Larry Swedroe: investing Uncomfortably

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Random Walker
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Re: Factor funds: Active or Passive?

Post by Random Walker »

Taylor Larimore wrote: Thu Jan 03, 2019 1:14 pm
Sorry. Vanguard disagrees :
Factor-based funds are a form of active management.* They offer the potential to achieve specific risk and return objectives by purposely and explicitly "tilting" portfolios toward certain stock characteristics, like recent momentum, higher quality, or lower stock prices.

But they come with significantly more risk than you'd experience investing in the broader stock market.
*Underline mine.

https://investor.vanguard.com/etf/factor-funds

Best wishes
Taylor
So does VG consider VISVX Vanguard Small Cap Value Index Fund an active fund? I doubt it.

Dave
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Re: Larry Swedroe: investing Uncomfortably

Post by packer16 »

In explaining factor investing this is true, but if you look at the implementation there is a good amount of judgement that goes into the rules. I am also sure that at times the rules are overridden. Also, if you have industry diversification in these funds then by definition the fund will care what industry the stock is in leading to another judgement call of which firm is in which industry. IMO these factor funds are quantitatively assisted active funds that may reduce some of the human error that may be present in active funds.

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Re: Larry Swedroe: investing Uncomfortably

Post by danielc »

packer16 wrote: Thu Jan 03, 2019 3:39 pm In explaining factor investing this is true, but if you look at the implementation there is a good amount of judgement that goes into the rules. I am also sure that at times the rules are overridden. Also, if you have industry diversification in these funds then by definition the fund will care what industry the stock is in leading to another judgement call of which firm is in which industry. IMO these factor funds are quantitatively assisted active funds that may reduce some of the human error that may be present in active funds.
By that argument, an S&P 500 index fund is also actively managed. The S&P 500 involves judgments of which firm is in which industry. Not only that, but the S&P 500 has certain profitability requirements for a stock entering the index, and the decision to remove a stock from the index is done by a committee.
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Re: Larry Swedroe: investing Uncomfortably

Post by packer16 »

I think it is a matter of degree & you can see this by turnover. Traditional indicies have lower turnover than factor indicies & therefore you know what you have in terms of components vs. factors.

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Re: Larry Swedroe: investing Uncomfortably

Post by Dead Man Walking »

Perhaps a definition of agnostic would help us understand some of the arguments about factor based investing:

1 : a person who holds the view that any ultimate reality (such as God) is unknown and probably unknowable
broadly : one who is not committed to believing in either the existence or the nonexistence of God or a god
2 : a person who is unwilling to commit to an opinion about something

Definition number two probably describes my view of factor based investing. I have invested in SCV funds and SCB funds for a couple of decades and in LCV funds for much longer. Therefore, I probably could be considered a factor based investor.

I do not understand how screening for stocks that exhibit various factors can be agnostic. The factors are known. Applying the screen(s) determines which stocks are known to exhibit the factor(s) for which the market is being screened. As I see it, an active manager may actually use the same screens and then selects the individual stocks he/she believes will out perform the other stocks in the group. As experienced investors know, that is a real trip into the unknown. The factor based managers select a basket of stocks that exhibit the factors for which they have screened and often apply another screen to thin the herd. There aren’t a lot of unknowns in the process.

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Re: Larry Swedroe: investing Uncomfortably

Post by bluquark »

danielc wrote: Thu Jan 03, 2019 7:07 am
bluquark wrote: Wed Jan 02, 2019 2:46 pm Like all market information, this data nullifies itself by being publicly known and exploited. That's why I don't think it's enough. I also need data that the data is currently underexploited by today's market participants.
No. That is only true if you think of factors as a market anomaly, or a mispricing. But it is not true if factors are a legitimate source of risk. If small-cap companies are legitimately riskier than large-cap companies, that fact will persist, and investors will rightfully demand greater return to compensate for that greater risk. Fama and French do not see factors as market anomalies; they see them as sources of risk. Then the argument is about risk, return, and diversification. If small-cap companies are 3% of the market, and they have additional return and volatility for reasons that are uncorrelated with what the rest of the market is doing, then the most efficient portfolio might not be the market portfolio but one that puts more than 3% of the equity in those small-cap companies.
OK, makes sense, it is a risk parity portfolio construction argument. I can accept it for size, but I'm struggling with applying it for the Value factor. Intuitively, Growth sounds riskier because it's projecting uncertain future flows of money that are not yet on the books, but do factor advocates claim that Value is somehow riskier? What is the theoretical explanation for that, is it simply working backwards from the historical evidence of a premium?
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Re: Larry Swedroe: investing Uncomfortably

Post by nisiprius »

What I will call the "uncomfortable" funds did not cover themselves with glory this year. They didn't do terribly, they didn't do worse than stocks. And of course one year doesn't mean much.

But three out of the four I'm thinking of did worse than a 60/40 traditional stock/bond portfolio.

LENDX was the exception. If I've done the math right, it earned +3.46% in 2018.

I don't mind "failing conventionally" when the alternative is "failing unconventionally."

Blue, the AQR Style Premia Alternative Fund. For comparison, Morningstar's chosen benchmark (orange) and the most traditional of all traditional funds, Vanguard Balanced Index (green).

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Last edited by nisiprius on Thu Jan 03, 2019 9:22 pm, edited 3 times in total.
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Re: Larry Swedroe: investing Uncomfortably

Post by danielc »

bluquark wrote: Thu Jan 03, 2019 5:29 pm OK, makes sense, it is a risk parity portfolio construction argument. I can accept it for size, but I'm struggling with applying it for the Value factor. Intuitively, Growth sounds riskier because it's projecting uncertain future flows of money that are not yet on the books, but do factor advocates claim that Value is somehow riskier? What is the theoretical explanation for that, is it simply working backwards from the historical evidence of a premium?
Yes. Value companies tend to be companies in financial distress, or operating well below capacity (i.e. can't find customers), etc. The value factor means that the price/book is low. If the price/book is low, that correlates with investors being worried about something. At least, that's how I understand the value factor.
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Re: Larry Swedroe: investing Uncomfortably

Post by columbia »

nisiprius wrote: Thu Jan 03, 2019 6:01 pm What I will call the "uncomfortable" funds did not cover themselves with glory this year. They didn't do terribly, they didn't do worse than stocks. And of course one year doesn't mean much.

But three out of the four I'm thinking of did worse than a 60/40 traditional stock/bond portfolio.

LENDX was the exception. If I've done the math right, it earned +3.46% in 2018.

I don't mind "failing conventionally" when the alternative is "failing unconventionally."

Blue, the AQR Style Premia Alternative Fund. For comparison, Morningstar's chosen benchmark (orange) and the most traditional of all traditional funds, Vanguard Balanced Index (green).

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You didn’t need to go to this extent, as even piling into SCV, international SCV and EM are fairly dubious strategies.
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Re: Factor funds: Active or Passive?

Post by retiringwhen »

Random Walker wrote: Thu Jan 03, 2019 3:28 pm
Taylor Larimore wrote: Thu Jan 03, 2019 1:14 pm
Sorry. Vanguard disagrees :
Factor-based funds are a form of active management.* They offer the potential to achieve specific risk and return objectives by purposely and explicitly "tilting" portfolios toward certain stock characteristics, like recent momentum, higher quality, or lower stock prices.

But they come with significantly more risk than you'd experience investing in the broader stock market.
*Underline mine.

https://investor.vanguard.com/etf/factor-funds

Best wishes
Taylor
So does VG consider VISVX Vanguard Small Cap Value Index Fund an active fund? I doubt it.

Dave
I would say no since as per the prospectus, it:
Seeks to track the performance of the CRSP US Small Cap Value Index, which measures the investment return of small-capitalization value stocks.
In other words it is a vanilla index fund (and passive at that....)
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Re: Larry Swedroe: investing Uncomfortably

Post by betablocker »

packer16 wrote: Wed Jan 02, 2019 10:15 pm
betablocker wrote: Wed Jan 02, 2019 6:12 pm
packer16 wrote: Wed Jan 02, 2019 2:38 pm IMO the weakness in the factor (value) argument is the factors are based upon past correlations holding true in the future (i.e. folks value vs. growth stocks in a similar way as in the past (so the factor can revert). Fundamental factors (such as beta) are based upon fundamental differences in the securities & do not change with time. Bonds are first claims against firm cash flows & thus should have lower returns than equity claims which have lower priority claims. In the end I know fundamental factors will revert due to economics. Non-fundamental factors reversion are based more upon taste than economics thus IMO not comparable to fundamental factors & with less certainty will revert. Looking at historical data can be misleading here as we have only gone through a few value/growth cycles where folks have invested in a factor way.

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I’m not sure what a fundamental factor is. If you mean fundamental research, I don’t think those investors would share a boglehead’s enthusiasm for market cap weighted index funds. If you mean that market beta, duration, and credit risk have a longer history as known factors I agree but momentum, value and quality are all based on the same data. Given the ongoing debate between risk and behavioral explanations for those factors I can understand being more cautious but I don’t think dismissing them is warranted by the evidence. In fact market beta underperforms for longer periods than momentum for example.
By a fundamental factor is the factor cannot be changed over time. A stock is stock & a bond a bond. A "value" stock can become a "growth" stock and visa versa. The same is true for momentum. The returns for the non-fundamental factors are based upon past empirical returns not underlying economics or characteristics of the securities. Given that past empirical data with someone implementing these non-fundamental strategies is limited (maybe the past 20 years at most & only a few periods of out-performance/under-performance), the probability of these correlations happening by chance increases. You also have a measurement problem with value. Stocks with less growth should fundamentally less than those with high growth. However, all measures of cheapness of value I have seen do not include this factor in their estimation of cheapness.

The examples Larry gives is three instances of value doing better than beta. However, only one is during a period when factor investing was being used. So if you assume the market likes value vs. growth on 50/50 basis, then with only one trial you have at most a 75% confidence that value will work in the future. If we had more examples of markets where factor investing has been used over many non-fundamental cycles, then the case would be clearer. At this point you are making a "bet" that these non-fundamental factor correlations will continue. Just my 2 cents.

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Ben Graham was doing net bets before any of us were born and people wrote about momentum 100s of years ago. Don’t think those facts check out.
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Re: Larry Swedroe: investing Uncomfortably

Post by Scooter57 »

One of the first things I learned when I started reading this forum was that though DFA funds had slightly outperformed Vanguard broad market index funds in the past the advantage disappeared when you took into account another factor: the advisory fees you had to pay to get access to those funds. I wonder if that is still true 5 years later.
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Re: Larry Swedroe: investing Uncomfortably

Post by packer16 »

betablocker wrote: Thu Jan 03, 2019 10:20 pm
packer16 wrote: Wed Jan 02, 2019 10:15 pm
betablocker wrote: Wed Jan 02, 2019 6:12 pm
packer16 wrote: Wed Jan 02, 2019 2:38 pm IMO the weakness in the factor (value) argument is the factors are based upon past correlations holding true in the future (i.e. folks value vs. growth stocks in a similar way as in the past (so the factor can revert). Fundamental factors (such as beta) are based upon fundamental differences in the securities & do not change with time. Bonds are first claims against firm cash flows & thus should have lower returns than equity claims which have lower priority claims. In the end I know fundamental factors will revert due to economics. Non-fundamental factors reversion are based more upon taste than economics thus IMO not comparable to fundamental factors & with less certainty will revert. Looking at historical data can be misleading here as we have only gone through a few value/growth cycles where folks have invested in a factor way.

Packer
I’m not sure what a fundamental factor is. If you mean fundamental research, I don’t think those investors would share a boglehead’s enthusiasm for market cap weighted index funds. If you mean that market beta, duration, and credit risk have a longer history as known factors I agree but momentum, value and quality are all based on the same data. Given the ongoing debate between risk and behavioral explanations for those factors I can understand being more cautious but I don’t think dismissing them is warranted by the evidence. In fact market beta underperforms for longer periods than momentum for example.
By a fundamental factor is the factor cannot be changed over time. A stock is stock & a bond a bond. A "value" stock can become a "growth" stock and visa versa. The same is true for momentum. The returns for the non-fundamental factors are based upon past empirical returns not underlying economics or characteristics of the securities. Given that past empirical data with someone implementing these non-fundamental strategies is limited (maybe the past 20 years at most & only a few periods of out-performance/under-performance), the probability of these correlations happening by chance increases. You also have a measurement problem with value. Stocks with less growth should fundamentally less than those with high growth. However, all measures of cheapness of value I have seen do not include this factor in their estimation of cheapness.

The examples Larry gives is three instances of value doing better than beta. However, only one is during a period when factor investing was being used. So if you assume the market likes value vs. growth on 50/50 basis, then with only one trial you have at most a 75% confidence that value will work in the future. If we had more examples of markets where factor investing has been used over many non-fundamental cycles, then the case would be clearer. At this point you are making a "bet" that these non-fundamental factor correlations will continue. Just my 2 cents.

Packer
Ben Graham was doing net bets before any of us were born and people wrote about momentum 100s of years ago. Don’t think those facts check out.
There are a large differences between the net-nets being done by Ben Graham and the value factor. The net-net's were arbitrages based upon economics of the situations, the value factor is a correlation not based upon economics but correlation, its greatest weakness. As the market becomes more efficient the arbitrages go away & you are left with correlations, which may change over time.

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Re: Larry Swedroe: investing Uncomfortably

Post by Vulcan »

Random Walker wrote: Wed Jan 02, 2019 2:39 pm
magneto wrote: Wed Jan 02, 2019 1:50 pm
This current factor fad seems like active in sheep's clothing (certainly momentum, aka 'market timing', can often become active on steroids).
This too shall pass?
What would it take for you to consider factors more than a fad? We have extensive historical data and out of sample tests provided by different time periods, different geographies, even different asset classses in some cases. I think Fama French’s Cross Section Of Expected Returns paper may well be the single most widely cited academic paper in the world. You might be correct that factor investing won’t work out in the future, but at what point does data carry enough weight?

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Re: Factor funds: Active or Passive?

Post by fennewaldaj »

retiringwhen wrote: Thu Jan 03, 2019 10:02 pm
Random Walker wrote: Thu Jan 03, 2019 3:28 pm
Taylor Larimore wrote: Thu Jan 03, 2019 1:14 pm
Sorry. Vanguard disagrees :
Factor-based funds are a form of active management.* They offer the potential to achieve specific risk and return objectives by purposely and explicitly "tilting" portfolios toward certain stock characteristics, like recent momentum, higher quality, or lower stock prices.

But they come with significantly more risk than you'd experience investing in the broader stock market.
*Underline mine.

https://investor.vanguard.com/etf/factor-funds

Best wishes
Taylor
So does VG consider VISVX Vanguard Small Cap Value Index Fund an active fund? I doubt it.

Dave
I would say no since as per the prospectus, it:
Seeks to track the performance of the CRSP US Small Cap Value Index, which measures the investment return of small-capitalization value stocks.
In other words it is a vanilla index fund (and passive at that....)
Yeah I think the distinction for them is they consider cap weighted style funds passive but something weighted by another factor other than price in its market segment would be active. So any smart beta product is active in their view
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Re: Factor funds: Active or Passive?

Post by Random Walker »

fennewaldaj wrote: Fri Jan 04, 2019 12:25 am
retiringwhen wrote: Thu Jan 03, 2019 10:02 pm
Random Walker wrote: Thu Jan 03, 2019 3:28 pm
Taylor Larimore wrote: Thu Jan 03, 2019 1:14 pm
Sorry. Vanguard disagrees :
Factor-based funds are a form of active management.* They offer the potential to achieve specific risk and return objectives by purposely and explicitly "tilting" portfolios toward certain stock characteristics, like recent momentum, higher quality, or lower stock prices.

But they come with significantly more risk than you'd experience investing in the broader stock market.
*Underline mine.

https://investor.vanguard.com/etf/factor-funds

Best wishes
Taylor
So does VG consider VISVX Vanguard Small Cap Value Index Fund an active fund? I doubt it.

Dave
I would say no since as per the prospectus, it:
Seeks to track the performance of the CRSP US Small Cap Value Index, which measures the investment return of small-capitalization value stocks.
In other words it is a vanilla index fund (and passive at that....)
Yeah I think the distinction for them is they consider cap weighted style funds passive but something weighted by another factor other than price in its market segment would be active. So any smart beta product is active in their view
Aren’t most asset class long only factor funds cap weighted? DFA for example are.

Dave
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Re: Factor funds: Active or Passive?

Post by danielc »

fennewaldaj wrote: Fri Jan 04, 2019 12:25 am Yeah I think the distinction for them is they consider cap weighted style funds passive but something weighted by another factor other than price in its market segment would be active. So any smart beta product is active in their view
I actually wouldn't mind defining everything that is not cap weighted as active. There's a good reason for that: cap weights require no maintenance, while every other weight rule requires constant buying and selling of stocks to maintain target weights.

All the factor funds that I know are cap weighted.
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Re: Factor funds: Active or Passive?

Post by fennewaldaj »

Random Walker wrote: Fri Jan 04, 2019 12:31 am
fennewaldaj wrote: Fri Jan 04, 2019 12:25 am
retiringwhen wrote: Thu Jan 03, 2019 10:02 pm
Random Walker wrote: Thu Jan 03, 2019 3:28 pm
Taylor Larimore wrote: Thu Jan 03, 2019 1:14 pm
Sorry. Vanguard disagrees :

*Underline mine.

https://investor.vanguard.com/etf/factor-funds

Best wishes
Taylor
So does VG consider VISVX Vanguard Small Cap Value Index Fund an active fund? I doubt it.

Dave
I would say no since as per the prospectus, it:
Seeks to track the performance of the CRSP US Small Cap Value Index, which measures the investment return of small-capitalization value stocks.
In other words it is a vanilla index fund (and passive at that....)
Yeah I think the distinction for them is they consider cap weighted style funds passive but something weighted by another factor other than price in its market segment would be active. So any smart beta product is active in their view
Aren’t most asset class long only factor funds cap weighted? DFA for example are.

Dave
I guess it depends. The RAFI fundamental indexes are not. Wisdomtree products are weighted by other things (earnings or dividends). Vanguards factor funds are super far from cap weighted.
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Re: Factor funds: Active or Passive?

Post by bluquark »

fennewaldaj wrote: Fri Jan 04, 2019 12:25 am Yeah I think the distinction for them is they consider cap weighted style funds passive but something weighted by another factor other than price in its market segment would be active. So any smart beta product is active in their view
I totally agree with this view. Smart beta is a transparent attempt to coopt "passive indexing" while still charging high ER
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Re: Factor funds: Active or Passive?

Post by danielc »

bluquark wrote: Fri Jan 04, 2019 12:52 am I totally agree with this view. Smart beta is a transparent attempt to coopt "passive indexing" while still charging high ER
+1
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Re: Larry Swedroe: investing Uncomfortably

Post by betablocker »

packer16 wrote: Thu Jan 03, 2019 11:31 pm
betablocker wrote: Thu Jan 03, 2019 10:20 pm
packer16 wrote: Wed Jan 02, 2019 10:15 pm
betablocker wrote: Wed Jan 02, 2019 6:12 pm
packer16 wrote: Wed Jan 02, 2019 2:38 pm IMO the weakness in the factor (value) argument is the factors are based upon past correlations holding true in the future (i.e. folks value vs. growth stocks in a similar way as in the past (so the factor can revert). Fundamental factors (such as beta) are based upon fundamental differences in the securities & do not change with time. Bonds are first claims against firm cash flows & thus should have lower returns than equity claims which have lower priority claims. In the end I know fundamental factors will revert due to economics. Non-fundamental factors reversion are based more upon taste than economics thus IMO not comparable to fundamental factors & with less certainty will revert. Looking at historical data can be misleading here as we have only gone through a few value/growth cycles where folks have invested in a factor way.

Packer
I’m not sure what a fundamental factor is. If you mean fundamental research, I don’t think those investors would share a boglehead’s enthusiasm for market cap weighted index funds. If you mean that market beta, duration, and credit risk have a longer history as known factors I agree but momentum, value and quality are all based on the same data. Given the ongoing debate between risk and behavioral explanations for those factors I can understand being more cautious but I don’t think dismissing them is warranted by the evidence. In fact market beta underperforms for longer periods than momentum for example.
By a fundamental factor is the factor cannot be changed over time. A stock is stock & a bond a bond. A "value" stock can become a "growth" stock and visa versa. The same is true for momentum. The returns for the non-fundamental factors are based upon past empirical returns not underlying economics or characteristics of the securities. Given that past empirical data with someone implementing these non-fundamental strategies is limited (maybe the past 20 years at most & only a few periods of out-performance/under-performance), the probability of these correlations happening by chance increases. You also have a measurement problem with value. Stocks with less growth should fundamentally less than those with high growth. However, all measures of cheapness of value I have seen do not include this factor in their estimation of cheapness.

The examples Larry gives is three instances of value doing better than beta. However, only one is during a period when factor investing was being used. So if you assume the market likes value vs. growth on 50/50 basis, then with only one trial you have at most a 75% confidence that value will work in the future. If we had more examples of markets where factor investing has been used over many non-fundamental cycles, then the case would be clearer. At this point you are making a "bet" that these non-fundamental factor correlations will continue. Just my 2 cents.

Packer
Ben Graham was doing net bets before any of us were born and people wrote about momentum 100s of years ago. Don’t think those facts check out.
There are a large differences between the net-nets being done by Ben Graham and the value factor. The net-net's were arbitrages based upon economics of the situations, the value factor is a correlation not based upon economics but correlation, its greatest weakness. As the market becomes more efficient the arbitrages go away & you are left with correlations, which may change over time.

Packer
I think this is begging the question. Agreed that fundamental analysis is different method for selecting investments than the quantitative analysis but they get you to the same place so what's the difference in the end. I'd say the only difference is allowing for human error and performance chasing.

But if you index you target not fundamental analysis but an abstract factor called market beta. While the evidence for it is more robust given how long it has been recognized and sold/bought as such, it is based on the same evidence as the other generally accepted factors.
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Re: Factor funds: Active or Passive?

Post by Random Walker »

danielc wrote: Fri Jan 04, 2019 12:37 am
fennewaldaj wrote: Fri Jan 04, 2019 12:25 am Yeah I think the distinction for them is they consider cap weighted style funds passive but something weighted by another factor other than price in its market segment would be active. So any smart beta product is active in their view
I actually wouldn't mind defining everything that is not cap weighted as active. There's a good reason for that: cap weights require no maintenance, while every other weight rule requires constant buying and selling of stocks to maintain target weights.

All the factor funds that I know are cap weighted.
The passive factor funds define target metrics, say given size and value metric, then agnosticslly implement a fund using stocks meeting those criteria in a market cap weighted fashion. That’s about as passive as you can get. But maintenance is required. Stocks will need to be bought and sold as they enter and leave the identified factor space. Value can be added by using buy/hold ranges and by being a patient trader supplying liquidity rather than buying it. Buy/hold ranges allow the fund to avoid negative momentum and gain a bit of positive momentum. So these passive funds first and foremost are market cap weighted, but extra value can be added in the details of how they are maintained. Fine tuning the execution of trades though, I do not believe, in any way makes these funds active. The key is they are agnostic to the individual stocks used, don’t market time, and of course are cap weighted.

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Re: Factor funds: Active or Passive?

Post by danielc »

Random Walker wrote: Fri Jan 04, 2019 10:54 am
danielc wrote: Fri Jan 04, 2019 12:37 am I actually wouldn't mind defining everything that is not cap weighted as active. There's a good reason for that: cap weights require no maintenance, while every other weight rule requires constant buying and selling of stocks to maintain target weights.

All the factor funds that I know are cap weighted.
The passive factor funds define target metrics, say given size and value metric, then agnosticslly implement a fund using stocks meeting those criteria in a market cap weighted fashion. That’s about as passive as you can get.
Exactly.
Random Walker wrote: Fri Jan 04, 2019 10:54 am But maintenance is required. Stocks will need to be bought and sold as they enter and leave the identified factor space.
Yeah, but this is a feature of all index investing to some extent or another. Every time the index is reconstituted there is some amount of turnover due to stocks entering and leaving the index. Some indices have very little of that (e.g. CRSP US Total Market Index, S&P 500) and some have more (e.g. Russell 3000) and that's a consideration when choosing which index fund you want to put money in.

Random Walker wrote: Fri Jan 04, 2019 10:54 am Value can be added by using buy/hold ranges and by being a patient trader supplying liquidity rather than buying it. Buy/hold ranges allow the fund to avoid negative momentum and gain a bit of positive momentum. So these passive funds first and foremost are market cap weighted, but extra value can be added in the details of how they are maintained. Fine tuning the execution of trades though, I do not believe, in any way makes these funds active. The key is they are agnostic to the individual stocks used, don’t market time, and of course are cap weighted.
I don't think that a buy/hold range makes a fund active. It makes it "not an index fund", but as long as it's all done mechanically (no human picking stocks or times) it's still perfectly passive and it's cap weighted.
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Re: Larry Swedroe: investing Uncomfortably

Post by bertilak »

I don't understand factors. Really.

If one puts together the perfect "factor portfolio," that portfolio must exist as a subset of TSM. How big a subset is that? How poorly does the rest of TSM perform?
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Re: Factor funds: Active or Passive?

Post by vineviz »

bluquark wrote: Fri Jan 04, 2019 12:52 am
fennewaldaj wrote: Fri Jan 04, 2019 12:25 am Yeah I think the distinction for them is they consider cap weighted style funds passive but something weighted by another factor other than price in its market segment would be active. So any smart beta product is active in their view
I totally agree with this view. Smart beta is a transparent attempt to coopt "passive indexing" while still charging high ER
Except that most "smart beta" funds neither charge a high ER nor do they attempt to coopt "passive indexing" .
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Re: Factor funds: Active or Passive?

Post by vineviz »

danielc wrote: Fri Jan 04, 2019 11:11 am I don't think that a buy/hold range makes a fund active. It makes it "not an index fund", but as long as it's all done mechanically (no human picking stocks or times) it's still perfectly passive and it's cap weighted.
But now you're back to a definition of "passive" that includes the vast majority of factor funds.

What objective criteria exists that would make an ETF which follows the S&P 500 Value Index a "passive fund" but an ETF which follows the S&P 500 Quality, Value & Momentum Multi-Factor Index an "active fund"?
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Re: Larry Swedroe: investing Uncomfortably

Post by packer16 »

betablocker wrote: Fri Jan 04, 2019 10:42 am
packer16 wrote: Thu Jan 03, 2019 11:31 pm
betablocker wrote: Thu Jan 03, 2019 10:20 pm
packer16 wrote: Wed Jan 02, 2019 10:15 pm
betablocker wrote: Wed Jan 02, 2019 6:12 pm

I’m not sure what a fundamental factor is. If you mean fundamental research, I don’t think those investors would share a boglehead’s enthusiasm for market cap weighted index funds. If you mean that market beta, duration, and credit risk have a longer history as known factors I agree but momentum, value and quality are all based on the same data. Given the ongoing debate between risk and behavioral explanations for those factors I can understand being more cautious but I don’t think dismissing them is warranted by the evidence. In fact market beta underperforms for longer periods than momentum for example.
By a fundamental factor is the factor cannot be changed over time. A stock is stock & a bond a bond. A "value" stock can become a "growth" stock and visa versa. The same is true for momentum. The returns for the non-fundamental factors are based upon past empirical returns not underlying economics or characteristics of the securities. Given that past empirical data with someone implementing these non-fundamental strategies is limited (maybe the past 20 years at most & only a few periods of out-performance/under-performance), the probability of these correlations happening by chance increases. You also have a measurement problem with value. Stocks with less growth should fundamentally less than those with high growth. However, all measures of cheapness of value I have seen do not include this factor in their estimation of cheapness.

The examples Larry gives is three instances of value doing better than beta. However, only one is during a period when factor investing was being used. So if you assume the market likes value vs. growth on 50/50 basis, then with only one trial you have at most a 75% confidence that value will work in the future. If we had more examples of markets where factor investing has been used over many non-fundamental cycles, then the case would be clearer. At this point you are making a "bet" that these non-fundamental factor correlations will continue. Just my 2 cents.

Packer
Ben Graham was doing net bets before any of us were born and people wrote about momentum 100s of years ago. Don’t think those facts check out.
There are a large differences between the net-nets being done by Ben Graham and the value factor. The net-net's were arbitrages based upon economics of the situations, the value factor is a correlation not based upon economics but correlation, its greatest weakness. As the market becomes more efficient the arbitrages go away & you are left with correlations, which may change over time.

Packer
I think this is begging the question. Agreed that fundamental analysis is different method for selecting investments than the quantitative analysis but they get you to the same place so what's the difference in the end. I'd say the only difference is allowing for human error and performance chasing.

But if you index you target not fundamental analysis but an abstract factor called market beta. While the evidence for it is more robust given how long it has been recognized and sold/bought as such, it is based on the same evidence as the other generally accepted factors.
The question of getting you to the same place depends upon the correlation & time frame examined. The factors are theoretical constructs not based upon fundamentals of the firms or securities. Equities, loosely what you refer to as beta, are defined as subordinate claims on firm cash flows. Bonds are senior claims. In an efficient market, economics states that equities should reward equities more than bonds due to their risk.

Value is not by itself a characteristic of a firm or security & it can change over time. What the market will pay for value varies over time depending upon the "taste" of the market. In an efficient market, economics does not say that value firms should earn a premium over a growth firm. As a matter of fact, US growth firms should sell at a premium due to their US tax advantaged status. Therefore, the "taste" based factors should provide returns similar to Bogle's LT charts of growth vs. value. Now there has been some value premium in the past & it appears to have declined quite a bit in the past 10 years so I would argue it is removal of inefficiencies. Some argue that value firms have more operational & financial risk but if this is case for the risk premium why not put together of portfolios of higher operationally & financially leveraged firms determined directly vs. indirectly via value firms?

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Re: Factor funds: Active or Passive?

Post by danielc »

vineviz wrote: Fri Jan 04, 2019 12:48 pm
danielc wrote: Fri Jan 04, 2019 11:11 am I don't think that a buy/hold range makes a fund active. It makes it "not an index fund", but as long as it's all done mechanically (no human picking stocks or times) it's still perfectly passive and it's cap weighted.
But now you're back to a definition of "passive" that includes the vast majority of factor funds.
I don't think that factor funds necessarily have to be active. The factor funds that I'm personally aware of are all passive. I thought most of them were passive, but I haven't really looked.

vineviz wrote: Fri Jan 04, 2019 12:48 pm What objective criteria exists that would make an ETF which follows the S&P 500 Value Index a "passive fund" but an ETF which follows the S&P 500 Quality, Value & Momentum Multi-Factor Index an "active fund"?
With that specific fund, my concern would not be that it's "active". My concern would be that I'm not sure I trust factors enough to make a big bet on a very small and narrowly defined subset of the market. You make a good point that maybe we shouldn't be saying that multi-factor funds are active management by another name; but some of them do kind of feel like chasing the latest investment fad.
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Re: Factor funds: Active or Passive?

Post by columbia »

danielc wrote: Fri Jan 04, 2019 1:02 pm
vineviz wrote: Fri Jan 04, 2019 12:48 pm
danielc wrote: Fri Jan 04, 2019 11:11 am I don't think that a buy/hold range makes a fund active. It makes it "not an index fund", but as long as it's all done mechanically (no human picking stocks or times) it's still perfectly passive and it's cap weighted.
But now you're back to a definition of "passive" that includes the vast majority of factor funds.
I don't think that factor funds necessarily have to be active. The factor funds that I'm personally aware of are all passive. I thought most of them were passive, but I haven't really looked.

vineviz wrote: Fri Jan 04, 2019 12:48 pm What objective criteria exists that would make an ETF which follows the S&P 500 Value Index a "passive fund" but an ETF which follows the S&P 500 Quality, Value & Momentum Multi-Factor Index an "active fund"?
With that specific fund, my concern would not be that it's "active". My concern would be that I'm not sure I trust factors enough to make a big bet on a very small and narrowly defined subset of the market. You make a good point that maybe we shouldn't be saying that multi-factor funds are active management by another name; but some of them do kind of feel like chasing the latest investment fad.
If factor funds are indeed successful at identifying “winners” based on their specified criteria, aren’t they also in a somewhat constant churn of selling the losers (as they drop out of the...is index the right word)?
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Re: Factor funds: Active or Passive?

Post by vineviz »

columbia wrote: Fri Jan 04, 2019 1:09 pm If factor funds are indeed successful at identifying “winners” based on their specified criteria, aren’t they also in a somewhat constant churn of selling the losers (as they drop out of the...is index the right word)?
I'm not sure how you define "winner" in this context, but "identifying winners" isn't the way I'd characterize either the goal or the result of using factors in investment management.

Instead, I diversify across multiple factors in an effort to manage the expected riskiness of my portfolio relative to its expected return.

But, yes, it is certainly reasonable to expect that a portfolio that is diversifying across factors is going to have a higher turnover than a market cap weighted portfolio.

iShares S&P Small-Cap 600 Value ETF has 39% annual turnover, for instance, compared to just 8% for iShares Core S&P Total U.S. Stock Market ETF.
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Re: Larry Swedroe: investing Uncomfortably

Post by nedsaid »

I have always invested across factors. I have always invested across asset classes and sub-asset classes. I have tried to get every kind of diversification possible into my portfolio. Larry, I am with you. The thing is, in 2007, I was the man. It was working. US Value and International Stocks were killing the S&P 500. Real Estate was doing great, loved those REITs. I loved TIPS. That International Bond fund I bought was working great. My favorite mutual fund company, American Century, was just killing it.

Fast forward to early 2019, I feel like a bum. Like the poor guy that goes 2 for 19 during the World Series. Uggh, the agony of defeat. I was crying in my root bear over New Year's Day two years in a row over my year 2017 and year 2018 portfolio performance. I trailed the 3 fund portfolio and it makes me look bad. All that stuff that was working so great in 2007 ain't working so good now. Value isn't working, International had a bad decade vs US, REITs look expensive, and TIPS have been trailing Total Bond Market. American Century didn't have a very good year in 2018.

Thing is, I have seen the market cycles play out before. I have seen long stretches where Growth outperformed Value and where Value outperformed Growth. Ditto for Large vs. Small and US vs. International. Even seeing this with TIPS vs. Total Bond Market. I have seen the American Century fund performance wax and wane. The worm will turn eventually but I don't know when. Just have to have patience and the courage of my convictions.
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Re: Larry Swedroe: investing Uncomfortably

Post by CaliJim »

Taylor Larimore wrote: Thu Jan 03, 2019 10:45 am
Jack Bogle wrote "The beauty of owning the market is that you eliminate individual stock risk, you eliminate market sector risk, and you eliminate manager risk. -- In my view, owning the market and holding it forever is the ultimate strategy for winners."

The Three-Fund Portfolio

Best wishes.
Taylor
Beautiful quote. It is often hard to distill a complex topic down to something so clear and unarguable.
Jack puts it so simply and succinctly.

One could add by eliminating all these risk, one reduces, if not eliminates investor behavioural risk. some stock pickering investors who are wedded to their methods might argue that indexers are "leaving money on the table". and that WINNING means BEATING THE INDEX. I have an former acquantance, a vc "angel investor", and a seth klarman "deep value" adherant, who bragged that he beat the indexes "all the time". I never asked for statements or proof as that would have violated the terms (no bs, personal integrity, honest talk) of our friendship. Sometime back in the 200xs, he did give me some "deep value picks" that I've been watching ever since: GE, BofA. I sure am glad I didn't sell any index funds and to take concentrated risk position in those stinkers.
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Re: Factor funds: Active or Passive?

Post by columbia »

vineviz wrote: Fri Jan 04, 2019 1:57 pm
columbia wrote: Fri Jan 04, 2019 1:09 pm If factor funds are indeed successful at identifying “winners” based on their specified criteria, aren’t they also in a somewhat constant churn of selling the losers (as they drop out of the...is index the right word)?
I'm not sure how you define "winner" in this context, but "identifying winners" isn't the way I'd characterize either the goal or the result of using factors in investment management.

Instead, I diversify across multiple factors in an effort to manage the expected riskiness of my portfolio relative to its expected return.

But, yes, it is certainly reasonable to expect that a portfolio that is diversifying across factors is going to have a higher turnover than a market cap weighted portfolio.

iShares S&P Small-Cap 600 Value ETF has 39% annual turnover, for instance, compared to just 8% for iShares Core S&P Total U.S. Stock Market ETF.

Does this translate to selling low (on assets no longer eligible to meet the screening criteria)? It seems like it would.
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Re: Larry Swedroe: investing Uncomfortably

Post by peppers »

pkcrafter wrote: Thu Jan 03, 2019 12:26 pm I'm guarded on Swedroe's recommendations over the recent past. Swedroe used to recommend indexing, now he doesn't. What's different? BAM (Buckingham Asset Management) and BAM alliance. Larry works for both and is on the board of directors (director of research}. Who are the partners in the BAM alliance? Buckingham Asset Management isn't new and Larry has worked for them since 1996, but the BAM alliance appears to be fairly new and that's what has caused the change in Larry's recommendations.

Who's in the Alliance?

http://www.bamadvisorservices.com/who-we-are/

Using Larry's recommendations will increase costs and take you out of the Bogleheads' strategy.

Paul
Good point
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Re: Factor funds: Active or Passive?

Post by vineviz »

columbia wrote: Sat Jan 05, 2019 8:36 am Does this translate to selling low (on assets no longer eligible to meet the screening criteria)? It seems like it would.
Not necessarily, and certainly not in theory.

I mean, some stocks will certainly drop out of a value fund (for instance) because their fundamentals deteriorate horribly. But others will drop out because their fundamentals rebound to the point that their stock price has increased. In aggregate, the higher risk-adjusted returns we see with value stocks suggest that the latter tends to more-than-compensate for the former.
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Re: Larry Swedroe: investing Uncomfortably

Post by betablocker »

packer16 wrote: Fri Jan 04, 2019 12:55 pm
betablocker wrote: Fri Jan 04, 2019 10:42 am
packer16 wrote: Thu Jan 03, 2019 11:31 pm
betablocker wrote: Thu Jan 03, 2019 10:20 pm
packer16 wrote: Wed Jan 02, 2019 10:15 pm

By a fundamental factor is the factor cannot be changed over time. A stock is stock & a bond a bond. A "value" stock can become a "growth" stock and visa versa. The same is true for momentum. The returns for the non-fundamental factors are based upon past empirical returns not underlying economics or characteristics of the securities. Given that past empirical data with someone implementing these non-fundamental strategies is limited (maybe the past 20 years at most & only a few periods of out-performance/under-performance), the probability of these correlations happening by chance increases. You also have a measurement problem with value. Stocks with less growth should fundamentally less than those with high growth. However, all measures of cheapness of value I have seen do not include this factor in their estimation of cheapness.

The examples Larry gives is three instances of value doing better than beta. However, only one is during a period when factor investing was being used. So if you assume the market likes value vs. growth on 50/50 basis, then with only one trial you have at most a 75% confidence that value will work in the future. If we had more examples of markets where factor investing has been used over many non-fundamental cycles, then the case would be clearer. At this point you are making a "bet" that these non-fundamental factor correlations will continue. Just my 2 cents.

Packer
Ben Graham was doing net bets before any of us were born and people wrote about momentum 100s of years ago. Don’t think those facts check out.
There are a large differences between the net-nets being done by Ben Graham and the value factor. The net-net's were arbitrages based upon economics of the situations, the value factor is a correlation not based upon economics but correlation, its greatest weakness. As the market becomes more efficient the arbitrages go away & you are left with correlations, which may change over time.

Packer
I think this is begging the question. Agreed that fundamental analysis is different method for selecting investments than the quantitative analysis but they get you to the same place so what's the difference in the end. I'd say the only difference is allowing for human error and performance chasing.

But if you index you target not fundamental analysis but an abstract factor called market beta. While the evidence for it is more robust given how long it has been recognized and sold/bought as such, it is based on the same evidence as the other generally accepted factors.
The question of getting you to the same place depends upon the correlation & time frame examined. The factors are theoretical constructs not based upon fundamentals of the firms or securities. Equities, loosely what you refer to as beta, are defined as subordinate claims on firm cash flows. Bonds are senior claims. In an efficient market, economics states that equities should reward equities more than bonds due to their risk.

Value is not by itself a characteristic of a firm or security & it can change over time. What the market will pay for value varies over time depending upon the "taste" of the market. In an efficient market, economics does not say that value firms should earn a premium over a growth firm. As a matter of fact, US growth firms should sell at a premium due to their US tax advantaged status. Therefore, the "taste" based factors should provide returns similar to Bogle's LT charts of growth vs. value. Now there has been some value premium in the past & it appears to have declined quite a bit in the past 10 years so I would argue it is removal of inefficiencies. Some argue that value firms have more operational & financial risk but if this is case for the risk premium why not put together of portfolios of higher operationally & financially leveraged firms determined directly vs. indirectly via value firms?

Packer
Surprisingly I disagree. The equity risk premium changes all the time and goes negative for periods of time just like all the other factors. It’s no more a “taste” than any other factor. While value has underperformed for 10 years in the US (as it has in other periods I might add), momentum, quality, low vol, etc. have outperformed in the recent past. While I greatly respect Bogle there are many threads on here that highlight how inaccurate his mean reversion data is. It’s so inaccurate that it is meaningless. Finally, I’m quite clear on the claims of equity and bond holders but disagree with how you are characterizing market beta. Market beta is not your return on a stock. It’s the return on a stock that is accounted for by the returns of the overall market. Same with the value factor. If you buy a stock that you selected because it has value characteristics you have an equity holder’s claim on that business but you hope those returns outperform because of the value factor. Same as when you buy an equity to get the market return plus idiosyncratic risk of that security. Also understand that you would have to long short to get just value and not market beta as well in first example. In the end I believe the market is mostly efficient except in cases where career risk, limits to arb, and persistent behavioral aspects of human beings exist. You don’t believe that and that’s fine too.
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"Mean Reversion"

Post by Taylor Larimore »

betablocker wrote:While I greatly respect Bogle there are many threads on here that highlight how inaccurate his mean reversion data is. It’s so inaccurate that it is meaningless.
betablocker:

Please read Mr. Bogle's great speech (which I attended) delivered to The Morningstar Investment Forum in
Chicago, IL on June 26, 2002. It is about "mean reversion" which I believe is a generally accepted theory.

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

Best wishes.
Taylor
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Re: Larry Swedroe: investing Uncomfortably

Post by betablocker »

Taylor,

Read the threads about how he used active funds as his data which engage in style drift. So his data shows how when growth did well active value managers bought growth stocks.
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Re: Larry Swedroe: investing Uncomfortably

Post by packer16 »

betablocker wrote: Sat Jan 05, 2019 11:39 am
packer16 wrote: Fri Jan 04, 2019 12:55 pm
betablocker wrote: Fri Jan 04, 2019 10:42 am
packer16 wrote: Thu Jan 03, 2019 11:31 pm
betablocker wrote: Thu Jan 03, 2019 10:20 pm
Ben Graham was doing net bets before any of us were born and people wrote about momentum 100s of years ago. Don’t think those facts check out.
There are a large differences between the net-nets being done by Ben Graham and the value factor. The net-net's were arbitrages based upon economics of the situations, the value factor is a correlation not based upon economics but correlation, its greatest weakness. As the market becomes more efficient the arbitrages go away & you are left with correlations, which may change over time.

Packer
I think this is begging the question. Agreed that fundamental analysis is different method for selecting investments than the quantitative analysis but they get you to the same place so what's the difference in the end. I'd say the only difference is allowing for human error and performance chasing.

But if you index you target not fundamental analysis but an abstract factor called market beta. While the evidence for it is more robust given how long it has been recognized and sold/bought as such, it is based on the same evidence as the other generally accepted factors.
The question of getting you to the same place depends upon the correlation & time frame examined. The factors are theoretical constructs not based upon fundamentals of the firms or securities. Equities, loosely what you refer to as beta, are defined as subordinate claims on firm cash flows. Bonds are senior claims. In an efficient market, economics states that equities should reward equities more than bonds due to their risk.

Value is not by itself a characteristic of a firm or security & it can change over time. What the market will pay for value varies over time depending upon the "taste" of the market. In an efficient market, economics does not say that value firms should earn a premium over a growth firm. As a matter of fact, US growth firms should sell at a premium due to their US tax advantaged status. Therefore, the "taste" based factors should provide returns similar to Bogle's LT charts of growth vs. value. Now there has been some value premium in the past & it appears to have declined quite a bit in the past 10 years so I would argue it is removal of inefficiencies. Some argue that value firms have more operational & financial risk but if this is case for the risk premium why not put together of portfolios of higher operationally & financially leveraged firms determined directly vs. indirectly via value firms?

Packer
Surprisingly I disagree. The equity risk premium changes all the time and goes negative for periods of time just like all the other factors. It’s no more a “taste” than any other factor. While value has underperformed for 10 years in the US (as it has in other periods I might add), momentum, quality, low vol, etc. have outperformed in the recent past. While I greatly respect Bogle there are many threads on here that highlight how inaccurate his mean reversion data is. It’s so inaccurate that it is meaningless. Finally, I’m quite clear on the claims of equity and bond holders but disagree with how you are characterizing market beta. Market beta is not your return on a stock. It’s the return on a stock that is accounted for by the returns of the overall market. Same with the value factor. If you buy a stock that you selected because it has value characteristics you have an equity holder’s claim on that business but you hope those returns outperform because of the value factor. Same as when you buy an equity to get the market return plus idiosyncratic risk of that security. Also understand that you would have to long short to get just value and not market beta as well in first example. In the end I believe the market is mostly efficient except in cases where career risk, limits to arb, and persistent behavioral aspects of human beings exist. You don’t believe that and that’s fine too.
We appear to be talking about two different things. What you are describing as factors are correlations that may have either a direct economic rational or implied economic rationale. I am describing economic drivers of security returns. Now factors that have a direct economic rationale and economic drivers have quite a bit of overlap. Some examples are equity returns vs. bonds (market returns) and size. Places where there is divergence is in the implied economic rationale bucket. These include value and momentum. These are the factors that I characterize as "taste" as there is no direct economic rationale for their existence in an efficient market. I am not saying these cannot be found in times of distress or in small corners of the market but to harvest them using a diversified portfolio of securities (factor portfolio's) is much more difficult. You are comparing the characteristics of the factors (correlations) that change over time. One of the huge assumptions in factors is you have found direct economic reasons for returns. I agree with the case where direct economic evidence exists & am skeptical of the others. IMO what has been done here is a mixing of true economic drivers of return with other factors that may or not have a direct economic rationale. I agree with you on three exceptions to market efficiency but I think most of the exceptions happen during periods of distress except in small corners of the market.

Another misleading use of language in factor investing is factors explain returns. Factors are correlations not explanations. However, some of these correlations are related to some economic rationale & some are not so it has lead to IMO the equivalence of factors as explanations. IMO it also provides a false sense of control to the manager who thinks a factor based approach will help his returns when it is more of a historical correlation exercise than explanation exercise.

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