Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

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Taylor Larimore
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What Experts Say About "Simplicity."

Post by Taylor Larimore » Wed Jun 05, 2019 9:56 am

Salesmen peddling excess simplicity are just as dangerous as those peddling excess complexity, IMHO.
vineviz:

Sorry, I strongly disagree. So do these experts (which includes our mentor, Jack Bogle). Be sure to read what Scott Burns has to say about complexity.
Scott Adams, author of Dilbert: "I once tried to write a book about personal investing. After extensive research I realized I could describe everything that a young first-time investor needs to know on one page."

Antoine de Saint-Exupéry: "A designer knows he has achieved perfection not when there is nothing left to add, but when there is nothing left to take away."

Christine Benz, Morningstar Director of Personal Finance: "Simplicity is one of the greatest--but in my view, woefully underrated--virtues when managing a portfolio."

Bill Bernstein, author of Four Pillars of Investing: ""The more real people I get to know, the more I am convinced the simpler the solution, the better the solution."

Richard Bernstein, Merrill Lynch strategist: "Investors find it hard to believe that ignoring the vast majority of investment noise might actually improve their performance."

Jack Bogle: "Simplicity is the master key to financial success. -- We ignore the real diamonds of simplicity, seeking instead the illusory rhinestones of complexity."

Dan Bortolotti, CFP, and author of The Money Sense Guide to the Perfect Portfolio: "The peace of mind that comes with a simple investing strategy is priceless."

Jack Brennan, former Vanguard CEO and author of Straight Talk on Investing: "It's in the interest of many financial service companies to make you think that investing is difficult.--It's really quite simple."

Warren Buffet: "To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these."

Scott Burns, creator of The Couch Potato Strategy: The advocates of complexity are generally people who are making their living from the complexity they create for us.”

Ben Carlson, author of A Wealth of Common Sense: ""I’ve spent my entire career working in portfolio management. This experience has taught me that less is always more when making investment decisions. Simplicity trumps complexity."

Jean Chatzky, NBC Financial Editor: "The problem with so much personal financial advice is that it's unnecessarily complicated, often with the goal of selling you something you don't need."

Andrew Clarke, author of "Wealth of Experience": "In investing, simple is usually more productive than complex."

Jonathan Clements, Wall Street Journal columnist: "Investing is simple. To be sure, you can make it ludicrously complicated."

J.L.Collins, author of The Simple Path to Wealth: The more complex an investment is, the less likely it is to be profitable. At best they are costly. At worst they are a cesspool of swindlers.

Paul Crafter, author of "Investment Guide": "After doing it all, I now feel I've come around in a complete circle, ending up with this: The more I learn, the less I really need to know."

James Dahle, Editor of The White-Coat Investor: "In my view, the simpler the financial product, the better it is for the consumer."

Edsger Dijkstra, famed physicist: “Simplicity is a great virtue but it requires hard work to achieve it and education to appreciate it. And to make matters worse: complexity sells better.”

Laura Dogu, Ambassador to Nicaragua and co-author of "The Bogleheads Guide to Retirement Planning": A simple portfolio is actually the ultimate in sophistication. It almost always lowers cost (including taxes), makes analysis easier, simplifies rebalancing, simplifies tax-preparation, reduces paper-work and record-keeping, and enables caregivers and heirs to easily take-over the portfolio when necessary. Best of all, a simple portfolio allows the investor to spend more time with family and friends."

Michael Edesess, author of The Big Invesment Lie: "As a mathematician I know when mathematical-sounding analyses are little more than elaborate sales pitches, designed to thoroughly obscure the simple fact that smart investing is non-mathematical and accessible to everyone."

Albert Einstein: "The five ascending levels of intellect are: smart, intelligent, brilliant, genius, simple."

Charles Ellis, co-author of "The Elements of Investing": "KISS investing--Keep It Simple, Sweetheart--is the best and easiest and lowest cost and worry-free way to invest for retirement security."

Javier Estrada Ph.D., Professor of finance: "Simplicity is often underrated; simple static strategies (balanced portfolios) have been shown to perform as well as—and often better than—more complex strategies in a wide variety of settings."

Paul Farrell, author of "The Lazy Person's Guide to Investing": "Perhaps the most amazing insight I got out of this review of the investment habits of Nobel laureates is the simplicity of their investing strategies."

Rick Ferri, CFA, advisor, and author of six financial books:[/i] "Don’t assume that a complex strategy is better than a simple strategy. The only thing extra complexity is likely to add is extra cost." -- "Complexity is the third stage in the education of an index investor; Simplicity is the fourth and final stage."

The Finance Buff: "Making fewer decisions usually leads to better results than making more decisions."

Future Metrics looked at the performance of 224 pension plans over about 14 years compared with the performance of 60% S&P 500 index and 40% aggregate bond index benchmark. Of those 224 plans, only 19 beat that simple benchmark.

Gensler & Baer, authors of "The Great Mutual Fund Trap": "If you simply buy and hold you don't need to read investing magazines, watch financial news networks, subscribe to newsletters, or pay a broker to execute new trades."

Benjamin Graham, author, teacher, famed investor: "If you merely try to bring just a little extra knowledge and cleverness to bear upon your investment program, instead of realizing a little better than normal results, you may well find that you have done worse. -- In the stock market, the more elaborate and abstruse the mathematics, the more uncertain and speculative are the conclusions we draw therefrom."

Alan Greenspan, former Chairman of the Federal Reserve: "This decade is strewn with examples of bright people who thought they built a better mousetrap that could consistently extract abnormal returns from financial markets. Some succeed for a time. But while there may occasionally be misconfigurations among market prices that allow abnormal returns, they do not persist."

Morgan Housel: financial columnist for Wall Street Journal and Motley Fool's "Simple almost always beats complex."

Daniel Kahneman, Nobel Laureate: "All of us would be better investors if we just made fewer decisions"

Edmund Kean: "Complexity is easy. Simplicity is hard."

Kiplinger: "The big secret to successful investing is that it's actually not all that complicated. Most of the mumbo jumbo doesn't matter."

Darrow Kirkpatrick, author of Retiring Sooner: "In financial life, you should run from complexity, and run toward simplicity."

Michael LeBoeuf, author of "The Millionaire in You": "The master key to wealth can be summed up in just one word: Simplicity."

Bruce Lee: "One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity"

Leonardo da Vinci: “Simplicity is the ultimate sophistication.”

Peter Lynch, legendary fund manager: "If you spend more than fifteen minutes a year worrying about the market, you've wasted twelve minutes."

MIT Study: "The less well-informed group did far better than the group that was given all the financial news."

Scott MacKillop, CEO First Ascent Asset Management: " People who don’t know any better equate complexity with sophistication. But truly it takes more sophistication to build elegantly simple portfolios."

Joe Maglia, CEO TD Ameritrade: "Wall Street goes out of its way to make investing incredibly sophisticated and complex because they can make a tremendous amount of money by doing so."

Burton Malkiel, author of "Random Walk Down Wall Street": "The overarching rule for achieving financial security: Keep it simple. -- The most important financial advice is stunningly simple and fits on an index card."

John Markese, CEO of American Association of Individual Investors: "If you have more than eight funds you should slap yourself."

Wm McNabb, Vanguard CEO: "If you can't understand an investment product in five minutes, walk away."

Eric McWhinnie, chief analyst, Wall Street Cheat Sheet: "Keep your investment strategy simple and steer clear of complicated vehicles that are designed to benefit the people selling them."

James Montier, author of The Little Book of Behavioral Investing : "Never underestimate the value of doing nothing."

Morningstar Guide to Mutual Funds: "Good investing doesn't have to be complicated. In fact, simplification may lead to better investment results."

Charles Munger, Vice President, Berkshire Hathaway: "Where there is complexity there is by nature fraud and mistakes."

Issac Newton: “Truth is ever to be found in the simplicity, and not in the multiplicity and confusion of things.”

Suze Orman: "We make investing so complicated and it really is not. -- A total market index fund is a great one-stop-shopping choice that provides you instant diversification among different types of stocks."

Mike Piper, financial author: "There's an entire industry built on convincing us that investing is complicated."

David Nadig, president of Index Universe's ETF Analytics: "Most investors—myself included—are better off the simpler we keep things."

Bob Pisani, CNBC: "Increasing complexity does not decrease risk, it increases risk."

Jane Bryant Quinn, syndicated columnist and author of "Smart and Simple Financial Strategies": "You shouldn't buy anything too complex to explain to the average 12-year old."

Anna Pryor Wall Street Journal writer: "It may sound counter-intuitive, but for the average individual investor, less is actually more."

John Rekenthaler, Morningstar Research Director: "How many funds should you have? Four to six should do.-- A complex investment strategy, with many moving parts, means more wheels that are stuck at any given time, leading to more questions and more uncertainty."

Rodc on Bogleheads Forum: "While doing this financial engineering my wife who does no math just shook her head at my optimization games and said, 'Rod, life is uncertain, get over it.' After a lot of work, I discovered much to my surprise, she was right."

Allan Roth, CFP, CPA, author and advisor: "If you’re thinking complexities such as smart beta and the like will best simplicity, think again."

Paul Samuelson, Nobel Laureate: "Investing should be like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."

Bill Schulthies, author of "The Coffeehouse Investor": "When you simplify your investment decisions, not only do you enrich your life by spending more time on families, friends and careers, but you enhance portfolio returns in the process."

Chandon Sengupta, author of "The Only Proven Road to Investment Success": "There is overwhelming evidence that the simplest possible investment method works much better than all the other more complex ones."

Wm. Sharpe, Nobel Laureate: "Smart Beta ? Hearing it makes me sick."

George Sisti, CFP, MarketWatch contributor: "There is no perfect portfolio — yours should emphasize simplicity and shun complexity."

Larry Swedroe, author of "The Successful Investor Today": "The more complex the investment, the faster you should run away."

David Swensen, Yale Chief Investment Officer: "As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run."

Henry David Thoreau: “Our life is frittered away by detail. Simplify, simplify.”

Andrew Tobias, author of The Only Investment Guide You Will Ever Need: "I believe in selecting the most straightforward and easiest-to-implement strategy for achieving our goals."

Tweddell and Pierce, authors of "Winning with Index Mutual Funds": "Keep it simple. Investment success depends on asset allocation, diversification, and risk management, not on complexity."

Eric Tyson, author of "Mutual Funds for Dummies:" "Planners may try to make it all so complicated that you believe you can't possibly manage your finances or make major financial decisions without them."

Walter Updegrave, Editor of Money magazine: "Simpler is better. Ignore the siren song of sophisticated investments"

Richard Young, author of "The Intelligence Report": "If you can't run your portfolio taking 60 minutes a month, it's too complicated."

Karen Wallace, Morningstar senior editor: "Having fewer accounts can help you streamline your monitoring and rebalancing efforts. And having your assets in one place can allow you to better assess your overall asset mix.

Jason Zweig, Wall Street Journal columnist and author of "The Intelligent Investor": "The less you fool with your portfolio, the less often you'll play the fool."

Warren Buffett: "There seems to be some perverse human characteristic that likes to make easy things difficult."
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: What Experts Say About "Simplicity."

Post by vineviz » Wed Jun 05, 2019 10:19 am

Taylor Larimore wrote:
Wed Jun 05, 2019 9:56 am
Salesmen peddling excess simplicity are just as dangerous as those peddling excess complexity, IMHO.
vineviz:

Sorry, I strongly disagree. So do these experts (which includes our mentor, Jack Bogle). Be sure to read what Scott Burns has to say about complexity.
I’m not surprised you disagree.

My experience may differ from yours, but the people I’ve worked with and studied who were the most successful at what they did have been characterized by a willingness to embrace nuance where it was necessary to do so.

I’ve witnessed people taking an unnecessarily complicated approach to problems, where a simpler solution would have been both more successful and less expensive.

I’ve also witnessed people taking an unnecessarily simplistic approach to problems, overlooking crucial details out of either anti-intellectual hubris or flat-out ignorance. This rarely ends well either.

So as much as possible I commit myself to understanding things before I dismiss them, with a goal of finding balance by avoiding dogma.

Jack Bogle was a smart man, and given how passionate he was about both financial research and financial education I choose to believe that he would have agreed with Einstein: as simple as possible, but no simpler.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by skeptic42 » Wed Jun 05, 2019 10:42 am

Random Walker wrote:
Wed Jun 05, 2019 9:24 am
skeptic42 wrote:
Wed Jun 05, 2019 4:22 am
I agree that factors are a unique source of risk. But I disagree that the currently known factors are a unique source of positive return in the future, because we cannot know it yet.
Completely true. And that statement applies equally to the market factor. All we can do is think in terms of expected returns, expected volatilities, expected correlations. With so much uncertainty, especially for people approaching or in withdrawal phase, diversification across unique and independent sources of risk and return seems most prudent. If markets are efficient, and all sources of return have about the same Sharpe ratio, diversification across them appears way more rational than limiting oneself to a single risk basket. Market beta is certainly the cheapest and most readily available source of risk and return, but paying a little more for a more efficient portfolio makes a lot of sense. Take a look at how 1/n portfolios decrease the likelihood of underperformance over any time frame in chapter 9 of Larry’s factor book.

Dave
I understand your reasoning, but I am skeptical about factor investing for a more efficient portfolio. The market factor is easy to understand and simple to invest. The other factors are academic constructs which help to better explain asset pricing. First, one needs the conviction that the underlying risks of these factors can be captured by factor investing. Secondly, one needs a high enough allocation to the other risk factors, so that the MPT diversification magic can make a meaningful difference, this could create a large tracking error to the market. And finally, we know that costs matter and that for every winner there has to be a loser, who is the loser which voluntarily holds the less efficient portfolio?

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by matjen » Wed Jun 05, 2019 11:39 am

Rick Ferri wrote:
Wed Jun 05, 2019 9:51 am
I get it. From my perspective, investing is way overdone. Topics talked about on this site change with the seasons. While interesting and entertaining, it's confusing for a lot of people.

Someone asked me on Twitter last night what I thought of the "Larry Portfolio?" I said, "Which one? This year's portfolio? The one five years ago? The one ten years ago?"

I'm not picking on Larry ( :wink: ), it's a bias we have as humans that when something great is sitting right in front of us, we don't see it and seek something better.

Just buy a few total market index funds and fuggetaboutit!

Rick Ferri
Rick the common criticisms against factor investing/tilting is that 1) it is needlessly complicated, 2) hasn't done all that well for 10+ years leading to tracking error/investor regret/behavioral mistakes, and 3) requires expensive (1%) advisor access often.

#1 is just plain silly. As Larry mentioned somewhere above and as you well know there are plenty of Core and core type funds first from DFA and now others that provide SCV exposure at the very minimum.

#3 gets less and less accurate by the day. I think you were charging like 28-30 bps 10 years ago? A bargain for anyone who isn't passionate about investing to have your skill or those trained by you working with them. Hourly a better bargain for sure though. Plenty of DFA in large retirement plans and there is DFA (used as a proxy for basic factor investing) in some 529 plans. I have had access to basically anything for both me and spouse for a flat 1k a year and that includes managed (rebalanced) AQR, DFA, etc. portfolios if I desire.

However, #2 is what really fascinates me with regard to criticisms from the total market indexing purists. Because other than Bogle almost everyone else (including me) would have a ton of International-ex US exposure these past 10+ years and those funds have been crushed relative to Total US. I find it hard to believe that someone will bail on a SCV fund that has done a bit worse in US and better in International and just sit tight with no behavioral issues on the potentially much larger Total International position. Same story for the more esoteric funds like QSPIX that have had a rough 1.5 years. Big whoop, that is part of investing and part of why it works (though I admit to being a bit put off by the drawdown in QSPIX).

Pardon the pun but "factor" in someone who has a large dose of international the past 10+ years running across a quote from Jack Bogle or Warren Buffett about Equities only being total US/S&P and then what happens? Who the hell is Bill Sharpe, Rick Ferri, William Bernstein, Larry Swedroe, Taylor Larimore, etc. compared to these two titans?

How does one continually harp on tracking/behavioral issues regarding factor investing when 1/3rd of the the three-fund portfolio has been horrid for over a decade? The answer is you just believe your story (as do I) but someone who believes in factor investing (as do I) should believe theirs as well. There is less of a reason to dump any type of factor portfolio compared to any type of international exposure it seems to me. Far less of a reason.

FWIW, my solution to this for the handful of HNW friends I have helped is to put them in balanced funds wherever I can. A LifeStrategy or Target-Date Fund minimizes this issue IMO plus much less or zero rebalancing required in the total portfolio depending on how much is outside of tax sheltered accounts.


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VTI Vanguard Total Stock Market ETF
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Wed Jun 05, 2019 11:48 am

skeptic42 wrote:
Wed Jun 05, 2019 10:42 am
The market factor is easy to understand and simple to invest.
But the same is true of all the other factors: market cap and valuation metrics (e.g. price to book, price to earnings, EV/EBITDA) are no harder to understand or invest in than beta.
skeptic42 wrote:
Wed Jun 05, 2019 10:42 am
The other factors are academic constructs which help to better explain asset pricing.
On the contrary, market beta is a much more "academic construct" than the other factors. Market beta is entirely a figment of data mining: there is not fundamental analog that explains market beta as there is with other factors. I suspect that market beta gets a pass on this because it was published first, but by any objective measure it's more theoretical than the factors that were published later.
skeptic42 wrote:
Wed Jun 05, 2019 10:42 am
First, one needs the conviction that the underlying risks of these factors can be captured by factor investing.
Again, this applies to market beta just as much as it does to other factors.
skeptic42 wrote:
Wed Jun 05, 2019 10:42 am
Secondly, one needs a high enough allocation to the other risk factors, so that the MPT diversification magic can make a meaningful difference, this could create a large tracking error to the market.
Technically, it's not tracking error if you're not actually attempting to replicate the market. It'd be logically inconsistent to hold a portfolio that was intentionally different from the market portfolio accountable for closely tracking that market portfolio.
skeptic42 wrote:
Wed Jun 05, 2019 10:42 am
And finally, we know that costs matter and that for every winner there has to be a loser, who is the loser which voluntarily holds the less efficient portfolio?
Having a well-diversified portfolio needn't be very costly: plenty of great choices at 15bps or less.

As to the last point, I think it's best to address the underlying nature of the problem. The market portfolio is only "efficient" for an investor who has precisely the same preferences in every regard as the so-called "average" investor. In reality, no one is the average investor: we are all different.

I might have all my assets in a tax-advantaged account. You might have all your assets in a taxable account and be in the top marginal tax bracket. Clearly, we care very differently about tax-effiency and should therefore invest differently.

I might be 25 years old with virtually nothing invested and have a long period of future earnings power ahead of me. You might be 85 years old and heavily reliant on your portfolio to provide for your annual spending. Clearly, we care very differently about the risk of high inflation over the next 5 years.

I might be psychologically capable of handling very little market volatility while you can handle wild swings without reacting counter-productively. Clearly, we should have portfolios with significantly different variance profiles.

Together you and I make the market, but individually the market portfolio is "efficient" for neither of us.

The most "efficient" portfolio for me would be to invest in assets that have risks which I don't care about but that you prefer to avoid. And vice-versa. Because the risks we face are different, it's actually possible for us EACH to have better risk-adjusted returns than the market portfolio offers us.

In short, it's logically inconsistent to talk about there being multiple risk factors but only one efficient portfolio. In the original MPT framework, there was one dimension of risk (i.e. volatility) and therefore one portfolio that was risk-return efficient. The more risk factors there are, the more efficient portfolios there are.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by nedsaid » Wed Jun 05, 2019 12:38 pm

larryswedroe wrote:
Wed Jun 05, 2019 8:10 am
nedsaid, a problem with your comments is the mistake of thinking equity like means say 10% which is historical return, but no financial economist I know expects that going forward given valuations, more like 4-% real, so equity like would then be say 6%+, not 10%, which is history not expected. And when I have said equity like that is exactly what I have meant. And bond like would be 2%.

And the idea of retiring soon and thus short horizon is reason to avoid such vehicles is exactly backwards IMO. Reason is simple, sequence risk--and market beta can collapse far more than a diversified portfolio across unique sources of risk like QSPRX. BTW, Sharpe ratio since inception is .22 and Sortino is .33. So even with the disappointing performance it's not that bad, and certainly within range of expected. You want the downside protection even more in retirement when cannot recover from losses on money spent to live on

Larry
Thanks for your response. As you know, I am neutral about the Alts, though for the reasons cited above I have considered them for a form of portfolio insurance. Not against them but they have to provide diversification benefits at least as good as boring, old, investment grade bonds. Other forms of portfolio insurance have had rather mixed results. For example, I considered Precious Metals funds but figured the price of depressed returns wasn't worth whatever benefit I might get in a crisis.

We were discussing QSPIX and QSPRX, in fairness you recommend a total of 4 alts. One factor fund that uses shorting and leverage and three interval funds. I would expect that the combination of Alts would give even better diversification benefits than QSPIX or QSPRX on its own. Would be interesting to know how the 3 interval funds are doing.

One reason to consider the Alts are the depressed future expected returns for stocks and bonds. Also why I want more International.

By the way, it is interesting that Rick Ferri is now the reincarnation of John Bogle. They seem one and the same now. Earlier work, including All About Asset Allocation has been forgotten. Granted, Bogle is a heck of a guy to emulate and folks are allowed to change their mind. For all the criticism that you have gotten about changing your mind, Mr. Ferri is getting a free pass. Factors? Never heard of them! As for me, my advice stays the same, factor tilt if you believe the research and 3-5 fund if you don't.

Again, thank you for your many responses here. I really appreciate it.
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by klaus14 » Wed Jun 05, 2019 12:56 pm

vineviz wrote:
Wed Jun 05, 2019 11:48 am

As to the last point, I think it's best to address the underlying nature of the problem. The market portfolio is only "efficient" for an investor who has precisely the same preferences in every regard as the so-called "average" investor. In reality, no one is the average investor: we are all different.

I might have all my assets in a tax-advantaged account. You might have all your assets in a taxable account and be in the top marginal tax bracket. Clearly, we care very differently about tax-effiency and should therefore invest differently.

I might be 25 years old with virtually nothing invested and have a long period of future earnings power ahead of me. You might be 85 years old and heavily reliant on your portfolio to provide for your annual spending. Clearly, we care very differently about the risk of high inflation over the next 5 years.

I might be psychologically capable of handling very little market volatility while you can handle wild swings without reacting counter-productively. Clearly, we should have portfolios with significantly different variance profiles.

Together you and I make the market, but individually the market portfolio is "efficient" for neither of us.

The most "efficient" portfolio for me would be to invest in assets that have risks which I don't care about but that you prefer to avoid. And vice-versa. Because the risks we face are different, it's actually possible for us EACH to have better risk-adjusted returns than the market portfolio offers us.

In short, it's logically inconsistent to talk about there being multiple risk factors but only one efficient portfolio. In the original MPT framework, there was one dimension of risk (i.e. volatility) and therefore one portfolio that was risk-return efficient. The more risk factors there are, the more efficient portfolios there are.
This is very good framing.
Then the question is: what kind of investors are better of with market cap investing vs factor investing?
Some parameters seem to be that you need longer investment horizons, discipline, knowledge and conviction for factor investing. For majority of the investors, market cap investing (with some home bias) is probably better. Especially if you think about behavioral requirements of factor investing vs simplicity of market cap. This is why Taylor is right to promote his 3 fund portfolio everywhere.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by larryswedroe » Wed Jun 05, 2019 1:15 pm

Nedsaid,
Few things, I do own three other alts, the three Stone Ridge Funds, one has done very well, LENDX with very high SR and 7.3 percent return for FI fund since June 2016 inception. Would not expect quite that high going forward, but in that range. The reinsurance fund had first few years of good returns and as we should expect occasionally bad years, and we got two in row now. But with much higher rates on renewals the "no loss" expected return is now about 22% vs 17%, and expected losses should be about say 9%. But that is going forward as renewals were much higher rates in March (Japan) and June (US), though some increases came through last year due to Cal fire losses. Of course it is possible, just like with stocks, that we could get third bad year. But logically over long term writers of insurance own risk premiums and the premium is totally uncorrelated with stocks and bonds and has no duration risk either. The most logical of all alternatives IMO.

The VRP fund also had good start and then bad year last year as vol spiked in every asset class (thanks for trade wars). Since inception up about 3% per annum due to loss in 2018 when vol spiked all over. Note the VRP has as much evidence and logic as market beta does.

SRRIX up only about 1% per annum since inception due to two bad years of losses in row. But now expected returns higher due to the typical increased premiums (this is normal cycle in reinsurance). So far two of three have not performed so well but I have not changed my views and recently added funds to all three. Again it's all about diversifying across unique sources of risk.

BTW, here is a way to think about things. So you are a doctor and you have treated patients with a condition a certain way and then you learn new information that offers better treatment, though it is "more complex". You read the literature and the evidence is persistent and pervasive and intuitive for why the new treatment is LIKELY to produce better outcomes. Do you adapt it or ignore it? Same thing with investing, smart people when they learn something new that has strong evidence and logic behind it you change your views.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Wed Jun 05, 2019 1:44 pm

klaus14 wrote:
Wed Jun 05, 2019 12:56 pm
Then the question is: what kind of investors are better of with market cap investing vs factor investing?
Some parameters seem to be that you need longer investment horizons, discipline, knowledge and conviction for factor investing. For majority of the investors, market cap investing (with some home bias) is probably better. Especially if you think about behavioral requirements of factor investing vs simplicity of market cap. This is why Taylor is right to promote his 3 fund portfolio everywhere.
I mostly agree with this.

For investors who can't (or choose not to) evaluate their own behavioral tendencies and their individual investment goals, I think the that global market cap weights should definitely be the default choice for their equity allocation. This should almost certainly be in the form of a balanced fund (e.g. Vanguard LifeStrategy fund) or a target date index fund.

Likewise, there are two particular behavioral biases that - if identified as strongly present in an investor - probably also indicate that global market cap weighted balanced fund would be highly preferred. The two biases are regret aversion and fallacy of composition: if one or both of those are present to a significant degree, the investor probably has no business constructing and managing their own DIY portfolio (factor or otherwise).

I suspect it is true that a majority of investors belong in one of those two groups, but few Bogleheads would self-identify into those groups. Once an investor has committed to managing their own portfolio, I don't think it's unreasonable for them make an honest and sincere attempt to learn the fundamentals of modern portfolio construction.

To do otherwise strikes me as folly, akin to rewiring an electric outlet without bothering to learn the basics facts about electricity or modern building codes. Or writing an iOS app using a computer science textbook from the 1970s as a reference.

The state of knowledge has advance greatly since the days that Jack Bogle wrote his college thesis at Princeton, and it is entirely possible to honor Bogle's values without having to build portfolios as if we are living in the 1950s.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by Random Walker » Wed Jun 05, 2019 2:47 pm

larryswedroe wrote:
Wed Jun 05, 2019 1:15 pm
BTW, here is a way to think about things. So you are a doctor and you have treated patients with a condition a certain way and then you learn new information that offers better treatment, though it is "more complex". You read the literature and the evidence is persistent and pervasive and intuitive for why the new treatment is LIKELY to produce better outcomes. Do you adapt it or ignore it? Same thing with investing, smart people when they learn something new that has strong evidence and logic behind it you change your views.
Just thought I’d elaborate on this a bit, especially since I happen to be a doctor myself. When I left residency one of the last things my residency director said to me was something to this effect. Some of the worst doctors are the ones who read the journals every week and change what they do every week according to what they last read. Instead the doctor needs to leave residency with solid basic knowledge, core beliefs, and a philosophy for treating patients. Then, when out in the real world, the doctor has a framework in place to use when choosing whether to adopt anything new he learns.

For investors, that basic scaffolding should be strong belief in market efficiency, modern portfolio theory, passive investing, cost matters hypothesis, some knowledge of financial history, possibly some conviction about the persistence of human behavior. When we learn of something new such as a factor or an alternative, we need to consider how it fits within or can be attached to that fundamental scaffolding. It’s not a fly by night, fad, week to week changing decision.

For some people, deep belief or near tunnel vision focus on costs alone will exclude any new investments. For others, there may well be room to attach something new within the framework of the core principles. When looking at a new potential portfolio addition, one needs to look at expected returns, volatility, correlations, when correlations tend to change, and costs. He needs to decide on what he is trying to accomplish with the potential new addition, and that is directly related to deciding on which current positions to exchange for the new one. When it appears likely that the potential marginal benefit will outweigh the certain increased marginal cost, the investor should strongly consider incorporating the change.

Dave
Last edited by Random Walker on Wed Jun 05, 2019 3:50 pm, edited 1 time in total.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by skeptic42 » Wed Jun 05, 2019 2:56 pm

Thanks for your great explanation, vineviz!

I agree, it is mostly a matter of taste/risk preference to choose a portfolio with or without factors.

But I don' agree with this:
vineviz wrote:
Wed Jun 05, 2019 11:48 am
skeptic42 wrote:
Wed Jun 05, 2019 10:42 am
The other factors are academic constructs which help to better explain asset pricing.
On the contrary, market beta is a much more "academic construct" than the other factors. Market beta is entirely a figment of data mining: there is not fundamental analog that explains market beta as there is with other factors. I suspect that market beta gets a pass on this because it was published first, but by any objective measure it's more theoretical than the factors that were published later.
skeptic42 wrote:
Wed Jun 05, 2019 10:42 am
First, one needs the conviction that the underlying risks of these factors can be captured by factor investing.
Again, this applies to market beta just as much as it does to other factors.
One can invest in the total market portfolio without talking about factors. Just weight all securities according to their market weight. This is a simple and sensible approach to harvest the market return.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by larryswedroe » Wed Jun 05, 2019 3:08 pm

Dave, could not agree more and just to make a point, there are over 600 factors identified in the literature, we use a handful, I would say that is sign of being highly skeptical and needing strong evidence before considering investment when you reject 99% of the research.
Skepticism is healthy but not when you take it to extreme and ignore all evidence that disagrees with your premise of simplicity is the primary objective
Last edited by larryswedroe on Wed Jun 05, 2019 7:40 pm, edited 1 time in total.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Wed Jun 05, 2019 3:30 pm

skeptic42 wrote:
Wed Jun 05, 2019 2:56 pm
One can invest in the total market portfolio without talking about factors. Just weight all securities according to their market weight. This is a simple and sensible approach to harvest the market return.
But not talking about something doesn't mean its not an essential part of the process.

I mean, millions of people drive cars every day without knowing what a fuel pump looks like or where the brake fluid reservoir is located. But if either component fails, you're either not going anywhere or not coming back.

Value investors and small cap investors (these were called OTC stocks back in the day) have been doing their thing since long before the factor research was published. Heck, Warren Buffet has been managing a multifactor portfolio since 1964.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by acegolfer » Wed Jun 05, 2019 8:08 pm

vineviz wrote:
Wed Jun 05, 2019 11:48 am
As to the last point, I think it's best to address the underlying nature of the problem. The market portfolio is only "efficient" for an investor who has precisely the same preferences in every regard as the so-called "average" investor. In reality, no one is the average investor: we are all different.
I believe you meant to say "optimal". A portfolio being "efficient" has nothing to do with one's utility function.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by larryswedroe » Wed Jun 05, 2019 8:16 pm

Skeptic
This is such an important topic I thought I would weigh in
"One can invest in the total market portfolio without talking about factors. Just weight all securities according to their market weight. This is a simple and sensible approach to harvest the market return."

First, completely agree. But with that said, it leaves the investor with exposure to only one single unique risk factor, one which has produced negative premiums over 15 years from 29-43, 17 years from 66-82, and 13 years from 00-12. And we know sequence risk matters greatly. And with valuations high the risk of poor returns going forward (all three of those periods started with historically high valuations). And you have to hold more equity risk than if own more small and value stocks as they have higher expected returns. And that increases tail risk. Just ask Japanese investors how that has turned out for them over the last 29 years. Clearly it could happen here. And for strategy to make sense it should work wherever you live, or it might just be you got lucky.

While it is correct to be concerned about tracking error risk, investors are also prone to performance chasing anyway. I wonder how many Bogleheads could stay the course through 17 years of underperforming tbills? And three periods of at least 13 years.

And note as I have explained, those three periods are HALF the last 90 years. Of course that could happen for any risk asset, which is why IMO the prudent strategy is diversifying across as many unique factors as one can identify that meets all the criteria you set. It's why smart investors like Swensen and Ray Dalio build portfolios based on the concept of diversifying risks--a risk parity type strategy. Sure small and value can underperform for long time, but TSM, and all risk assets have as well.

So pick your poison if you will. Have all your eggs in one basket that might just be the one that performs awfully causing your portfolio to blow up, or diversify and cut tail risks, on both sides, which improves your odds of not blowing up, while also reducing probability of getting great returns, but takes on the psychological risk of tracking error which is only relevant to those that care about relative performance and make the mistake of resulting--judging by results and not what made sense before you knew the outcome.


Best wishes
Larry

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by abuss368 » Wed Jun 05, 2019 8:26 pm

Rick Ferri wrote:
Wed Jun 05, 2019 9:51 am

Just buy a few total market index funds and fuggetaboutit!

Rick Ferri
Priceless! :beer
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Wed Jun 05, 2019 8:32 pm

acegolfer wrote:
Wed Jun 05, 2019 8:08 pm
vineviz wrote:
Wed Jun 05, 2019 11:48 am
As to the last point, I think it's best to address the underlying nature of the problem. The market portfolio is only "efficient" for an investor who has precisely the same preferences in every regard as the so-called "average" investor. In reality, no one is the average investor: we are all different.
I believe you meant to say "optimal". A portfolio being "efficient" has nothing to do with one's utility function.
No, I said what I meant.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by acegolfer » Wed Jun 05, 2019 8:41 pm

vineviz wrote:
Wed Jun 05, 2019 8:32 pm
acegolfer wrote:
Wed Jun 05, 2019 8:08 pm
vineviz wrote:
Wed Jun 05, 2019 11:48 am
As to the last point, I think it's best to address the underlying nature of the problem. The market portfolio is only "efficient" for an investor who has precisely the same preferences in every regard as the so-called "average" investor. In reality, no one is the average investor: we are all different.
I believe you meant to say "optimal". A portfolio being "efficient" has nothing to do with one's utility function.
No, I said what I meant.
Fama says
The market portfolio is always efficient
https://www.vanguard.com/bogle_site/sp20020626.html

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by Taylor Larimore » Wed Jun 05, 2019 8:48 pm

Larry Swedroe wrote:So pick your poison if you will. Have all your eggs in one basket that might just be the one that performs awfully causing your portfolio to blow up ..
Larry:

This is a primary reason I recommend total market index funds--the investor never needs to worry about under-performing the overall stock market. Small-cap value is currently the WORST 5-year performer (longest period shown) in all 15 Morningstar style categories). It's 5-year return is less than half the total stock market. :(
Jack Bogle: "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."
Best wishes
Taylor
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by acegolfer » Wed Jun 05, 2019 9:07 pm

skeptic42 wrote:
Wed Jun 05, 2019 10:42 am
The market factor is easy to understand and simple to invest. The other factors are academic constructs which help to better explain asset pricing.
FYI, all FF factors are academic. The difference is MKT is derived theoretically by Sharpe and Lintner in 60s. SMB and HML factors are derived empirically in 90's.

But I do agree with some of your views on factor investing.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Wed Jun 05, 2019 9:19 pm

acegolfer wrote:
Wed Jun 05, 2019 8:41 pm
Fama says
The market portfolio is always efficient
That snippet is devoid of all the context that surrounded it. I know, because I've been in the the room with Fama when he said something similar. The list of assumptions and conditions necessary for that result to apply would fill a notebook.

Not least is the one that I mentioned at the very beginning:

"The market portfolio is only "efficient" for an investor who has precisely the same preferences in every regard as the so-called "average" investor."
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by packer16 » Wed Jun 05, 2019 10:13 pm

Given all the theoretical discussions of factors & their positive review by many, you would expect to see many successful real life implementations of this versus just a cap-weighted index portfolio. However, I have only seen one by Robert T that has actually done better than a simple cap-weighted index. Is there any one else that has a real-life portfolio that has done better than the Taylor type of portfolio? Although the explanation of factors is simple, the implementation that results in a better portfolio is anything but simple. Thanks.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by nedsaid » Wed Jun 05, 2019 10:50 pm

Just love it, a good old fashioned Swedroe vs. Ferri and Larimore debate here on this thread. Brings back old times when Swedroe and Ferri battled over commodities, battled over the meaning of beta, and now battling over factors. Also a debate over who has changed his mind more, Swedroe or Ferri. This is better than local Professional Wresting on Saturday nights over my local TV station.

Good for three reasons, first it is very informative even though a lot of this is very nuanced. Second, it gives the forum a competition of ideas that it so badly needs. Third, this is just plain fun and though we want the forum to be informational, this adds entertainment value as well. Having more fun than a human being should be allowed to have.

No way to really settle the debate as we even debate the evidence around here. It boils down to what you consider good data and if there is enough of it to draw conclusions. Personally, I am on the factors side of the issue and I do have Small/Value tilts in my own portfolio. I also believe the case the academics make to be very good but not airtight. I also think it is a matter of core beliefs and philosophy.

My core belief is that the more diversification, the better. This means not only diversification across the basic asset classes stocks, bonds, and cash but also means diversification across geography. Furthermore, I believe that you want to be diversified across not dozens, not hundreds, but over thousands of securities. Finally, I believe in diversification across factors. We know that securities with different characteristics behave differently from each other.

Man, how lucky Mr. Bogle was to be born in the United States and not Japan. He would have said that Japan is all you need and not only that but a stock portfolio 100% in Japanese securities had International representation because so much revenue of Japanese companies comes from overseas. Not only that but Japan is a homogenous society which is superior because of its greater cultural harmony and discipline not like those rowdy Americans across the Pacific that practice a free wheeling style of capitalism. We make our decisions by consensus and not by the whims of cowboy CEOs in the United States. Better to have the cooperation of Government, Labor, and Business than the chaotic relationships between the three that exist in the United States.

Now Mr. Bogle, whatever his Japanese name would have been, would have scoffed at Small/Value tilting even though that would have helped a Japanese investor with a 100% Japan stock portfolio during the 30 year bear market. Bogle would also have been skeptical of owning American stocks even though that would have greatly helped Japanese investors. "Stay the course, I tell you, stay the course no matter what," he said. But it turns out that at a mutual fund industry meeting in Tokyo back in 1989, Mr. Bogle admitted to adjusting his portfolio of 70% Japanese stocks and 30% Japanese bonds to 30% Japanese stocks. Not only that, Bogle said that in comparison, American stocks were "the steal of the century." So he sold Japanese stocks to buy cheaper American stocks. Rumor has it that he sold his ultra expensive and relatively spacious apartment just outside of Tokyo and bought a huge ranch in Montana. "America is so cheap compared to Japan that I could buy a whole &*$%# state!," he said. So he wound up owning most of the State of Montana.

Japanese real estate and stock market crashed and Mr. Bogle sailed right through the bear market. In 1999, Bogle noticed how expensive US Stocks were sold much of them and bought US Bonds at 6%-7%, rates unheard of in Japan. Rumor has it that he repurchased his old apartment in Tokyo, still expensive but cheaper than he bought it. He might have even bought more of that Total Japanese Stock Market Index. I think I read somewhere that Bogle took that huge ranch in Montana and sold it to Ted Turner, making a killing. Mr. Bogle and family lived happily ever after.

I am being silly here of course. In real life, Mr. Bogle didn't believe in factors but he actually did sell a lot of his stocks and swapped them for bonds in about 1999. He did look at future expected returns just as Larry Swedroe does and calculated that stocks would return about 2% a year during the 2000's and that bonds would return 6%-7%. So while he wasn't a factor believer, he did recognize that valuations matter and matter a lot. It occurred to him that cheap stocks had higher future expected returns than expensive stocks. In real life, he was always skeptical of International Stocks but the United States had huge competitive advantages that Japan, even in 1989, did not. Point is, he was pragmatic and though not a market timer, he made changes when circumstances dictated. He was never severely criticized for "changing his mind" as Mr. Swedroe, and to a lesser degree, Mr. Ferri were on this forum.

So I had some fun with this and hopefully folks will see a point or two in here.
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by nedsaid » Wed Jun 05, 2019 11:29 pm

One other thing. Swedroe and Bogle weren't so much different after all. In 1997, Swedroe took his stocks all to Value as he saw the market as a whole getting very expensive. He didn't have the exquisite timing that Bogle did, but he sold what was expensive and bought what was cheap. Bogle in 1999 sold expensive US Stocks and bought cheap US Bonds.
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by acegolfer » Thu Jun 06, 2019 6:29 am

vineviz wrote:
Wed Jun 05, 2019 9:19 pm
acegolfer wrote:
Wed Jun 05, 2019 8:41 pm
Fama says
The market portfolio is always efficient
That snippet is devoid of all the context that surrounded it. I know, because I've been in the the room with Fama when he said something similar. The list of assumptions and conditions necessary for that result to apply would fill a notebook.

Not least is the one that I mentioned at the very beginning:

"The market portfolio is only "efficient" for an investor who has precisely the same preferences in every regard as the so-called "average" investor."
1. Cochrane also agrees with Fama that MKT is efficient
every point on the multifactor efficient frontier can be reached by some combination of three multifactor efficient funds. The most convenient set of portfolios is the risk-free rate (money-market security), the market portfolio (the risky portfolio held by the average investor), and one additional multifactor efficient portfolio on the tangency region as shown in panel B of figure 2. It is convenient to take this third portfolio to be a zero-cost, zero-beta portfolio, so that it isolates the extra dimension of risk.
https://faculty.chicagobooth.edu/john.c ... 3Q99_4.pdf

2. Whether a portfolio being on multifactor efficient frontier has nothing to do with one's utility function. OTOH, the utility function will determine his "optimal" portfolio (where the indifference curve is tangent to the efficient frontier) See Figure 2 in Cochrane. I clearly shows in black and blue the difference between "optimal" and "efficient".
Panel A shows an indifference surface and optimal portfolio in the case with no risk-free rate. The dot marks the optimal portfolio where the indifference surface touches the multifactor efficient frontier.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Thu Jun 06, 2019 7:07 am

acegolfer wrote:
Thu Jun 06, 2019 6:29 am
1. Cochrane also agrees with Fama that MKT is efficient
And with all the same applied caveats about the underlying assumptions required to make that statement true.

You must distinguish between two related, but distinct concepts: the market portfolio is efficient in aggregate, but it may not be efficient for any individual investor. The former is theoretical true (in part because it is somewhat tautological), but the latter can only be empirically established
acegolfer wrote:
Thu Jun 06, 2019 6:29 am
2. Whether a portfolio being on multifactor efficient frontier has nothing to do with one's utility function.
On the contrary, the shape of the efficient frontier has EVERYTHING to do with one's utility function. Classic MPT requires some generalized assumptions about utility functions in order to plot the mean-variance efficient frontier and to avoid dealing with the non-normality of stock returns. These include assuming constant relative risk aversion, a quadratic utility function, etc.

Think about it this way: an efficient portfolio is specified as a portfolio that maximizes return per unit of risk. What's the measure of "unit of risk"? Economically, it is the measure of cost that gets matched with "return" in a utility function. Using standard deviation as the the unit is a convenient shorthand which facilitates the theoretical discussion, nothing more than that.
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Thu Jun 06, 2019 7:13 am

acegolfer wrote:
Thu Jun 06, 2019 6:29 am
OTOH, the utility function will determine his "optimal" portfolio (where the indifference curve is tangent to the efficient frontier)
BTW, I haven't read this paper in a while but I see that it is available online. If you enjoyed Cochrane's articles, you might like this too.

Mean–Variance and Expected Utility:The Borch Paradox by David Johnstone and Dennis Lindley
Abstract. The model of rational decision-making in most of economics and statistics is expected utility theory (EU) axiomatised by von Neumann and Morgenstern, Savage and others. This is less the case, however, in financial economics and mathematical finance, where investment decisions are commonly based on the methods of mean–variance (MV) introduced in the 1950s by Markowitz. Under the MV framework, each available investment opportunity (“asset”) or portfolio is represented in just two dimensions by the ex ante mean and standard deviation (μ,σ) of the financial return anticipated from that investment. Utility adherents consider that in general MV methods are logically incoherent. Most famously, Norwegian insurance theorist Borch presented a proof suggesting that two-dimensional MV indifference curves cannot represent the preferences of a rational investor (he claimed that MV indifference curves “do not exist”). This is known as Borch’s paradox and gave rise to an important but generally little-known philosophical literature relating MV to EU. We examine the main early contributions to this literature, focussing on Borch’s logic and the arguments by which it has been set aside.
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by marcopolo » Thu Jun 06, 2019 7:50 am

larryswedroe wrote:
Wed Jun 05, 2019 8:10 am
nedsaid, a problem with your comments is the mistake of thinking equity like means say 10% which is historical return, but no financial economist I know expects that going forward given valuations, more like 4-% real, so equity like would then be say 6%+, not 10%, which is history not expected. And when I have said equity like that is exactly what I have meant. And bond like would be 2%.

And the idea of retiring soon and thus short horizon is reason to avoid such vehicles is exactly backwards IMO. Reason is simple, sequence risk--and market beta can collapse far more than a diversified portfolio across unique sources of risk like QSPRX. BTW, Sharpe ratio since inception is .22 and Sortino is .33. So even with the disappointing performance it's not that bad, and certainly within range of expected. You want the downside protection even more in retirement when cannot recover from losses on money spent to live on

Larry
I find this explanation confusing, and a bit of "blaming the victim".

We are told:
1) These ALTs/ should be held and judged over long periods of time (decades)
2) They are useful because they are uncorrelated to equities.

If that is true, then when someone promoting them uses the nebulous phrase "equity like returns", why would we be expected to think that means "today's low expected equity returns due to unusually high valuations". If they are meant to be held long term, and are uncorrelated to equities, why would their long term expected returns be tied to today's temporary valuations of equities?
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by larryswedroe » Thu Jun 06, 2019 8:13 am

Marco
Any statement about what is expected from equities should be based on TODAY, not what some historical figure was, which has no value as it is the current valuations that have information as to future returns, not the past.
And most financial economists are forecasting real returns in the 4-5%, and that is exactly what I meant and mean by equity like, in that range, depending on which asset and it's riskiness/volatility. If anyone had asked I would have told them about 4% above cash, on average.

Taylor
Re this comment.

This is a primary reason I recommend total market index funds--the investor never needs to worry about under-performing the overall stock market. Small-cap value is currently the WORST 5-year performer (longest period shown) in all 15 Morningstar style categories). It's 5-year return is less than half the total stock market. :(

While I fully agree that you don't have to worry about underperforming the market nor tracking error regret, relativism has no place in investing. It's about managing risks and having best chance of achieving your goals. BTW, you know who said that about relativism? John Bogle!!!!

And yes SV has the worst performance for last five years, but try this, from 66-82 SV outperformed the S&P by 1100%, No one knows which will perform well which is why one should consider diversifying and not put all eggs in one basket. At least that is worth considering, understanding that owning TSM takes all risk in just one unique factor that could do miserably for very long time, and the most important time. I've shown you three periods of at least 13 years when TSM underperformed tbills and in those periods size and value did much better, particularly in 66-82 and 00-12, providing massive diversification benefits which you and other Bogleheads continue to ignore, let alone acknowledge. Just saying

So again, TSM is a perfectly reasonable approach, one I would never argue against as a bad strategy, but it does take on far more tail risk historically than a more diversified portfolio, one diversified across unique sources of risk. If you believe markets are efficient, which I believe you do, then all risky assets should have same risk/adjusted returns, meaning small and small value have same risk-adjusted returns as the market--so why concentrate in just the market? And if believe market is inefficient, due to behavioral errors than tilting gives you some free benefit. Simple is not always better.

Again hope that is helpful to at least some, getting some to at least think about the issues. And for those interested in learning more and seeing the evidence, suggest reading Reducing the Risk of Black Swans, 2018 edition.

don't want to keep repeating myself so that's all for now.

Best wishes
Larry

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by typical.investor » Thu Jun 06, 2019 8:21 am

matjen wrote:
Wed Jun 05, 2019 11:39 am

Rick the common criticisms against factor investing/tilting is that 1) it is needlessly complicated, 2) hasn't done all that well for 10+ years leading to tracking error/investor regret/behavioral mistakes, and 3) requires expensive (1%) advisor access often.
...

#3 gets less and less accurate by the day. I think you were charging like 28-30 bps 10 years ago? A bargain for anyone who isn't passionate about investing to have your skill or those trained by you working with them. Hourly a better bargain for sure though. Plenty of DFA in large retirement plans and there is DFA (used as a proxy for basic factor investing) in some 529 plans. I have had access to basically anything for both me and spouse for a flat 1k a year and that includes managed (rebalanced) AQR, DFA, etc. portfolios if I desire.
Given the propensity for value to underperform for long periods, and then suddenly do very well, is it really advisable for 529 investors to be using them there? I have access to DFA via the UTAH 529 (now called the my529) but haven't used them for that reason.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by packer16 » Thu Jun 06, 2019 8:47 am

To a certain extent this is a discussion about what is knowable & what is not. The factor folks believe that factors (historical explanations) are knowable & will continue to work as in the past in the future. The pure index folks are not so sure & rely on the market to weight factors for them. This not science so there is no obvious right answer here. The more you claim you know (more factors) the more that can go wrong (as illustrated by QSPIX). IMO some folks are conflating diversification with knowing more.

This is the same with active managers. They claim they know more than the market & via their strategies they can provide a higher return & diversification benefit.

One weakness of the implementation of factors & active management is they do not rely on the market mechanism to set weights but rely on their own knowledge to guide the weights of securities in their portfolios. This gets back to the known vs. unknown behavior of markets.

I also disagree about the analogy to medicine. Medicine is a science where if you do x, y & z the probability of being correct is much higher than in investing or investing in factors. For example if a doctor prescribes a medication for a condition, the probability that it will work does not radically change all the time while investing in the value factor for example does have large changes in the probability of doing better than the market over a sizable period of time.

A better analogy IMO is horse betting as you have a market setting the odds versus not. In horse betting, the only way you can win is to bet on a mispriced horse or bet with a low cost bookie. The former is rare & the latter more in your control. IMO what factor investors are doing is placing bet on mispriced horse but with a higher cost bookie. From what I have seen of complex factor strategies is any mispricing has gone to the bookie (AQR is the case of QSPIX) vs. the bettor.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by larryswedroe » Thu Jun 06, 2019 10:08 am

typical investor
Let me reframe your statement which was
Given the propensity for value to underperform for long periods, and then suddenly do very well, is it really advisable for 529 investors to be using them there? I have access to DFA via the UTAH 529 (now called the my529) but haven't used them for that reason.
to read
Given the propensity for market beta (S&P 500) to underperform for long periods, and then suddenly do very well, is it really advisable for 529 investors to be using them there? I have access to Vanguard via the UTAH 529 (now called the my529) but haven't used them for that reason.

Remember the 3 periods of at least 13 years totaling 45 of last 90 where market beta underperformed tbills while small and value did much better, as much as 1100% better
Larry

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by azanon » Thu Jun 06, 2019 10:25 am

larryswedroe wrote:
Thu Jun 06, 2019 10:08 am
typical investor
Let me reframe your statement which was
Given the propensity for value to underperform for long periods, and then suddenly do very well, is it really advisable for 529 investors to be using them there? I have access to DFA via the UTAH 529 (now called the my529) but haven't used them for that reason.
to read
Given the propensity for market beta (S&P 500) to underperform for long periods, and then suddenly do very well, is it really advisable for 529 investors to be using them there? I have access to Vanguard via the UTAH 529 (now called the my529) but haven't used them for that reason.

Remember the 3 periods of at least 13 years totaling 45 of last 90 where market beta underperformed tbills while small and value did much better, as much as 1100% better
Larry
typical gets a prize, larry get a prize, everyone gets a prize!

Quoting the my529 website so go easy on me: "my529 (formerly named Utah Educational Savings Plan (UESP)) offers investment options consisting of Vanguard and Dimensional funds, the PIMCO Interest Income Fund and an FDIC-insured account option."

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by Dialectical Investor » Thu Jun 06, 2019 10:33 am

larryswedroe wrote:
Thu Jun 06, 2019 10:08 am

Remember the 3 periods of at least 13 years totaling 45 of last 90 where market beta underperformed tbills while small and value did much better, as much as 1100% better
Nothing to do with factors specifically, but this is a troublesome way to present these statistics that will invite discerning critics. If you're going to represent a percentage or proportion (45 of 90), the units should match the individual periods, in this case, single years in which market beta underperformed T-bills, not multi-year periods. Or you could change the proportion to match the multi-year periods, such as x out of y for z-year rolling periods. Or just state the periods and leave out the proportion. We see this presentation issue for other assets as well, such as US vs. ex-US stocks. It can be quite misleading.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by skeptic42 » Thu Jun 06, 2019 10:45 am

larryswedroe wrote:
Wed Jun 05, 2019 8:16 pm
Skeptic
This is such an important topic I thought I would weigh in
"One can invest in the total market portfolio without talking about factors. Just weight all securities according to their market weight. This is a simple and sensible approach to harvest the market return."

First, completely agree. But with that said, it leaves the investor with exposure to only one single unique risk factor, one which has produced negative premiums over 15 years from 29-43, 17 years from 66-82, and 13 years from 00-12. And we know sequence risk matters greatly. And with valuations high the risk of poor returns going forward (all three of those periods started with historically high valuations). And you have to hold more equity risk than if own more small and value stocks as they have higher expected returns. And that increases tail risk. Just ask Japanese investors how that has turned out for them over the last 29 years. Clearly it could happen here. And for strategy to make sense it should work wherever you live, or it might just be you got lucky.

While it is correct to be concerned about tracking error risk, investors are also prone to performance chasing anyway. I wonder how many Bogleheads could stay the course through 17 years of underperforming tbills? And three periods of at least 13 years.

And note as I have explained, those three periods are HALF the last 90 years. Of course that could happen for any risk asset, which is why IMO the prudent strategy is diversifying across as many unique factors as one can identify that meets all the criteria you set. It's why smart investors like Swensen and Ray Dalio build portfolios based on the concept of diversifying risks--a risk parity type strategy. Sure small and value can underperform for long time, but TSM, and all risk assets have as well.

So pick your poison if you will. Have all your eggs in one basket that might just be the one that performs awfully causing your portfolio to blow up, or diversify and cut tail risks, on both sides, which improves your odds of not blowing up, while also reducing probability of getting great returns, but takes on the psychological risk of tracking error which is only relevant to those that care about relative performance and make the mistake of resulting--judging by results and not what made sense before you knew the outcome.


Best wishes
Larry
Thanks Larry!
I agree, it is prudent to diversify. Diversifying across stocks, bonds, cash, and geographically makes a lot of sense to me. Diversifying across factors not so much.
If you believe markets are efficient, which I believe you do, then all risky assets should have same risk/adjusted returns, meaning small and small value have same risk-adjusted returns as the market--so why concentrate in just the market?
Are you talking about the academic factor definition of long/short portfolios?
An actual long-only small value fund has a strong correlation to the total stock market. Not convincing to gain a lot of diversification from such a fund compared to e.g. long-term treasuries.
From the perspective of a total market investor, a small value fund looks a lot like a concentrated bet on a small part of the total stock market.
I know the factor experts disagree. 8-)

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by Random Walker » Thu Jun 06, 2019 10:49 am

typical.investor wrote:
Thu Jun 06, 2019 8:21 am
matjen wrote:
Wed Jun 05, 2019 11:39 am

Rick the common criticisms against factor investing/tilting is that 1) it is needlessly complicated, 2) hasn't done all that well for 10+ years leading to tracking error/investor regret/behavioral mistakes, and 3) requires expensive (1%) advisor access often.
...

#3 gets less and less accurate by the day. I think you were charging like 28-30 bps 10 years ago? A bargain for anyone who isn't passionate about investing to have your skill or those trained by you working with them. Hourly a better bargain for sure though. Plenty of DFA in large retirement plans and there is DFA (used as a proxy for basic factor investing) in some 529 plans. I have had access to basically anything for both me and spouse for a flat 1k a year and that includes managed (rebalanced) AQR, DFA, etc. portfolios if I desire.
Given the propensity for value to underperform for long periods, and then suddenly do very well, is it really advisable for 529 investors to be using them there? I have access to DFA via the UTAH 529 (now called the my529) but haven't used them for that reason.
Read the other current thread on Larry’s Death of value article.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by Jiu Jitsu Fighter » Thu Jun 06, 2019 11:04 am

If you believe in efficient markets, the small-value segment of the market must outperform TSM over the long run. Otherwise, there would be nobody investing in these mostly junky companies compared to the larger well-known blue-chip companies. I understand if someone has reservations on the actual product (fund) that can deliver the performance, but the literature supports the small-value premium which is consistent with efficient markets.

If you do not believe in efficient markets like Jack, you should just do what he recommends and focus on cost and the US-centric total market fund.

I'm in the efficient market camp (yes, there are anomalies but very difficult to exploit).

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by Random Walker » Thu Jun 06, 2019 11:12 am

packer16 wrote:
Thu Jun 06, 2019 8:47 am
To a certain extent this is a discussion about what is knowable & what is not. The factor folks believe that factors (historical explanations) are knowable & will continue to work as in the past in the future. The pure index folks are not so sure & rely on the market to weight factors for them. This not science so there is no obvious right answer here. The more you claim you know (more factors) the more that can go wrong (as illustrated by QSPIX). IMO some folks are conflating diversification with knowing more.
Hi Packer, I think you have it 180 degrees backwards. Informed factor folks don’t claim to know anything about the future. That’s why we diversify across the factors. We don’t know which will perform well or poorly, when, or for how long. One could even go so far as to say the TSM people are showing overconfidence in their own predictive power; they put all their faith in a single factor, market beta. This is especially true over fairly short periods, say the 5-10 years on either side of retirement. Factor folks diversify because they don’t know!

Dave

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by Dialectical Investor » Thu Jun 06, 2019 11:25 am

Random Walker wrote:
Thu Jun 06, 2019 11:12 am
packer16 wrote:
Thu Jun 06, 2019 8:47 am
To a certain extent this is a discussion about what is knowable & what is not. The factor folks believe that factors (historical explanations) are knowable & will continue to work as in the past in the future. The pure index folks are not so sure & rely on the market to weight factors for them. This not science so there is no obvious right answer here. The more you claim you know (more factors) the more that can go wrong (as illustrated by QSPIX). IMO some folks are conflating diversification with knowing more.
Hi Packer, I think you have it 180 degrees backwards. Informed factor folks don’t claim to know anything about the future. That’s why we diversify across the factors. We don’t know which will perform well or poorly, when, or for how long. One could even go so far as to say the TSM people are showing overconfidence in their own predictive power; they put all their faith in a single factor, market beta. This is especially true over fairly short periods, say the 5-10 years on either side of retirement. Factor folks diversify because they don’t know!

Dave
I'm not sure what Packer means by the market "weighting" the factors, but regarding past versus future and what is knowable, I think what certain critics are saying is that if you perform a factor analysis 100 years from now, the factors most investors currently are focused on might be found to have been suboptimal in explaining returns. That is, they question the future persistence of the explanatory power of the current dominant factors.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by larryswedroe » Thu Jun 06, 2019 11:33 am

Few thoughts, re critique about those three selected periods.
I showed those three long periods because that is exactly what investors experienced, and to show it can and likely will happen again. At least investors should be aware of that risk, if not certainty, that it will happen again. Just not knowable when. And it happens to all risky asset classes/investments. All.

Skeptic
Re small value, and high correlation to market. Of course long only funds will show high correlation to the market even if small value as they obviously have market beta exposure as well, often more than 1! But what you have to consider is SV must have higher expected returns (much more volatile) if you think markets efficient as all TSMers must believe, and that means can hold more safe bonds. So you have to consider that you have much more diversification of risk across unique factors as your market beta went down (depending on how much you tilt), while exposure to size and value went up, and importantly allocation to Treasuries or equivalent went up, and that is what pulls in the left tail risk (historically). So you get more and more of a risk parity portfolio the more you tilt away from the market. Now if you think you don't get diversification, again just look at 66-82 when SV beat S&P by 1100%. And look at recently when it underperforms. Clearly they are unique factors, for those skeptics. Just look at the data all over the world and it shows uniqueness over time


Hope that helps
Larry
Last edited by larryswedroe on Thu Jun 06, 2019 5:25 pm, edited 1 time in total.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by markcoop » Thu Jun 06, 2019 1:02 pm

I have found this thread very interesting. Thanks to the contributors.

I have always been a small tilter (approx 85% TSM + 15% SV). Have been doing this over the past couple of decades having read some of Larry's and Rick's books. I work for a large company, so in addition to the factor play, I have always thought SV was a nice complement.

If someone such as myself was interested in increasing these factor exposures, I'd be interested to know what would be the recommendation. Would it be to replace my Vanguard SV with another fund - maybe Vanguard's VFMFX or some other fund mentioned here (AQR or maybe a DFA fund in my 401K)? Or perhaps to undertake true factor investing would mean a more drastic change?
Mark

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by RayLopez » Thu Jun 06, 2019 1:12 pm

Rick Ferri wrote:
Tue May 28, 2019 8:17 am
azanon wrote:
Tue May 28, 2019 8:05 am
The weak money is pretty much already gone.
People who manage factor funds would disagree. Wes Gray was my last guest on Bogleheads on Investing. Wes earned a Ph.D. in finance under Gene Fama at the University of Chicago's Booth School of Business. Toward the end of the interview, we discuss factor cost, the crowding out of factor premiums and potential returns.

Rick Ferri


Swedroe himself disagrees with you, and in the below book makes the point alpha is very small these days. Swedroe cites, from memory, a paper that implies total alpha in today's market is a mere couple of tens of billions, and most of it is consumed by expenses from analysis and others trying to marshal the data.

"The 2013 Credit Suisse report “Alpha and the Paradox of Skill” by Michael Mauboussin and Dan Callahan examined the effects of increasing skill in investing. They plotted the rolling five-year average standard deviation of excess returns in U.S. large-cap mutual funds over the last 45 years. You should expect to see wide dispersions when there are large differences in the level of skill. Their plot below, updated through 2013, demonstrates a clear trend of declining dispersion in excess returns, which fits nicely with our narrative indicating that competition is getting tougher."

Swedroe, Larry E. The Incredible Shrinking Alpha: And What You Can Do to Escape Its Clutches . BAM ALLIANCE Press. Kindle Edition.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by RayLopez » Thu Jun 06, 2019 1:27 pm

pkcrafter wrote:
Tue Jun 04, 2019 12:31 pm
Thank you Rick!

1. Over 80% of Bogleheads should not/could not hold a factor-constructed portfolio. You must hold for lengthy periods of underperformance, deal with lots of tracking error, higher costs, etc.

Finally, factor investing is not Boglehead investing. If factor investing gets too popular, the profile will be part of total market.

Paul
Thanks Paul for your comment. I would also add that over 80% of Bogleheads should not/ could not hold a factor based portfolio for two additional reasons:

1) many factors are artifacts (no pun) of data, that work in-sample but not out of sample. From memory, in a Ben Carlson or Meb Faber podcast it was found only like 15% of factors actually work out of sample. Factors largely cannot be replicated.

2) a lot of factors are long term neutral, such as for example factors relating to exchange rates. If you play the foreign currency markets and try and hedge your currency exposure or do carry trade and so on, you'll find over time it's a wash, a zero sum game. By contrast, the factor of stock market beta is not a wash, or zero sum game: historically, US stock markets go up about 7%/yr over the long run (Siegel's constant). For buy and hold investors, as opposed to day traders, a zero sum game is not ideal.

In short, for most people factors based investing is not suitable, unless they want to become traders rather than investors.

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Thu Jun 06, 2019 1:32 pm

markcoop wrote:
Thu Jun 06, 2019 1:02 pm
If someone such as myself was interested in increasing these factor exposures, I'd be interested to know what would be the recommendation. Would it be to replace my Vanguard SV with another fund - maybe Vanguard's VFMFX or some other fund mentioned here (AQR or maybe a DFA fund in my 401K)? Or perhaps to undertake true factor investing would mean a more drastic change?
Most investors can accomplish significant improvements in portfolio diversification simply by allocating more to their small cap value fund, especially if it tracks the S&P 600 Value Index. The "holy trinity to tilting" ETFs are SLYV, VIOV, and IJS, but if you have access to Vanguard S&P Small-Cap 600 Value Index Fund Institutional Shares (VSMVX) it's great too. Vanguard Small-Cap Value Index Fund Admiral Shares (VSIAX) is a perfectly good fund, though, and if you're already using it then there's no good reason not to stick with it. Diversification will keep increasing as you allocate more to small cap value, up to about 50% of your US equities. And because the small cap value funds are so inexpensive, this approach has much appeal.

Interestingly enough, a utility sector fund also can be a powerful factor diversifier (especially adding exposure to the quality and BAB factors). Vanguard Utilities ETF (VPU) and Vanguard Utilities Index Fund Admiral Shares (VUIAX) are both excellent choices. VUIAX has a minimum investment of $100,000 though.

Vanguard U.S. Multifactor Fund Admiral Shares (VFMFX) is a fantastic single fund solution, in my mind, with an intellectually rigorous process and very reasonable expenses. For simplicity, you could do a lot worse. I wouldn't normally recommend trying to combine VFMFX in a portfolio with the other funds, though. It'd be redundant and unnecessarily complex, IMHO.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by packer16 » Thu Jun 06, 2019 1:36 pm

Random Walker wrote:
Thu Jun 06, 2019 11:12 am
packer16 wrote:
Thu Jun 06, 2019 8:47 am
To a certain extent this is a discussion about what is knowable & what is not. The factor folks believe that factors (historical explanations) are knowable & will continue to work as in the past in the future. The pure index folks are not so sure & rely on the market to weight factors for them. This not science so there is no obvious right answer here. The more you claim you know (more factors) the more that can go wrong (as illustrated by QSPIX). IMO some folks are conflating diversification with knowing more.
Hi Packer, I think you have it 180 degrees backwards. Informed factor folks don’t claim to know anything about the future. That’s why we diversify across the factors. We don’t know which will perform well or poorly, when, or for how long. One could even go so far as to say the TSM people are showing overconfidence in their own predictive power; they put all their faith in a single factor, market beta. This is especially true over fairly short periods, say the 5-10 years on either side of retirement. Factor folks diversify because they don’t know!

Dave
I think you are claiming you know factors will continue to perform the way they have done in the past that is why you are investing in them. If that was not the case you would be investing in market weighted stock fund not a set of factor funds. You have sliced the market return into sub-components that you believe will be there in the future. It may be true but it may be not true. What you are not doing is using the market mechanism to select the weights of stocks in your portfolio. Therefore, you are stating the market is wrong & you know more than the market when it comes to factors.

Packer
Buy cheap and something good might happen

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Thu Jun 06, 2019 1:47 pm

RayLopez wrote:
Thu Jun 06, 2019 1:27 pm
1) many factors are artifacts (no pun) of data, that work in-sample but not out of sample. From memory, in a Ben Carlson or Meb Faber podcast it was found only like 15% of factors actually work out of sample. Factors largely cannot be replicated.
Fortunately, this problem is easily solvable. There is a short list of factors whose robustness has been confirmed repeatedly, in multiple out-of-sample tests. These "core" factors include all the ones most investors would care to access: size, value, quality, momentum, and cluster of ways to implementat low volatility and/or low beta.
RayLopez wrote:
Thu Jun 06, 2019 1:27 pm
2) a lot of factors are long term neutral, such as for example factors relating to exchange rates.
Assets and/or factors with an expected real return of zero (or less) are still very valuable tools in portfolio construction. The improvements in diversification can more than outweigh their low returns.

You can see this even without getting into the math by reading Daniel Sotiroff's blog post from 2016 entitled Rebalancing With Shannon’s Demon.

Claude Shannon is widely considered the father of information theory.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by vineviz » Thu Jun 06, 2019 1:57 pm

packer16 wrote:
Thu Jun 06, 2019 1:36 pm
Therefore, you are stating the market is wrong & you know more than the market when it comes to factors.
It seems like we covered this ground already. Factor investing does NOT depend on an assumption or belief that "the market is wrong", only that an investor's preferences may or may not match those of the markets.

For instance, municipal bonds make up about 15% of the bond market: should I invest 15% of my IRA's bond portfolio in municipal bonds? Of course not.

I don't build my library of books based only on matching the sales-weighted corpus of all published books, after all. Or buy music according only to what the "market" has pushed to the top of the Billboard charts.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by nedsaid » Thu Jun 06, 2019 2:13 pm

packer16 wrote:
Thu Jun 06, 2019 1:36 pm
Random Walker wrote:
Thu Jun 06, 2019 11:12 am
packer16 wrote:
Thu Jun 06, 2019 8:47 am
To a certain extent this is a discussion about what is knowable & what is not. The factor folks believe that factors (historical explanations) are knowable & will continue to work as in the past in the future. The pure index folks are not so sure & rely on the market to weight factors for them. This not science so there is no obvious right answer here. The more you claim you know (more factors) the more that can go wrong (as illustrated by QSPIX). IMO some folks are conflating diversification with knowing more.
Hi Packer, I think you have it 180 degrees backwards. Informed factor folks don’t claim to know anything about the future. That’s why we diversify across the factors. We don’t know which will perform well or poorly, when, or for how long. One could even go so far as to say the TSM people are showing overconfidence in their own predictive power; they put all their faith in a single factor, market beta. This is especially true over fairly short periods, say the 5-10 years on either side of retirement. Factor folks diversify because they don’t know!

Dave
I think you are claiming you know factors will continue to perform the way they have done in the past that is why you are investing in them. If that was not the case you would be investing in market weighted stock fund not a set of factor funds. You have sliced the market return into sub-components that you believe will be there in the future. It may be true but it may be not true. What you are not doing is using the market mechanism to select the weights of stocks in your portfolio. Therefore, you are stating the market is wrong & you know more than the market when it comes to factors.

Packer
Again, my thesis is that different segments of the stock market act differently from each other and I haven't seen lots of change in those relationships over the years. Things get overbought and oversold but the essential behavior of these sub-sets of the market are largely the same.

An example is that defensive stocks (consumer staples, utilities) pretty much act the way they always have. When investors perceive market turbulence ahead, money flows towards these kind of stocks because their slow but reliable earnings growth and higher dividends provide a buffer against market downturns. The defensive or Low Volatility stocks will get expensive compared to historic P/E ratios but they never get pushed to speculative levels like the High Tech and Internet stocks did in the late 1990's.

Cyclical stocks still behave like cyclical stocks, they tend to have high P/E ratios during recessions and low P/E ratios during booms. In the case of high P/E's, the market knows recovery is coming. When P/E ratios are low, the market knows there will be a recession. No one mistakes these economically sensitive stocks as Blue Chips, the classic all-weather growth stocks.

We just don't see speculative stocks trading like utility stocks and we don't see utility stocks trade with very high volatility. So while certain parts of the stock market can get relatively cheap or relatively expensive, their basic behavior really hasn't changed. A stodgy utility with a high dividend payout and earnings growth of 4%-5% a year is not going to trade at a P/E of 200 unless, of course, that utility had really bad earnings that were temporary in nature.

Factors, in my view, are caused by human nature, human behavior, and human emotion. The old greed and fear thing. A factor might get overbought but it won't stay that way forever.

I just don't see random behavior from market segment to market segment. Utilities aren't acting like Tech Stocks, Financial stocks don't act like Industrial stocks. Small/Value tends to me more volatile than Large Growth. Etc. Etc. Big changes in behavior don't happen unless the underlying earnings trends change, for example buggy whip companies would not be a substantial part of any index today. Emerging industries with unbelievable growth potential or dying industries in decline. So it isn't like stock behavior is completely random and completely without explanation.
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by packer16 » Thu Jun 06, 2019 3:10 pm

I agree with you (about how cheap value is) but you are making a bet that your weights are better than the market weights set by market participants. As long this is understood & you are not under the impression that you are developing a more efficient portfolio (which is the portfolio other participants have set) then I am fine.

One of the key aspects of index investing is using the power of the market mechanism to correctly weight firms in a portfolio. Active or factor investing is not doing this & stating that by using an alternative weighting system a better return for a given level of risk can be obtained.

Packer
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Re: Excellent Larry Swedroe Podcast Interview: Factors For The Long Run

Post by larryswedroe » Thu Jun 06, 2019 5:12 pm

Packer,
I agree with you (about how cheap value is) but you are making a bet that your weights are better than the market weights set by market participants.
That is correct from a risk-adjusted perspective but not in terms of higher expected returns (assuming you believe market is perfectly efficient and there is no behavioral story to the value factor, which goes against much of the literature which shows at least some is likely to be attributed to). And you still have the unique risk story.

So you get higher expected returns (allowing you to lower beta exposure and still have same portfolio expected return) and get significant diversification from not only SV unique risks but also higher allocation to safe Treasuries, creating downside protection.

Larry

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