Can You Get A Meaningful Factor Tilt With Present Investment Products?

[Park]

https://www.factorresearch.com/research ... or-returns

"We’re going to focus on the largest smart beta ETFs in the US focused on Value and Growth. All of these have more than 10 years of trading history and at least $4bn in AUM. We calculate the excess returns for each smart beta ETF by deducting the benchmark returns from the smart beta returns. We also calculate the factor performance for Value and Growth by creating long-short portfolios comprised of the top and bottom 30% of the US stock universe. The portfolios are constructed dollar-neutral and include 10bps of transaction costs. The table below provides an overview of the 14 smart beta ETFs used in the analysis.

https://www.factorresearch.com/wp-conte ... a-ETFs.png

The next chart shows the excess returns of the Value smart beta ETFs compared to the Value factor performance. The factor is constructed by taking a long-short portfolio of stocks ranked by a combination of their book-value and price-earnings multiples, which is a fairly standard definition for the factor. We can observe that the factor generates much higher returns than any of the smart beta ETFs, which can be explained by the factor taking concentrated long and short positions while the smart beta funds have only overweights and underweights across all stocks in the universe. Investors who are familiar with Value factor returns and are using smart beta ETFs to harvest factor returns are likely to be disappointed by the excess returns from the ETFs."

https://www.factorresearch.com/wp-conte ... eturns.png

Edited to change the thread title from "Will You Get Increased Return From Your Factor Tilt?" to " Can You Get A Meaningful Factor Tilt With Present Investment Products?"

Edited a second time to include the following comment. The third link might initially give the impression that VBR and VTV have outperformed other value ETFs. However, the data for the other 5 value ETFs and the value factor (long/short) use a start date of 2000. The data for VBR and VTV is from 2004, when both funds were started.

[willthrill81]

Smart beta seems dumb.

If you want to tilt toward the 'mainstream' factors, you can do so easily and inexpensively without such funds. But no one knows if YOU will experience increased returns from tilting your portfolio over your investing time frame. And if you do tilt, we can say with a high degree of certainty that you will underperform the market at some point, and that underperformance can last for years, maybe a decade or longer. If you aren't prepared for that, then don't tilt.

YMMV.

[Park]

Smart beta seems dumb.

If you want to tilt toward the 'mainstream' factors, you can do so easily and inexpensively without such funds. But no one knows if YOU will experience increased returns from tilting your portfolio over your investing time frame. And if you do tilt, we can say with a high degree of certainty that you will underperform the market at some point, and that underperformance can last for years, maybe a decade or longer. If you aren't prepared for that, then don't tilt.

YMMV.

I agree with what you've written. However, the question is whether, with the investment products available to the retail investor, whether you will get a tilt that is of significance.

[willthrill81]

Smart beta seems dumb.

If you want to tilt toward the 'mainstream' factors, you can do so easily and inexpensively without such funds. But no one knows if YOU will experience increased returns from tilting your portfolio over your investing time frame. And if you do tilt, we can say with a high degree of certainty that you will underperform the market at some point, and that underperformance can last for years, maybe a decade or longer. If you aren't prepared for that, then don't tilt.

YMMV.

I agree with what you've written. However, the question is whether, with the investment products available to the retail investor, whether you will get a tilt that is of significance.

No one knows about the future.

With regard to the past, funds like Vanguard's small-cap value fund (VISVX) have generated higher returns than the market over their lifespan, in that particular case, by over 2% over the last 20 years.

[YRT70]

I agree with what you've written. However, the question is whether, with the investment products available to the retail investor, whether you will get a tilt that is of significance.

Wouldn't that be possible with a small cap value fund?

[Park]

With regard to the past, funds like Vanguard's small-cap value fund (VISVX) have generated higher returns than the market over their lifespan, in that particular case, by over 2% over the last 20 years.

Since its inception in May 21/98, $10K in VISVX would have grown on a pretax basis to $53,155. The comparable number for VTSMX (total US stock market index) is $40,283.

To calculate CAGR, I had to assume a 21 year period. For VISVX, that results in a CAGR of 8.28%. For VTSMX, that results in a CAGR of 6.86%. So an outperformance of 1.42%.

If you wanted to play devil's advocate, you could make a case that without the internet bubble of 1999, the outperformance may not have existed or even been underperformance.



Based on CAPE data since 1880, the only time that US stock have come close to the internet valuation peak is 1929 or today . The above link shows Shiller's older CAPE data in dark blue and his newer CAPE data in green.

VTSMX has a 30 day SEC yield of 1.97%. For VISVX, it's 2.24%. VISVX has a turnover rate of 17.6%. For VTSMX, it's 3.4%.

So VISVX, based on dividends, is slightly less tax efficient. But if the rules change, such that ETFs have the same exposure to cap gains as mutual funds, VISVX's tax efficiency would be more of an issue. Under those circumstances, Vanguard's mutual funds would not have the benefit of having ETF tax efficiency.

When you use portfolio visualizer on VISVX, loadings on market, size, value and momentum are 0.96, 0.53, 0.57 and -0.08 respectively.

The comparable numbers for VBR are 1.01, 0.58, 0.35 and -0.05 respectively.

The comparable numbers for IWD (Ishares Russell 1000 Value ETF, a large cap value ETF) are 0.93, -0.12, 0.36 and -0.01 respectively.


My impression is that a tilt to small cap value might result in outperformance of about 1.4%. This assumes that tax laws don't change. This also assumes that you use investment products with a relatively strong tilt.

With DFA small cap value funds, you might get more than 1.4%, but there is the added cost of advisor fees.

[Park]

I tried to add this to my previous post, but that didn't work.

https://www.factorresearch.com/wp-conte ... SP-500.png

The above link shows the 1 year correlations of three large value funds (IWD iShares Russell 1000 Value ETF, IVE iShares S&P500 Value ETF, VTV Vanguard Value ETF with the S&P500 from 2001 to 2017. It's basically 0.98 over the time period, except around 2001, when it got down to around 0.83.

[packer16]

You bring up some interesting points about factor investing vs. lets say simple index investing with Taylor's 3 fund portfolio. Successful factor investing is dependent upon said factor premium over your hold period but also a fund that can adequately capture the theoretical "factor" premium. I am not a factor expert but I think some of the DFA funds are said to have the most tilt/$ invested.

Packer

[willthrill81]

You bring up some interesting points about factor investing vs. lets say simple index investing with Taylor's 3 fund portfolio. Successful factor investing is dependent upon said factor premium over your hold period but also a fund that can adequately capture the theoretical "factor" premium. I am not a factor expert but I think some of the DFA funds are said to have the most tilt/$ invested.

Packer

But of course, the problem with DFA funds is that you need to earn a premium just to overcome the drag of the advisor fees needed to invest in DFA funds in the first place.

[packer16]

You bring up some interesting points about factor investing vs. lets say simple index investing with Taylor's 3 fund portfolio. Successful factor investing is dependent upon said factor premium over your hold period but also a fund that can adequately capture the theoretical "factor" premium. I am not a factor expert but I think some of the DFA funds are said to have the most tilt/$ invested.

Packer

But of course, the problem with DFA funds is that you need to earn a premium just to overcome the drag of the advisor fees needed to invest in DFA funds in the first place.

That is the corundum, fees vs. exposure to factors with fees being absolute and whether the premium shows up during your hold period uncertain.

Packer

[rascott]

You bring up some interesting points about factor investing vs. lets say simple index investing with Taylor's 3 fund portfolio. Successful factor investing is dependent upon said factor premium over your hold period but also a fund that can adequately capture the theoretical "factor" premium. I am not a factor expert but I think some of the DFA funds are said to have the most tilt/$ invested.

Packer

But of course, the problem with DFA funds is that you need to earn a premium just to overcome the drag of the advisor fees needed to invest in DFA funds in the first place.

That is the corundum, fees vs. exposure to factors with fees being absolute and whether the premium shows up during your hold period uncertain.

Packer

Merriman's Best in Class ETFs track the DFA funds very well. Which is what he has stated his goal to be....to offer a DFA like portfolio without the advisory fees.

[Stef]

Didn't want to start a new thread.

It seems like VBR and IJS are the only well-made multi-factor ETFs available right now? Its it worth the hassle to include factors in your portfolio or better just stick with global market cap?

[MotoTrojan]

Didn't want to start a new thread.

It seems like VBR and IJS are the only well-made multi-factor ETFs available right now? Its it worth the hassle to include factors in your portfolio or better just stick with global market cap?

Says who? VBR and IJS (along with it's twins SLYV and VIOV) are cap-weighted factor funds. I would say they are some of the most basic options available, but that also means they have the lowest expenses. I use both of them myself, but I don't think you can say these are the only well made funds. Many would argue they are the least well-made, but good enough and the lower expense makes them the best option.

[Stef]

Well at least in terms of diversification? If you take the 3600 stocks in the US and make a 3-factor ETF with excluding the "bad" 75% in each factor, you end up with only 56 stocks? Or is more complicated than that?

[Taylor Larimore]

Park:

After your opening post, you wrote:

Edited to change the thread title from "Will You Get Increased Return From Your Factor Tilt?" to " Can You Get A Meaningful Factor Tilt With Present Investment Products?"

I believe your first title was the most important and the answer is easy: Small-Cap Value has the WORST 5-year return of all 15 Morningstar style factors.

Index Performance: Return (%)

Best wishes.
Taylor

Jack Bogle's Words of Wisdom: "I don't believe in factor investing."

[nedsaid]

Park:

After your opening post, you wrote:

Edited to change the thread title from "Will You Get Increased Return From Your Factor Tilt?" to " Can You Get A Meaningful Factor Tilt With Present Investment Products?"

I believe your first title was the most important and the answer is easy: Small-Cap Value has the WORST 5-year return of all 15 Morningstar style factors.

Index Performance: Return (%)

Best wishes.
Taylor

Jack Bogle's Words of Wisdom: "I don't believe in factor investing."

Yes, Taylor. Small Value had a bad year in 2018 and made the 5 year averages look bad. I did buy a little more Small Value just the other day. I am continuing my program of Growth to Value, Large to Small, and US to International rebalancing. Have been doing this bit by bit, inch by inch, nothing dramatic. It just seems that rebalancing into cheaper and smaller stocks is a logical move here.

[nedsaid]

Didn't want to start a new thread.

It seems like VBR and IJS are the only well-made multi-factor ETFs available right now? Its it worth the hassle to include factors in your portfolio or better just stick with global market cap?

Says who? VBR and IJS (along with it's twins SLYV and VIOV) are cap-weighted factor funds. I would say they are some of the most basic options available, but that also means they have the lowest expenses. I use both of them myself, but I don't think you can say these are the only well made funds. Many would argue they are the least well-made, but good enough and the lower expense makes them the best option.

I use Vanguard Small-Cap Value Index ETF (based on CRSP index) and the iShares S&P Small-Cap Value 600 ETF for Small/Value tilting for US and Wisdom Tree International Small Cap Dividend ETF for Small/Value tilting for International. I have compared these with the new Avantis ETF products started by American Century, they look good but what I had looked plenty well good enough and decided not to switch.

[Stef]

Park:

After your opening post, you wrote:

Edited to change the thread title from "Will You Get Increased Return From Your Factor Tilt?" to " Can You Get A Meaningful Factor Tilt With Present Investment Products?"

I believe your first title was the most important and the answer is easy: Small-Cap Value has the WORST 5-year return of all 15 Morningstar style factors.

Index Performance: Return (%)

How is this relevant? 5 years are nothing.

[Taylor Larimore]

Park:

After your opening post, you wrote:

Edited to change the thread title from "Will You Get Increased Return From Your Factor Tilt?" to " Can You Get A Meaningful Factor Tilt With Present Investment Products?"

I believe your first title was the most important and the answer is easy: Small-Cap Value has the WORST 5-year return of all 15 Morningstar style factors.

Index Performance: Return (%)

How is this relevant? 5 years are nothing.

Stef:

You are right, "5 years are nothing."

What IS important is that factor investors are betting on only one small part of the total U.S. stock market. According to Morningstar, Small-Cap Value stocks are only 3% of the total market. This is a huge bet (promoted by the profit-seeking financial industry) which can go wrong and is now happening.

Callan Periodic Table of U.S. Investment returns

Those who do not learn from experience are doomed to repeat it.

Happy Holiday!
Taylor

Jack Bogle's Words of Wisdom: "Selecting funds that will significantly exceed market returns, a search in which hope springs eternal and in which past performance has proven of virtually no predictive value, is a loser’s game.”

[Stef]

I don't know what you are talking about. The factors value, size and momentum are well documented over the last 90 years. You don't get a better risk adjusted performance. You are taking more risk for more return.

Stop posting irrelevant quotes.

[Smith1776]

Null.

[Taylor Larimore]

I think factor tilting has merit.

However, I think the merit is much stronger when using factors for diversification.

If you are tilting because you are simply expecting higher returns, the data seems to suggest that that is slightly more pie in the sky.

Smith1776:

Overweighting factors reduces diversification. Read this:

Three Proofs That TSM IS Efficient

Happy Holiday!
Taylor

Jack Bogle's Words of Wisdom: "The beauty of owning the market is that you eliminate individual stock risk, you eliminate market sector risk, and you eliminate manager risk."

[Smith1776]

Null.

[Taylor Larimore]

I actually would agree that TSM is efficient, but that does not mean that factors cannot improve diversification. Those are entirely separate ideas.

Merry Christmas to you and your family!

Smith1776:

Allan Roth, CPA, CFP, author and advisor wrote this MarketWatch article:

The Most Diversified Stock Portfolio on the Planet

Best wishes and Happy New Year to you and your family.
Taylor

Jack Bogle's Words of Wisdom: "In my view, owning the market and holding it forever is the ultimate strategy for winners."

[abuss368]

I have always had a preference for total market index funds. Tilting and factors are not an issue.

[abuss368]

Park:

After your opening post, you wrote:

Edited to change the thread title from "Will You Get Increased Return From Your Factor Tilt?" to " Can You Get A Meaningful Factor Tilt With Present Investment Products?"

I believe your first title was the most important and the answer is easy: Small-Cap Value has the WORST 5-year return of all 15 Morningstar style factors.

Index Performance: Return (%)

How is this relevant? 5 years are nothing.

Stef:

You are right, "5 years are nothing."

What IS important is that factor investors are betting on only one small part of the total U.S. stock market. According to Morningstar, Small-Cap Value stocks are only 3% of the total market. This is a huge bet (promoted by the profit-seeking financial industry) which can go wrong and is now happening.

Callan Periodic Table of U.S. Investment returns

Those who do not learn from experience are doomed to repeat it.

Happy Holiday!
Taylor

Jack Bogle's Words of Wisdom: "Selecting funds that will significantly exceed market returns, a search in which hope springs eternal and in which past performance has proven of virtually no predictive value, is a loser’s game.”

I always liked the Callan Periodic table. It is important to stay the course.

[willthrill81]

I actually would agree that TSM is efficient, but that does not mean that factors cannot improve diversification. Those are entirely separate ideas.

The notion that efficiency is in opposition to the existence of factors is patently false but surprisingly common. Eugene Fama, one of the biggest early proponents of market efficiency, is also one of the biggest proponents of factor investing.

Having multiple factors drive one's returns, not just market beta, can actually be a good way to reduce downside risk. Over its lifetime, Vanguard's VISVX (i.e. SCV) funds has better 'low' returns over all rolling periods (i.e. 1, 3, 5, 10, and 15) than its TSM counterpart, VTSMX.