------ VALUE -- CORE -- GROWTH
LARGE---- 6.46%----- 8.89%--- 14.37%
MID ------- 8.45------ 6.70 ---- 10.53
SMALL ---- 6.15------ 7.75 ---- 11.60

Large Growth was the best performer; Small Value the worst performer.

Past performance does not forecast future performance.

Suggestion: Buy the market and you will never worry about having your entire portfolio in underperforming categories.

http://www.morningstar.com/

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Taylor
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by alpine_boglehead » Thu Jun 14, 2018 3:36 pm

MotoTrojan wrote:
Thu Jun 14, 2018 2:49 pm
People buying growth funds/stocks in the case of value factor. This is a weird question for me. If the guy who invests 100% Netflix is the winner, who is the loser?
The guy investing in General Electric.

Jokes aside, if a "factor" is comprised of subset of stocks at a given time, and that factor performs better than the overall market, then the remainder of the stocks not contained in this factor subset must perform worse than the market.

Have there been any studies that tell us "which stocks you need to buy to underperform"? (i.e. non-factor stocks, if factor stocks outperform?) If so, then it would of course be easy to outperform, i.e. pick the rest of the market :)

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by dbr » Thu Jun 14, 2018 3:45 pm

The Fama-French model for investment returns predicts higher returns than the total market for positive loading on small and value factors and lower returns than the total market for negative loading on small and value factors. The total market has zero loading on those factors and neither outperforms nor underperforms itself.

Is there more of a question here than that?

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by triceratop » Thu Jun 14, 2018 3:55 pm

dbr wrote:
Thu Jun 14, 2018 3:45 pm
The Fama-French model for investment returns predicts higher returns than the total market for positive loading on small and value factors and lower returns than the total market for negative loading on small and value factors. The total market has zero loading on those factors and neither outperforms nor underperforms itself.

Is there more of a question here than that?
Fama-French predicts higher explanatory power for returns given by models which include variables for small and value.

The Fama-French paper does not make a claim about the future, i.e. a prediction.
"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-based strategy is better (winer), OK. then who are the losers?

Post by larryswedroe » Thu Jun 14, 2018 3:58 pm

To help
Factors are long-short portfolios
Thus the long side has a premium and the short side a negative premium
Thus the "losers" are growth, large, negative momentum, low profitability, low quality, high liquidity, and high beta stocks, meaning they have below market returns historically

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by zwzhang » Thu Jun 14, 2018 3:59 pm

dbr wrote:
Thu Jun 14, 2018 3:45 pm
The Fama-French model for investment returns predicts higher returns than the total market for positive loading on small and value factors and lower returns than the total market for negative loading on small and value factors. The total market has zero loading on those factors and neither outperforms nor underperforms itself.

Is there more of a question here than that?
Yes, I do.
"higher returns than the total market for positive loading on small and value factors" If that is the case, all investors, in their rational minds, should all load up on small and value factors. Then again, if this does happen, who will be the losers?

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by vineviz » Thu Jun 14, 2018 4:00 pm

zwzhang wrote:
Thu Jun 14, 2018 2:43 pm
One of my basic beliefs is that all investors as a group in a market, must earn the average total return of that market before expenses. There are winners, there must be losers, so that they offset each other (zero-sum game before expense).
I think there is an subconscious assumption in your question that isn't necessarily a given: why do there HAVE to be winners and losers?

It's true that all investors, taken as a group, must earn the average return. But, in a multi-factor world, it doesn't necessarily follow that everyone earning less than the average return is a loser.

Imagine that some investors have a high tolerance for price volatility and some investors have a low tolerance for price volatility. Maybe the later group is just naturally risk-averse, maybe they are in retirement with just barely enough money to get by, maybe they are fund managers who report to a CEO who hates tracking error. Whatever.

Rationally, these investors with a low tolerance for price volatility might be perfectly happy holding a portfolio of less-than-average-volatility stocks and would need to be rewarded with EXTRA return to compensate them for holding higher-than-average (or even average) volatility stocks. They wouldn't view the lower returns that come from less volatile stocks as "losing". They'd view the lower volatility as "winning".

Then, you've got a whole other group that doesn't care one way or the other about price volatility. They are happy to take the extra volatility in exchange for higher returns.

Together, these groups make a market. High volatility stocks might outperform low volatility stocks with anyone "losing" in terms of economic utility.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

dbr
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by dbr » Thu Jun 14, 2018 4:01 pm

triceratop wrote:
Thu Jun 14, 2018 3:55 pm
dbr wrote:
Thu Jun 14, 2018 3:45 pm
The Fama-French model for investment returns predicts higher returns than the total market for positive loading on small and value factors and lower returns than the total market for negative loading on small and value factors. The total market has zero loading on those factors and neither outperforms nor underperforms itself.

Is there more of a question here than that?
Fama-French predicts higher explanatory power for returns given by models which include variables for small and value.

The Fama-French paper does not make a claim about the future, i.e. a prediction.
Your point is valid. Predicts means in the sense of explaining the data. However, it would seem that the answer to the question posed can only exist in the context of some theoretical construct which is required to define the term "factor," and from that point of view it seems F-F sheds light on the question of who is the loser if small and value is the winner.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by dbr » Thu Jun 14, 2018 4:04 pm

zwzhang wrote:
Thu Jun 14, 2018 3:59 pm
dbr wrote:
Thu Jun 14, 2018 3:45 pm
The Fama-French model for investment returns predicts higher returns than the total market for positive loading on small and value factors and lower returns than the total market for negative loading on small and value factors. The total market has zero loading on those factors and neither outperforms nor underperforms itself.

Is there more of a question here than that?
Yes, I do.
"higher returns than the total market for positive loading on small and value factors" If that is the case, all investors, in their rational minds, should all load up on small and value factors. Then again, if this does happen, who will be the losers?
They won't do that in their rational minds if the choice is accompanied by additional risk, nor will they do it if they don't believe it is true, nor will they do it if there are frictional costs to accomplish it in reality, nor will they do it if they think they have an asset strategy that is better, or a market timing strategy, or a stock picking strategy, etc.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by dbr » Thu Jun 14, 2018 4:05 pm

larryswedroe wrote:
Thu Jun 14, 2018 3:58 pm
To help
Factors are long-short portfolios
Thus the long side has a premium and the short side a negative premium
Thus the "losers" are growth, large, negative momentum, low profitability, low quality, high liquidity, and high beta stocks, meaning they have below market returns historically
Thank you. That was my point as well.

zwzhang
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by zwzhang » Thu Jun 14, 2018 4:08 pm

larryswedroe wrote:
Thu Jun 14, 2018 3:58 pm
To help
Factors are long-short portfolios
Thus the long side has a premium and the short side a negative premium
Thus the "losers" are growth, large, negative momentum, low profitability, low quality, high liquidity, and high beta stocks, meaning they have below market returns historically
Thanks Larry, this clearly answered my original question.

I bought and read your book on the topic. And I respect your research on the subjects.
Personally, I will stick to those total market funds like VTI, simply because while they are not perfect, but they are good enough for me.

Thanks,

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by alex_686 » Thu Jun 14, 2018 4:11 pm

zwzhang wrote:
Thu Jun 14, 2018 3:59 pm
Yes, I do.
"higher returns than the total market for positive loading on small and value factors" If that is the case, all investors, in their rational minds, should all load up on small and value factors. Then again, if this does happen, who will be the losers?
Points.

Small and Value factor premium are only statically significant and exploitable over long holding periods. Say 10 years.

These factors may not be exploitable. Small and value stocks tend to have low liquidity and high bid / ask spreads.

Small and value stocks have big tails. When the blow up, they blow up big. Big tails are not well handled by statistical tools over such a short time period of 100 years.

Lastly, and most importantly, what makes you think people have not? The small and value premiums have fallen. They may not exist anymore. I think investors have figured out this aberration and have now fully exploited it.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by triceratop » Thu Jun 14, 2018 4:12 pm

dbr wrote:
Thu Jun 14, 2018 4:01 pm
Your point is valid. Predicts means in the sense of explaining the data. However, it would seem that the answer to the question posed can only exist in the context of some theoretical construct which is required to define the term "factor," and from that point of view it seems F-F sheds light on the question of who is the loser if small and value is the winner.
You're right, sorry for the correction. In the context of the OP and reliant on that assumption, that is exactly what F-F predicts.
"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-based strategy is better (winer), OK. then who are the losers?

Post by dbr » Thu Jun 14, 2018 4:15 pm

zwzhang wrote:
Thu Jun 14, 2018 3:59 pm
dbr wrote:
Thu Jun 14, 2018 3:45 pm
The Fama-French model for investment returns predicts higher returns than the total market for positive loading on small and value factors and lower returns than the total market for negative loading on small and value factors. The total market has zero loading on those factors and neither outperforms nor underperforms itself.

Is there more of a question here than that?
Yes, I do.
"higher returns than the total market for positive loading on small and value factors" If that is the case, all investors, in their rational minds, should all load up on small and value factors. Then again, if this does happen, who will be the losers?
Of course if the market for large and growth stocks evaporated and people bought only small and value stocks the market would change and the factor loadings would change and the model would change. It is a kind of catch-22 hypothesis you have there. The current market apparently reflects the consensus of investors' selections that exists including that there are investors that load negatively (ie short in Larry's terms) on small and value (and all the other factors).

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by zwzhang » Thu Jun 14, 2018 4:22 pm

alex_686 wrote:
Thu Jun 14, 2018 4:11 pm
Lastly, and most importantly, what makes you think people have not? The small and value premiums have fallen. They may not exist anymore. I think investors have figured out this aberration and have now fully exploited it.
That is what I am thinking. After more investors find out this, more will load up on these factors, and finally their outperformance will gone.

I am happy with my total market fund (VTI), but this is just my own opinion. All roads leads to Rome.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by alex_686 » Thu Jun 14, 2018 4:28 pm

zwzhang wrote:
Thu Jun 14, 2018 4:22 pm
That is what I am thinking. After more investors find out this, more will load up on these factors, and finally their outperformance will gone.

I am happy with my total market fund (VTI), but this is just my own opinion. All roads leads to Rome.
Maybe. There is another path. I will use myself as a example.

I am concerned about the high value of the equity market. This suggests that I lower my equity AA and increase my bonds. However bonds don't offer much in the way of risk adjusted returns and I fear inflation. So maybe I don't lower my equity AA. Maybe I shift it to a "Low Beta" fund. Lower risk and lower return than Total Market. However, since it is equity I have a decent hedge against inflation.

So maybe not outperformance but perhaps a better risk-adjusted return for myself.

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JoMoney
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by JoMoney » Thu Jun 14, 2018 4:39 pm

alex_686 wrote:
Thu Jun 14, 2018 4:28 pm
...
So maybe not outperformance but perhaps a better risk-adjusted return for myself.
Which is still 'outperformance', and if people believe these are stocks with lower risk (but higher risk-adjusted returns) then that advantage can become over gleaned and self-defeating too as others attempt to do it... and there are critics who believe that is the case
https://www.researchaffiliates.com/en_u ... wrong.html
http://johncbogle.com/speeches/JCB_IASC0603.pdf
...as money flows into these alternative asset classes, the invisible hand of
competition in the financial markets often creates perverse and counterproductive consequences. When
more investment dollars chase a limited supply of goods in venture capital and in opportunistic hedging,
the value—if any—in these strategies is apt to get arbitraged away, even as yesterday’s successful
managers are flooded with money that precludes their repeating prior achievements. However
successfully these alternative asset strategies have been implemented in the past at Princeton, Yale, and
Harvard (at last, the forgotten “Big Three” of football’s yesteryear return in triumph on another field of
play!), we would be well reminded that “nothing fails like success.” Let’s not forget Immanuel Kant’s
categorical imperative: “Act only on that maxim which can at the same time become a universal law.”
Since, for investors as a group, the return on the policy portfolio, as it exists at any moment, is absolute,
there is no investment strategy that meets that universal imperative.
Last edited by JoMoney on Thu Jun 14, 2018 4:43 pm, edited 1 time in total.
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zwzhang
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by zwzhang » Thu Jun 14, 2018 4:43 pm

alex_686 wrote:
Thu Jun 14, 2018 4:28 pm
Maybe. There is another path. I will use myself as a example.

I am concerned about the high value of the equity market. This suggests that I lower my equity AA and increase my bonds. However bonds don't offer much in the way of risk adjusted returns and I fear inflation. So maybe I don't lower my equity AA. Maybe I shift it to a "Low Beta" fund. Lower risk and lower return than Total Market. However, since it is equity I have a decent hedge against inflation.

So maybe not outperformance but perhaps a better risk-adjusted return for myself.
Looks like a Valuation-Based Asset Allocation Strategy for me.
https://retirementresearcher.com/long-t ... trategies/

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by bertilak » Thu Jun 14, 2018 5:47 pm

zwzhang wrote:
Thu Jun 14, 2018 4:08 pm
Personally, I will stick to those total market funds like VTI, simply because while they are not perfect, but they are good enough for me.
My way of looking at it is about the same: Although not perfect they aren't far off.

Another way of looking at it: A total-market index fund contains within it, somewhere, the perfect AA. Consider that to be your base portfolio and all the rest is a bonus!
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker, the Cowboy Poet

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by vineviz » Thu Jun 14, 2018 5:57 pm

alex_686 wrote:
Thu Jun 14, 2018 4:11 pm
Small and Value factor premium are only statically significant and exploitable over long holding periods. Say 10 years.
Small cap value stocks have outperformed large cap stock in 63% of the calendar years for which we have data, and 70% of the five year periods. Some times SCV might outperform large cap for a while, but there's no magic number for how long you have to wait for outperformance to happen. For instance, Vanguard S&P Small-Cap 600 Value ETF is up 8.6% so far in 2018 versus 4.1% for Vanguard S&P 500 ETF.
alex_686 wrote:
Thu Jun 14, 2018 4:11 pm
Small and value stocks have big tails. When the blow up, they blow up big. Big tails are not well handled by statistical tools over such a short time period of 100 years.
Maybe if you're talking about individual stocks. Maybe.

But if you're talking about the relative performance of small cap value (for instance) relative to large cap stocks in aggregate (as we are here) you observer such disastrous moves. 1998 is the year when SCV underperformed large stocks by the most since 1930, and the underperformance was 31.50%. But that was because large cap stocks were up 28.58% that year (remember the dot com bubble?). The SCV investor experienced less than a 3% loss that year, which I'm sure was disappointing but hardly a disaster.

And don't forget that while large cap stocks turned in three consecutive years of losses from 2000 to 2002, SCV outperformed large caps by over 25% PER YEAR.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Bonus or "Disastrous Results?"

Post by Taylor Larimore » Thu Jun 14, 2018 6:13 pm

bertilak wrote:A total-market index fund contains within it, somewhere, the perfect AA. Consider that to be your base portfolio and all the rest is a bonus!
Or a loss!

Past performance does not forecast future performance.
Professor Jeremy Siegel, author of Stocks for the Long Run wrote: "For most of us, trying to beat the market leads to disastrous results."
Best Wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by Captain Haddock » Thu Jun 14, 2018 8:41 pm

alpine_boglehead wrote:
Thu Jun 14, 2018 3:36 pm
Have there been any studies that tell us "which stocks you need to buy to underperform"? (i.e. non-factor stocks, if factor stocks outperform?) If so, then it would of course be easy to outperform, i.e. pick the rest of the market :)
I think that's quite an interesting mental exercise. I've also heard traders recommend that you try paper-trading to lose trades as a means of getting insight on how to win.

Not too long ago, I was playing with a momentum strategy using Japanese sector ETFs. Basically, ranking them according to some criteria and holding the top-ranked ETF each month. The outcome was terrible, and each time I adjusted it in a way that I thought made sense, it got worse. So on a whim, I reversed the strategy and purchased the worst-ranked ETF each month. Suddenly I have a strategy that, at least on paper, is handily beating the market.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by knpstr » Thu Jun 14, 2018 9:17 pm

I find this whole factor-investing propaganda as a very ironic thing coming from fama/academia; especially after he used to say (still does say?) Buffett is just lucky.

I recall Munger mocking him (and the fact that he won a share of the nobel prize) in an interview since Bershire was regarded as a six-sigma event.
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by venkman » Thu Jun 14, 2018 9:39 pm

zwzhang wrote:
Thu Jun 14, 2018 4:22 pm
alex_686 wrote:
Thu Jun 14, 2018 4:11 pm
Lastly, and most importantly, what makes you think people have not? The small and value premiums have fallen. They may not exist anymore. I think investors have figured out this aberration and have now fully exploited it.
That is what I am thinking. After more investors find out this, more will load up on these factors, and finally their outperformance will gone.
Corporate bonds offer higher yields than Treasury bonds. How long will it take for investors to discover this "credit factor" and fully exploit it to the point that corporate bonds no longer outperform Treasuries?

Part of the small/value premium is a risk premium. There is a larger chance of your investment in a small and/or value company going to zero than there is with a large/growth company. Buying an index of many small value companies will eliminate single stock risk, but it also greatly increases the odds that one or more of the companies you hold will, in fact, go bankrupt. Given a choice between a small value stock and a large growth stock, both with equal expected return, a rational investor would choose the large growth stock, because it offers less risk of going under completely, for the same amount of return. Thus, the demand (and the price) for the small value stock will drop, until it offers enough of a higher expected return to compensate for its perceived level of extra risk.

To the extent that small and value premiums are behavioral, they might decline. But there's no rational reason to expect a risk premium to go away, as long as the risk is still there.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by stlutz » Thu Jun 14, 2018 10:47 pm

Part of the small/value premium is a risk premium. There is a larger chance of your investment in a small and/or value company going to zero than there is with a large/growth company. Buying an index of many small value companies will eliminate single stock risk, but it also greatly increases the odds that one or more of the companies you hold will, in fact, go bankrupt. Given a choice between a small value stock and a large growth stock, both with equal expected return, a rational investor would choose the large growth stock, because it offers less risk of going under completely, for the same amount of return. Thus, the demand (and the price) for the small value stock will drop, until it offers enough of a higher expected return to compensate for its perceived level of extra risk.
The individual stock picker does frequently choose been an individual large company and an individual small company. That's not what we're talking about here. We're comparing many thousands of small companies vs. a relatively few number of large companies.

If you own 100 small companies, yes, some of them will go bankrupt. But a large company has segments of it's business that just don't work out either. And of course big companies go bankrupt as well--sometimes many times over if you're talking big airline stocks.

At the end of the day, the risk profile of holding 5 separate stocks should not be significantly different than if all 5 of them merged and became a single company.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by MotoTrojan » Thu Jun 14, 2018 11:08 pm

venkman wrote:
Thu Jun 14, 2018 9:39 pm
zwzhang wrote:
Thu Jun 14, 2018 4:22 pm
alex_686 wrote:
Thu Jun 14, 2018 4:11 pm
Lastly, and most importantly, what makes you think people have not? The small and value premiums have fallen. They may not exist anymore. I think investors have figured out this aberration and have now fully exploited it.
That is what I am thinking. After more investors find out this, more will load up on these factors, and finally their outperformance will gone.
Corporate bonds offer higher yields than Treasury bonds. How long will it take for investors to discover this "credit factor" and fully exploit it to the point that corporate bonds no longer outperform Treasuries?

Part of the small/value premium is a risk premium. There is a larger chance of your investment in a small and/or value company going to zero than there is with a large/growth company. Buying an index of many small value companies will eliminate single stock risk, but it also greatly increases the odds that one or more of the companies you hold will, in fact, go bankrupt. Given a choice between a small value stock and a large growth stock, both with equal expected return, a rational investor would choose the large growth stock, because it offers less risk of going under completely, for the same amount of return. Thus, the demand (and the price) for the small value stock will drop, until it offers enough of a higher expected return to compensate for its perceived level of extra risk.

To the extent that small and value premiums are behavioral, they might decline. But there's no rational reason to expect a risk premium to go away, as long as the risk is still there.
Haven’t heard that analogy before wrt bonds; I like it. I know it’s an unpopular thought but I still think the longer the holding period, the less risky a riskier asset becomes.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by nedsaid » Thu Jun 14, 2018 11:10 pm

zwzhang wrote:
Thu Jun 14, 2018 2:43 pm
One of my basic beliefs is that all investors as a group in a market, must earn the average total return of that market before expenses. There are winners, there must be losers, so that they offset each other (zero-sum game before expense).

If the Factor-based strategy is better than the traditional Total Cap-weighted Market Index, as so many people believed here, (otherwise why bother?) then my question is who will be the losers?

No offense, I'm just curious.
Those who invest in the anti-factors, that is trying to beat the markets by trying to make the big score with the so-called lottery stocks in the Small Growth area of the market and the value traps in the Value area of the market. People that are speculating and not really investing.
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by alpine_boglehead » Fri Jun 15, 2018 6:06 am

Captain Haddock wrote:
Thu Jun 14, 2018 8:41 pm
alpine_boglehead wrote:
Thu Jun 14, 2018 3:36 pm
Have there been any studies that tell us "which stocks you need to buy to underperform"? (i.e. non-factor stocks, if factor stocks outperform?) If so, then it would of course be easy to outperform, i.e. pick the rest of the market :)
I think that's quite an interesting mental exercise. I've also heard traders recommend that you try paper-trading to lose trades as a means of getting insight on how to win.

Not too long ago, I was playing with a momentum strategy using Japanese sector ETFs. Basically, ranking them according to some criteria and holding the top-ranked ETF each month. The outcome was terrible, and each time I adjusted it in a way that I thought made sense, it got worse. So on a whim, I reversed the strategy and purchased the worst-ranked ETF each month. Suddenly I have a strategy that, at least on paper, is handily beating the market.
The problem is that that you can't really know whether your strategy worked (in that timeframe) because of pure luck (or bad luck) or because it actually makes sense. Because doing the opposite of what makes sense doesn't sound to be a good strategy either.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by dbr » Fri Jun 15, 2018 8:36 am

Regarding some of the above posts, there is an important point there that whatever the statistical systematics of the market, the investor gets only one of a wide range of possible outcomes. That actual outcome is determined more by noise than by any overwhelming trend in the system. The end result is that people need to be quite circumspect about trying to seek advantage through strategy. I suspect the only convincing strategic decision that really matters for most of us is decisions regarding large differences in how we allocate between stocks and bonds, and that is about it.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by rkhusky » Fri Jun 15, 2018 8:41 am

MotoTrojan wrote:
Thu Jun 14, 2018 11:08 pm
I know it’s an unpopular thought but I still think the longer the holding period, the less risky a riskier asset becomes.
That needs some caveats. You need a diversified portfolio. Holding buggy maker or vacuum tube or Enron stocks long term did not reduce risk. Even with diversification, individual investors have sequence of return risk related to their specific investing lifetime.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by nedsaid » Fri Jun 15, 2018 8:41 am

dbr wrote:
Fri Jun 15, 2018 8:36 am
Regarding some of the above posts, there is an important point there that whatever the statistical systematics of the market, the investor gets only one of a wide range of possible outcomes. That actual outcome is determined more by noise than by any overwhelming trend in the system. The end result is that people need to be quite circumspect about trying to seek advantage through strategy. I suspect the only convincing strategic decision that really matters for most of us is decisions regarding large differences in how we allocate between stocks and bonds, and that is about it.
I suppose what you are saying is that much of academic research is just statistical noise. There is a good case to be made for that though that is not my view.
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by dbr » Fri Jun 15, 2018 8:47 am

nedsaid wrote:
Fri Jun 15, 2018 8:41 am
dbr wrote:
Fri Jun 15, 2018 8:36 am
Regarding some of the above posts, there is an important point there that whatever the statistical systematics of the market, the investor gets only one of a wide range of possible outcomes. That actual outcome is determined more by noise than by any overwhelming trend in the system. The end result is that people need to be quite circumspect about trying to seek advantage through strategy. I suspect the only convincing strategic decision that really matters for most of us is decisions regarding large differences in how we allocate between stocks and bonds, and that is about it.
I suppose what you are saying is that much of academic research is just statistical noise. There is a good case to be made for that though that is not my view.
That was not the point at all. The point was that the outcome of any individual case is a matter of noise even when the outcome of a large sample of many cases has a statistically significant outcome.

Here is an example from epidemiology. It is a statistical fact that changing a certain health protocol decreases the ten year incidence of a certain cause of death from 12% to 10%. The difference in a population of hundreds of millions is tens or hundreds of thousands of deaths at costs of hundreds or millions of dollars to society. Thus there is a meaningful epidemiological benefit to implementing that change. For a single individual the issue is to be alive or to be dead at the end of that ten years by a difference of one chance in ten or one chance in twelve. For the individual this is an utterly meaningless difference in outcome. I am saying that outcomes in investing have the same nature.

Perhaps an even simpler example is that it is the difference between flipping coins thousands of times and realizing the number of heads and tails will approach equal and then expecting to get half heads and half tails on one toss of the coin. In fact the result of "noise" is that you will get one or the other for sure.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by bertilak » Fri Jun 15, 2018 8:51 am

dbr wrote:
Fri Jun 15, 2018 8:36 am
Regarding some of the above posts, there is an important point there that whatever the statistical systematics of the market, the investor gets only one of a wide range of possible outcomes. That actual outcome is determined more by noise than by any overwhelming trend in the system.
And that is why Russian Roulette is bad idea even though the odds are in your favor.

I suspect the only convincing strategic decision that really matters for most of us is decisions regarding large differences in how we allocate between stocks and bonds, and that is about it.
Foreign vs domestic might be the next most important differentiator.
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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by nedsaid » Fri Jun 15, 2018 8:53 am

dbr wrote:
Fri Jun 15, 2018 8:47 am
nedsaid wrote:
Fri Jun 15, 2018 8:41 am
dbr wrote:
Fri Jun 15, 2018 8:36 am
Regarding some of the above posts, there is an important point there that whatever the statistical systematics of the market, the investor gets only one of a wide range of possible outcomes. That actual outcome is determined more by noise than by any overwhelming trend in the system. The end result is that people need to be quite circumspect about trying to seek advantage through strategy. I suspect the only convincing strategic decision that really matters for most of us is decisions regarding large differences in how we allocate between stocks and bonds, and that is about it.
I suppose what you are saying is that much of academic research is just statistical noise. There is a good case to be made for that though that is not my view.
That was not the point at all. The point was that the outcome of any individual case is a matter of noise even when the outcome of a large sample of many cases has a statistically significant outcome.

Here is an example from epidemiology. It is a statistical fact that changing a certain health protocol decreases the ten year incidence of a certain cause of death from 12% to 10%. The difference in a population of hundreds of millions is tens or hundreds of thousands of deaths at costs of hundreds or millions of dollars to society. Thus there is a meaningful epidemiological benefit to implementing that change. For a single individual the issue is to be alive or to be dead at the end of that ten years by a difference of one chance in ten or one chance in twelve. For the individual this is an utterly meaningless difference in outcome. I am saying that outcomes in investing have the same nature.
What I was reacting to was that you said that what really matters is the allocation between stocks and bonds. In my view, this is largely correct. Your statement implied that factors don't matter that much to individual investors, that is a rational argument.

Yes of course, investment outcomes vary widely investor by investor. Many factors involved.

What I would say is that if investors will do certain things that they will increase the odds for investment success. No guarantees obviously but much of life is like that. Doing everything 100% right healthwise doesn't guarantee you won't die early but it will dramatically improve your odds of a longer life.
A fool and his money are good for business.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by jeffyscott » Fri Jun 15, 2018 8:57 am

stlutz wrote:
Thu Jun 14, 2018 10:47 pm
Part of the small/value premium is a risk premium. There is a larger chance of your investment in a small and/or value company going to zero than there is with a large/growth company. Buying an index of many small value companies will eliminate single stock risk, but it also greatly increases the odds that one or more of the companies you hold will, in fact, go bankrupt. Given a choice between a small value stock and a large growth stock, both with equal expected return, a rational investor would choose the large growth stock, because it offers less risk of going under completely, for the same amount of return. Thus, the demand (and the price) for the small value stock will drop, until it offers enough of a higher expected return to compensate for its perceived level of extra risk.
The individual stock picker does frequently choose been an individual large company and an individual small company. That's not what we're talking about here. We're comparing many thousands of small companies vs. a relatively few number of large companies.

If you own 100 small companies, yes, some of them will go bankrupt. But a large company has segments of it's business that just don't work out either. And of course big companies go bankrupt as well--sometimes many times over if you're talking big airline stocks.

At the end of the day, the risk profile of holding 5 separate stocks should not be significantly different than if all 5 of them merged and became a single company.
What percentage of small cap stocks are actually held in non-diversified portfolios? How many people have millions in a single or a few small cap stocks? If all or nearly all small caps are held in diversified accounts such as mutual funds, etfs, pension funds, etc. then the individual stock risk has been diversified away for all.

I would guess the exceptions would typically be insiders? The founders and executives of Microcorp would presumably keep a significant portion of their wealth in the company stock.
press on, regardless - John C. Bogle

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by selters » Fri Jun 15, 2018 2:28 pm

larryswedroe wrote:
Mon Sep 05, 2016 8:03 am
selters
Factors are LONG/SHORT portfolios so the factors that underperform are the SHORT side, so large, growth, low profitability, high investment, negative momentum, and so on.
Larry

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by stlutz » Fri Jun 15, 2018 6:35 pm

What percentage of small cap stocks are actually held in non-diversified portfolios? How many people have millions in a single or a few small cap stocks? If all or nearly all small caps are held in diversified accounts such as mutual funds, etfs, pension funds, etc. then the individual stock risk has been diversified away for all.
Generally if you look up the owners of a typical smallcap stock (which can be done on Yahoo), you'll find that 95+% of the shares are held by institutions. Blackrock, Vanguard, State Street and DFA are almost always in the top 6 or 7. So yes, it looks like the individual stock risk has been diversified away by most investors.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by venkman » Fri Jun 15, 2018 10:52 pm

stlutz wrote:
Thu Jun 14, 2018 10:47 pm
The individual stock picker does frequently choose been an individual large company and an individual small company. That's not what we're talking about here. We're comparing many thousands of small companies vs. a relatively few number of large companies.
But those individual active stock pickers are the one at the margins, setting the prices. If they demand a premium for investing in a small company over a larger company, that premium will carry over to everyone who owns the stock as part of an index. If you own thousands of small companies, you don't care that much if a few go bankrupt. But the active investor who only holds 10 different stocks at a time will care a lot more if one of his/her companies goes under, and is not going to take the risk of it happening unless she/he feels adequately compensated for that risk.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by stlutz » Fri Jun 15, 2018 11:05 pm

But those individual active stock pickers are the one at the margins, setting the prices. If they demand a premium for investing in a small company over a larger company, that premium will carry over to everyone who owns the stock as part of an index. If you own thousands of small companies, you don't care that much if a few go bankrupt. But the active investor who only holds 10 different stocks at a time will care a lot more if one of his/her companies goes under, and is not going to take the risk of it happening unless she/he feels adequately compensated for that risk.
On the other hand, individual investors picking a small number of smallcap stocks are often risk seeing more the risk avoiding. So, they often pay a premium to take the risk as opposed to demanding a discount.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by privatefarmer » Sat Jun 16, 2018 1:24 am

well, think more broadly. if stocks outperform bonds over the long-haul, and there are investors who "win" by tilting more towards equities and away from bonds, who are the "losers"?

accepting a lower return for less volatility is not "losing", it is making a choice. like buying life insurance. you're choosing to make a bet against the odds but a bet that will help you sleep better at night.

value/small are RISK-factors. riskier stocks SHOULD have a higher EXPECTED return, otherwise why would anyone own them? blue-chip, popular, large multinational companies that have brand recognition of course are less risky, as a group, and thus should not have as high an expected return.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by packer16 » Sat Jun 16, 2018 6:46 am

The issue with the risk based argument is that is based upon empirical observation of the firms that come out of the value screen. It is not based upon screening for the operational and financially risky firms. It would be interesting to see if the performance of SCV is more from the financially & operationally risky firms or from less risky firms. If it is from the more risky I would agree with you & that factor should be added to the SCV screen to enhance the riskiness of SCV. If not, then the SCV may be arbed away like other active strategies over time.

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Re: Factor-based strategy is better (winer), OK. then who are the losers?

Post by jeffyscott » Sat Jun 16, 2018 8:10 am

packer16 wrote:
Sat Jun 16, 2018 6:46 am
If not, then the SCV may be arbed away like other active strategies over time.
Hasn't that already happened?

I tend to think the excess gains from SCV have been more related to periodic irrational valuation differences, anyway. By 2010/11 after the 2008-09 losses had been recovered, I think the valuation differences between SCV and the overall stock market had been pretty much eliminated.
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