Small Value vs Multifactor

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FlyingMoose
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Small Value vs Multifactor

Post by FlyingMoose » Sat Jun 22, 2019 1:56 am

If I want to tilt a bit for higher volatility and possibly higher returns, should I use the old-fashioned Small Value or the newfangled Multifactor?

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Forester
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Re: Small Value vs Multifactor

Post by Forester » Sat Jun 22, 2019 5:40 am


livesoft
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Re: Small Value vs Multifactor

Post by livesoft » Sat Jun 22, 2019 5:49 am

Diversify and use both?
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dcabler
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Re: Small Value vs Multifactor

Post by dcabler » Sat Jun 22, 2019 5:58 am

FlyingMoose wrote:
Sat Jun 22, 2019 1:56 am
If I want to tilt a bit for higher volatility and possibly higher returns, should I use the old-fashioned Small Value or the newfangled Multifactor?
I go small value and mid value. You get 3 factors of Beta, size, and value and you can do so relatively cheaply.
Specifically with IJS for small value, you also get profitability when using the 5 factor model on portfoliovisualizer. I assume it's because the S&P index it tracks has some quality requirements for stock selection.

Note that not all multifactor funds are the same. As Larry Swedroe has noted, there is a universe of factors but a relatively small number of factors worth looking at. And some factors are negatively correlated making it more of a challenge to create a multifactor fund that adequately covers more than a handful of factors and do so cheaply.

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nisiprius
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Re: Small Value vs Multifactor

Post by nisiprius » Sat Jun 22, 2019 5:59 am

I don't tilt. I think I can make a valid observation anyway.

The multifactor funds are different from each other, don't follow any consensus index, and many of them are following proprietary time-varying weighting strategies. So as far as I can see, they can't really be benchmarked, and can't really be compared with each other. You can't really tell, independently, whether they are doing what they are supposed to be doing.

I guess you can at least use PortfolioVisualizer to see how they load on the major factors, but even that gets complicated because how do you know which set of factors to look at?

As with active funds, it's not clear to me anyone can compare them against each other except by past performance--and there isn't even very much past performance.

In the case of small-cap value, at least it is pretty well defined what the factors are, there are well-established indexes to benchmark funds against, you can do apples-to-apples comparisons of one fund with another, and you can check the factor loadings with PortfolioVisualizer.

In the case of small-cap value, you also at least have factors that are not working against each other, whereas the multifactor funds have to deal with factors that conflict with each other--you cannot have high loadings on both value and momentum at the same time.

I think multifactor funds are a setup for getting disappointing results and then being told by mavens, after the fact, "O, multifactor strategies work, but I never thought the fund you chose was really a multifactor fund..."

So here's my quick reality check. I found a list of the "ten largest multifactor ETFs" here. I'm going to chart several on them--I want US-based ones with at least three years of history. Then I'm going to chart three small value funds I hear mentioned in the forum from time to time. If I'm right, I expect to see that the small value funds are reasonably similar to each other, and that the "multifactor" funds are more different from each other. I'm limiting myself to three years because that's all we have for multifactor funds.

Small-cap value first. DFSVX (DFA US Small-Cap Value Portfolio), Reasonably similar to each other, and there's a Morningstar benchmark for "small value," and they are both reasonably similar to the benchmark.

Source
Image

Multifactor, now. These are the six US funds with three years of history that are on the list of the "ten largest multifactor ETFs." There isn't any Morningstar "multifactor" category or category average. Because they are multifactor, they get assigned to different style categories which probably change with time. Morningstar puts the first one I plotted in the "large value" category, but it seems pointless and silly to compare them to a large value benchmark, so I didn't put it on the chart.

Source

Image

I would call these "all over the map." How do you choose the best? Which is the most "multi-ish?" Which is the most "factor-ish?" Which did well because it wasn't very multi and happened to emphasis the factor that happened to perform best? Which is truest and purest to the multifactor Zen ideal? How, in short, do you make a sane decision--other than looking at three (not even ten) years of past performance and pretending we don't see the disclaimer?
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vineviz
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Re: Small Value vs Multifactor

Post by vineviz » Sat Jun 22, 2019 7:08 am

FlyingMoose wrote:
Sat Jun 22, 2019 1:56 am
If I want to tilt a bit for higher volatility and possibly higher returns, should I use the old-fashioned Small Value or the newfangled Multifactor?
My advice is to use a SCV fund if your intent is to supplement another core US stock fund (e.g. total stock market or S&P 500) and to use a "so called" multi-factor fund to replace a core US stock fund.

For instance, a 50/50 combination of iShares Core S&P Total US Stock Mkt ETF (ITOT) and SPDR S&P 600 Small Cap Value ETF (SLYV) would serve as an excellent US portfolio at just 0.09% in expense ratio.

Conversely, Vanguard US Multifactor ETF (VFMF) could take the place of that combination with a single fund albeit at 0.18% in expense ratio.

I say "so called" because SCV funds already are multi-factor funds. The weights of the factors differ (usually heavier on size weighting and less on momentum weighting), but otherwise eerily similar.

Image
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whodidntante
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Re: Small Value vs Multifactor

Post by whodidntante » Sat Jun 22, 2019 8:13 am

As you have no doubt noticed from the almost daily (OK, daily) factor doubt threads, you're going to need conviction to hold these other than market factor thingies. Other people will pronounce you wrong after a period of underperformance. So I think you should buy the one that you will keep buying through a long period of underperformance or none at all.

I am personally just fine holding multifactor funds as a core holding. That doesn't mean I think you should.

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vineviz
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Re: Small Value vs Multifactor

Post by vineviz » Sat Jun 22, 2019 8:29 am

whodidntante wrote:
Sat Jun 22, 2019 8:13 am
As you have no doubt noticed from the almost daily (OK, daily) factor doubt threads, you're going to need conviction to hold these other than market factor thingies. Other people will pronounce you wrong after a period of underperformance. So I think you should buy the one that you will keep buying through a long period of underperformance or none at all.

I am personally just fine holding multifactor funds as a core holding. That doesn't mean I think you should.
Well said.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

DecumulatorDoc
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Re: Small Value vs Multifactor

Post by DecumulatorDoc » Sat Jun 22, 2019 8:36 am

whodidntante wrote:
Sat Jun 22, 2019 8:13 am
As you have no doubt noticed from the almost daily (OK, daily) factor doubt threads, you're going to need conviction to hold these other than market factor thingies. Other people will pronounce you wrong after a period of underperformance. So I think you should buy the one that you will keep buying through a long period of underperformance or none at all.

I am personally just fine holding multifactor funds as a core holding. That doesn't mean I think you should.
Count down to the attack from the 3 Fund Portfolio crowd: 3..2..1..

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FlyingMoose
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Re: Small Value vs Multifactor

Post by FlyingMoose » Sat Jun 22, 2019 8:41 am

By the way, I’m specifically referring to the Vanguard Small Value fund and the Vanguard Multifactor fund...

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Re: Small Value vs Multifactor

Post by Park » Sat Jun 22, 2019 9:12 am

Some comments, for what they're worth.

If you keep on adding factors, couldn't you end up with a slightly more expensive market cap index fund?

When I look at the data for value, it's persuasive. The data for small cap, less so. But the data for small value versus large value gets my attention.

The academic data for momentum also looks persuasive. But after costs, considerably less persuasive.

About quality and profitability, it doesn't make sense. If there are going to be factors that get arbitraged away, those two are high on my list.

Finally, I realize that there are new models out, that don't have value in them. I would welcome comments, from those who are more knowledgeable than me, about the following. My impression is that these models help explain anomalies, such as small growth. But since I don't want to invest in small growth, are the new models relevant to me?

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Re: Small Value vs Multifactor

Post by nedsaid » Sat Jun 22, 2019 9:19 am

DecumulatorDoc wrote:
Sat Jun 22, 2019 8:36 am
whodidntante wrote:
Sat Jun 22, 2019 8:13 am
As you have no doubt noticed from the almost daily (OK, daily) factor doubt threads, you're going to need conviction to hold these other than market factor thingies. Other people will pronounce you wrong after a period of underperformance. So I think you should buy the one that you will keep buying through a long period of underperformance or none at all.

I am personally just fine holding multifactor funds as a core holding. That doesn't mean I think you should.
Count down to the attack from the 3 Fund Portfolio crowd: 3..2..1..
Come to think of it, where is Taylor? I guess the thread hasn't gone over the 10 post threshold quite enough. When it gets to 20, Taylor will probably show.
A fool and his money are good for business.

stan1
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Re: Small Value vs Multifactor

Post by stan1 » Sat Jun 22, 2019 9:37 am

Park wrote:
Sat Jun 22, 2019 9:12 am
Some comments, for what they're worth.

If you keep on adding factors, couldn't you end up with a slightly more expensive market cap index fund?

When I look at the data for value, it's persuasive. The data for small cap, less so. But the data for small value versus large value gets my attention.

The academic data for momentum also looks persuasive. But after costs, considerably less persuasive.

About quality and profitability, it doesn't make sense. If there are going to be factors that get arbitraged away, those two are high on my list.

Finally, I realize that there are new models out, that don't have value in them. I would welcome comments, from those who are more knowledgeable than me, about the following. My impression is that these models help explain anomalies, such as small growth. But since I don't want to invest in small growth, are the new models relevant to me?
I'm probably close to you. I have 50% of assets in an employer retirement account with only total market investment options and another 35% of assets in taxable (a lot of that bought in total market ETFs back in 2008). I've gone ahead and put S&P 600 Value Index ETFs in taxable but beyond that I haven't figured out a low cost way to slip in momentum with market and beta.

MTUM now has close to $10B in assets. Top ten holdings are MSFT, Visa, Mastercard, P&G, Disney, Cisco, Comcast, Merck, PayPal, and Starbucks accounting for 38.54% of holdings. So is it on the path of Fidelity Magellan or Windsor to become a closet index fund?

VFMO on the other hand has $31M in assets. Top ten holdings accounting for 9.7% of assets are
ServiceNow Inc.
Edwards Lifesciences Corp.
American Electric Power Co. Inc.
American Tower Corp.
Intuit Inc.
Eli Lilly & Co.
Mastercard Inc.
Keurig Dr Pepper Inc.
Procter & Gamble Co.
salesforce.com Inc.

Most of those drop out if they had $10B in assets and as seen in MTUM you have to make big bets on a few mega cap stocks.

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Re: Small Value vs Multifactor

Post by Park » Sat Jun 22, 2019 10:18 am

A stock, or stocks in general, can be underpriced or overpriced. Eventually, the market gets it right. But my impression is that the market has greater trouble with overpricing than underpricing. When it's underpriced, buy. When it's overpriced, sell. But you can only sell what you own. If you really want to take advantage of overpriced stocks, you have to short. And that's not straightfoward.

How to mitigate the risk of owning overpriced stocks? Exposure to the value factor. I don't know of other factors that can decrease that risk.

Someone might rightly point out that factor investing isn't just about underpricing and overpricing. It's also about risk, and there may be some risk in the value factor. There is risk in the small factor although the returns don't seem to reflect that. But I haven't seen good arguments for risk regarding momentum, quality or profitability.

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Re: Small Value vs Multifactor

Post by YRT70 » Sat Jun 22, 2019 10:24 am

vineviz wrote:
Sat Jun 22, 2019 7:08 am
FlyingMoose wrote:
Sat Jun 22, 2019 1:56 am
If I want to tilt a bit for higher volatility and possibly higher returns, should I use the old-fashioned Small Value or the newfangled Multifactor?
My advice is to use a SCV fund if your intent is to supplement another core US stock fund (e.g. total stock market or S&P 500) and to use a "so called" multi-factor fund to replace a core US stock fund.

For instance, a 50/50 combination of iShares Core S&P Total US Stock Mkt ETF (ITOT) and SPDR S&P 600 Small Cap Value ETF (SLYV) would serve as an excellent US portfolio at just 0.09% in expense ratio.

Conversely, Vanguard US Multifactor ETF (VFMF) could take the place of that combination with a single fund albeit at 0.18% in expense ratio.

I say "so called" because SCV funds already are multi-factor funds. The weights of the factors differ (usually heavier on size weighting and less on momentum weighting), but otherwise eerily similar.

Image
Interesting. How would these options compare to a small cap value fund + iShares Momentum added?

PS. What is the source of the picture?

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Re: Small Value vs Multifactor

Post by gtwhitegold » Sat Jun 22, 2019 10:55 am

My personal recommendation is to focus on a combination of size, value, and quality while trying to minimize negative alpha, momentum and low volatility loadings. Below is a link to a few examples. Personally, I prefer DESC, Xtrackers Russell 2000 Comprehensive Factor ETF.

https://www.portfoliovisualizer.com/fac ... e&total1=0

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Re: Small Value vs Multifactor

Post by vineviz » Sat Jun 22, 2019 11:52 am

YRT70 wrote:
Sat Jun 22, 2019 10:24 am
Interesting. How would these options compare to a small cap value fund + iShares Momentum added?
My opinion of the iShares USA Momentum Factor ETF isn't very high: you give back more on size, value, and quality than you get in momentum.

Maybe pairing a SCV fund with the Vanguard momentum fund (VFMO) would work, but at that point you might as well just buy VFMF.

YRT70 wrote:
Sat Jun 22, 2019 10:24 am
PS. What is the source of the picture?
I made the graph myself using data from PV.
"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: Small Value vs Multifactor

Post by YRT70 » Sat Jun 22, 2019 12:09 pm

vineviz wrote:
Sat Jun 22, 2019 11:52 am
YRT70 wrote:
Sat Jun 22, 2019 10:24 am
Interesting. How would these options compare to a small cap value fund + iShares Momentum added?
My opinion of the iShares USA Momentum Factor ETF isn't very high: you give back more on size, value, and quality than you get in momentum.

Maybe pairing a SCV fund with the Vanguard momentum fund (VFMO) would work, but at that point you might as well just buy VFMF.
Thanks. I just went on PV and compared IJS with VFMF. Seems like IJS has more loading on size, value and quality.
https://www.portfoliovisualizer.com/fac ... e&total1=0

Would that make IJS the better choice for factor exposure?

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Re: Small Value vs Multifactor

Post by vineviz » Sat Jun 22, 2019 12:28 pm

YRT70 wrote:
Sat Jun 22, 2019 12:09 pm
Would that make IJS the better choice for factor exposure?
"Better" is a dangerous word. ;) Depends on your goals and preferences.

If I were just picking one US equity funds, I'd probably choose VFMF. The factor exposures are somewhat more balanced than IJS/SLYV/VIOV (i.e. it has somewhat better diversification) and in principle I like the slightly more active approach because it should allow the fund to maintain a mores consistent factor exposure over time.

Index-based funds (like MSCI factor funds and S&P size/style funds) tend to load pretty strongly on their factors immediately after rebalancing and then experience factor decay until the next rebalancing date, whereas Vanguard should be able to maintain higher loads

Image

https://advisors.vanguard.com/iwe/pdf/FASFMTH.pdf

As long as they don't let transaction costs get out of hand due to turnover (which would show up as negative alpha in a performance attribution analysis), this seems like a clear advantage. If were managing my own mutual fund, this is exactly how I'd do it.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

muffins14
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Re: Small Value vs Multifactor

Post by muffins14 » Sat Jun 22, 2019 12:40 pm

vineviz wrote:
Sat Jun 22, 2019 12:28 pm
YRT70 wrote:
Sat Jun 22, 2019 12:09 pm
Would that make IJS the better choice for factor exposure?
"Better" is a dangerous word. ;) Depends on your goals and preferences.

If I were just picking one US equity funds, I'd probably choose VFMF. The factor exposures are somewhat more balanced than IJS/SLYV/VIOV (i.e. it has somewhat better diversification) and in principle I like the slightly more active approach because it should allow the fund to maintain a mores consistent factor exposure over time.

Index-based funds (like MSCI factor funds and S&P size/style funds) tend to load pretty strongly on their factors immediately after rebalancing and then experience factor decay until the next rebalancing date, whereas Vanguard should be able to maintain higher loads

Image

https://advisors.vanguard.com/iwe/pdf/FASFMTH.pdf

As long as they don't let transaction costs get out of hand due to turnover (which would show up as negative alpha in a performance attribution analysis), this seems like a clear advantage. If were managing my own mutual fund, this is exactly how I'd do it.
At what level would you say you’re concerned with negative alpha, given that VFMF currently does have negative alpha? How much data across what type of markets would you need to be confident in the regression for a new fund like VFMF that doesn’t have stated factor load targets?

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Re: Small Value vs Multifactor

Post by YRT70 » Sat Jun 22, 2019 12:47 pm

vineviz wrote:
Sat Jun 22, 2019 12:28 pm
YRT70 wrote:
Sat Jun 22, 2019 12:09 pm
Would that make IJS the better choice for factor exposure?
"Better" is a dangerous word. ;) Depends on your goals and preferences.

If I were just picking one US equity funds, I'd probably choose VFMF. The factor exposures are somewhat more balanced than IJS/SLYV/VIOV (i.e. it has somewhat better diversification)
How do you mean 'better diversification'? I thought the factor regression shows IJS is more diversified over the factors?
and in principle I like the slightly more active approach because it should allow the fund to maintain a mores consistent factor exposure over time.

Index-based funds (like MSCI factor funds and S&P size/style funds) tend to load pretty strongly on their factors immediately after rebalancing and then experience factor decay until the next rebalancing date, whereas Vanguard should be able to maintain higher loads

Image

https://advisors.vanguard.com/iwe/pdf/FASFMTH.pdf

As long as they don't let transaction costs get out of hand due to turnover (which would show up as negative alpha in a performance attribution analysis), this seems like a clear advantage. If were managing my own mutual fund, this is exactly how I'd do it.
Interesting. Thanks.

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Re: Small Value vs Multifactor

Post by Taylor Larimore » Sat Jun 22, 2019 12:49 pm

nedsaid wrote:Come to think of it, where is Taylor? I guess the thread hasn't gone over the 10 post threshold quite enough. When it gets to 20, Taylor will probably show.
nedsaid:

Here I am; still trying to keep "The Wisdom of Jack Bogle" alive.

Mr. Bogle was right: Although Morningstar does not have a "Multifactor" category, it does have a "Small Value" category--"Small Value" is currently its worst performing category. Small Value has lagged the the total stock market for the last 10-years and its 5-year return is less than half the Vanguard Total Market Index Fund. No one knows when the suffering will end.

http://news.morningstar.com/fund-category-returns/
The Wisdom of 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."
The Three-Fund Portfolio

Best wishes.
Taylor
Last edited by Taylor Larimore on Sat Jun 22, 2019 1:22 pm, edited 1 time in total.
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vineviz
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Re: Small Value vs Multifactor

Post by vineviz » Sat Jun 22, 2019 1:15 pm

muffins14 wrote:
Sat Jun 22, 2019 12:40 pm
At what level would you say you’re concerned with negative alpha, given that VFMF currently does have negative alpha? How much data across what type of markets would you need to be confident in the regression for a new fund like VFMF that doesn’t have stated factor load targets?
That's a good question, and it necessarily involves a great deal of judgement.

Basically, I think the right benchmark would be to compute the expected return from the fund's factor loadings net of the alpha and market beta. So long as that net number is positive, I think I'd feel okay with the fund's performance.

Right now, using daily regressions (which I think is appropriate given the active approach Vanguard QEG takes) on AQR factors in PortfolioVisualizer I get the following:

Code: Select all

Factor	Loading
AQR-MKT-RF	1.04
AQR-SMB	0.56
AQR-HML-DEV	0.43
AQR-MOM	0.24
AQR-QMJ	0.35
Pulling the annual returns for these factors from PV I get:

Code: Select all

Factor	Annualized Return
AQR-MKT-RF	5.07%
AQR-SMB	1.43%
AQR-HML	2.79%
AQR-HML-DEV	2.70%
AQR-MOM	7.36%
AQR-QMJ	4.44%
Assume these historic returns are the expected returns, sum the products of the loads and factor returns, and 1x market beta and the annual alpha.

Code: Select all

(1.04 x 5.07%) + (0.56 x 1.43%) + (0.43 x 2.70%) + (0.24 x 7.36%) + (0.35 x 4.44%) - 5.07% - 3.91% = 1.58%
So that's a factor return, net of alpha and market beta, of 1.58%. If that number were close to zero, I'd be worried.

And there are two ways that number could be lower. One would obviously be that the factor loadings weaken for some reason. The second is that you expect future factor returns to be lower than historic factor returns. That's a topic ripe for debate, I'm sure, but suffice it to say that if you haircut the historic factor returns by more than 30% then the expected returns of VFMF are no higher than VTI at current levels of alpha.
"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: Small Value vs Multifactor

Post by vineviz » Sat Jun 22, 2019 1:28 pm

YRT70 wrote:
Sat Jun 22, 2019 12:47 pm
How do you mean 'better diversification'? I thought the factor regression shows IJS is more diversified over the factors?
Yes, IJS does have a higher total factor load than VFMF.

I was referring to the fact that the factor loads of IJS are more concentrated (i.e. RMF and SMB account for 72% of the total factor load for IJS, versus 61% for VFMF). The factor exposures of VFM, while lower in aggregate, are more evenly spread across the factors I measured.

I'm not sure it's enough to represent a significant difference (the factor concentration index of IJS is only about 18% higher than VFMF, whereas VTI is about 4x the concentration of VFMF). I just noticed it.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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nedsaid
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Re: Small Value vs Multifactor

Post by nedsaid » Sat Jun 22, 2019 1:44 pm

Taylor Larimore wrote:
Sat Jun 22, 2019 12:49 pm
nedsaid wrote:Come to think of it, where is Taylor? I guess the thread hasn't gone over the 10 post threshold quite enough. When it gets to 20, Taylor will probably show.
nedsaid:

Here I am; still trying to keep "The Wisdom of Jack Bogle" alive.

Mr. Bogle was right: Although Morningstar does not have a "Multifactor" category, it does have a "Small Value" category--"Small Value" is currently its worst performing category. Small Value has lagged the the total stock market for the last 10-years and its 5-year return is less than half the Vanguard Total Market Index Fund. No one knows when the suffering will end.

http://news.morningstar.com/fund-category-returns/
The Wisdom of 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."
The Three-Fund Portfolio

Best wishes.
Taylor
Well Taylor, you have nothing to fear. My guess is that probably 2/3 or more of Bogleheads are in your camp. The factor tilters are a minority here. Even though I have posted a lot on these topics my tilts are not large, my bark is probably worse than my bite. Jack Bogle left a legacy of Vanguard, the Bogleheads, about 10 books, and numerous speeches, interviews, and articles. He also changed the ethos on Wall Street, more and more money is being passively managed. His most important legacy he left was his family, all indications are that Jack was a wonderful person who accomplished one heck of a lot and who was loved by many people. Lots of folks around who will carry on his ideas.

My prediction wasn't far off, I said it would take 20 posts for you to respond and it took 21! :wink:
A fool and his money are good for business.

muffins14
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Re: Small Value vs Multifactor

Post by muffins14 » Sat Jun 22, 2019 1:55 pm

vineviz wrote:
Sat Jun 22, 2019 1:15 pm
muffins14 wrote:
Sat Jun 22, 2019 12:40 pm
At what level would you say you’re concerned with negative alpha, given that VFMF currently does have negative alpha? How much data across what type of markets would you need to be confident in the regression for a new fund like VFMF that doesn’t have stated factor load targets?
That's a good question, and it necessarily involves a great deal of judgement.

Basically, I think the right benchmark would be to compute the expected return from the fund's factor loadings net of the alpha and market beta. So long as that net number is positive, I think I'd feel okay with the fund's performance.

Right now, using daily regressions (which I think is appropriate given the active approach Vanguard QEG takes) on AQR factors in PortfolioVisualizer I get the following:

Code: Select all

Factor	Loading
AQR-MKT-RF	1.04
AQR-SMB	0.56
AQR-HML-DEV	0.43
AQR-MOM	0.24
AQR-QMJ	0.35
Pulling the annual returns for these factors from PV I get:

Code: Select all

Factor	Annualized Return
AQR-MKT-RF	5.07%
AQR-SMB	1.43%
AQR-HML	2.79%
AQR-HML-DEV	2.70%
AQR-MOM	7.36%
AQR-QMJ	4.44%
Assume these historic returns are the expected returns, sum the products of the loads and factor returns, and 1x market beta and the annual alpha.

Code: Select all

(1.04 x 5.07%) + (0.56 x 1.43%) + (0.43 x 2.70%) + (0.24 x 7.36%) + (0.35 x 4.44%) - 5.07% - 3.91% = 1.58%
So that's a factor return, net of alpha and market beta, of 1.58%. If that number were close to zero, I'd be worried.

And there are two ways that number could be lower. One would obviously be that the factor loadings weaken for some reason. The second is that you expect future factor returns to be lower than historic factor returns. That's a topic ripe for debate, I'm sure, but suffice it to say that if you haircut the historic factor returns by more than 30% then the expected returns of VFMF are no higher than VTI at current levels of alpha.
Thanks for the quantitative response— going further, do you happen to know the variance of the expected returns for each factor? It would be interesting to make a confidence interval on the 1.58% estimate and see how it would change with more data, and how alpha evolves as the fund ages.

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Re: Small Value vs Multifactor

Post by YRT70 » Sat Jun 22, 2019 1:58 pm

Taylor Larimore wrote:
Sat Jun 22, 2019 12:49 pm
Mr. Bogle was right: Although Morningstar does not have a "Multifactor" category, it does have a "Small Value" category--"Small Value" is currently its worst performing category. Small Value has lagged the the total stock market for the last 10-years and its 5-year return is less than half the Vanguard Total Market Index Fund. No one knows when the suffering will end.
10 year returns (M*):
VTSMX 14.59%
IJS 13.53%
SLYV 14.04%

If that's suffering, I'll gladly suffer for the next 30 years ;)
vineviz wrote:
Sat Jun 22, 2019 1:28 pm
YRT70 wrote:
Sat Jun 22, 2019 12:47 pm
How do you mean 'better diversification'? I thought the factor regression shows IJS is more diversified over the factors?
Yes, IJS does have a higher total factor load than VFMF.

I was referring to the fact that the factor loads of IJS are more concentrated (i.e. RMF and SMB account for 72% of the total factor load for IJS, versus 61% for VFMF). The factor exposures of VFM, while lower in aggregate, are more evenly spread across the factors I measured.

I'm not sure it's enough to represent a significant difference (the factor concentration index of IJS is only about 18% higher than VFMF, whereas VTI is about 4x the concentration of VFMF). I just noticed it.
Thanks for explaining.

typical.investor
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Re: Small Value vs Multifactor

Post by typical.investor » Sun Jun 23, 2019 2:22 am

vineviz wrote:
Sat Jun 22, 2019 1:28 pm
YRT70 wrote:
Sat Jun 22, 2019 12:47 pm
How do you mean 'better diversification'? I thought the factor regression shows IJS is more diversified over the factors?
Yes, IJS does have a higher total factor load than VFMF.

I was referring to the fact that the factor loads of IJS are more concentrated (i.e. RMF and SMB account for 72% of the total factor load for IJS, versus 61% for VFMF). The factor exposures of VFM, while lower in aggregate, are more evenly spread across the factors I measured.

I'm not sure it's enough to represent a significant difference (the factor concentration index of IJS is only about 18% higher than VFMF, whereas VTI is about 4x the concentration of VFMF). I just noticed it.
Mind too that unless IJS and VFMF have the same volatility, then the loading isn't entirely comparable.

See https://pdfs.semanticscholar.org/d59d/0 ... e1f049.pdf

(note: "beta" in the follow quote refers to the factor loading and not Market Beta).
Because volatility varies considerably across portfolios, comparisons of betas can be misleading. Using the preceding equation, we can see that for the same level of correlation, the higher a portfolio’s volatility, the higher its beta. Let’s see why this matters.
Suppose an investor is comparing value exposure for two different portfolios: Portfolio A is a defensive equity portfolio (with lower volatility), and portfolio B is a levered equity portfolio (with higher volatility). It could be the case that portfolio B has a higher value beta, which would seem to indicate that it has higher value exposure. However, the higher beta could be a result of portfolio B’s higher volatility rather than more meaningful value exposure (assuming the same level of correlation between both portfolios and the value factor). When investors fail to account for different levels of volatilities between portfolios, they may conclude that one portfolio is providing more value exposure than another—it does in notional terms, but that may not be the case in terms of exposure per unit of risk.
Another interesting point from that article is how different loading are when using HML Devil. The model portfolio is 50% HML 50% MOM (UMD), but you really can't see the MOM (UMD) loading well. When not using HML Devil, excess returns from MOM (UMD) were about 1/3 of excess returns from value. When using it, they were greater.

Anyway, based on performance MFUS looks better than IJS or VFMF (albeit a brief period). It has the lowest volatility of the three, but I am not sure exactly how much that affects loadings - only that it does. Factor weight itself is adjusted based on factor momentum. Given it's lack of size exposure, I'd probably combine it with a small value fund. It's supposed to target value, quality, low volatility. momentum and size.

https://www.portfoliovisualizer.com/fac ... e&total1=0

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Re: Small Value vs Multifactor

Post by Robert T » Sun Jun 23, 2019 6:44 am

.
Small value = multifactor (more than one factor).

As more and more factors are added the incremental value on each declines.

Some examples I posted earlier. Just to note that these are back-tested data, not live returns.

July 1973 – Sept 2016: Annualized Return (%)/Annualized Standard Deviation
  • 11.1 / 15.6 = US Market
    13.3 / 15.1 = RAFI US Fundamental*
    13.5 / 15.2 = RAFII US Multi-factor (with systematic rebalancing)**

    * value factor
    ** value, low volatility, quality, momentum, and size factors

    +2.2% from adding value
    +0.2% from further adding low volatility, quality, momentum and size.

1975-2012: Annualized return (%) / Standard Deviation
  • 12.0 / 17.2 = US Market
    14.0 / 17.4 = DFA Core 2 without profitability
    14.3 / 17.6 = DFA Core 2 with profitability

    +2.0% from adding size and value
    +0.3% from further adding profitability

My concern with some of the marketing around funds with ‘multifactor’ in their name is that they are presented as something new (which they are not), and that adding many more factors is so much better (which it is not, or at least the incremental gains are smaller and smaller).

Unfortunately we don’t have long-term historical return data for the Vanguard Multifactor series so there is no way to gauge its likely long-term factor exposure characteristics (just over one year of data is way too short IMO). Time will tell.

Robert
.

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Re: Small Value vs Multifactor

Post by Park » Sun Jun 23, 2019 11:11 am

If one invests in multifactor funds for the long term, one assumes that those factors will make a noticeable improvement in performance over the long term. Is that a reasonable assumption?

One can make the case that factor investing started 38 years ago with research on the small factor in 1981. Since research on the small factor was published, its returns have markedly diminished. DFA's first fund, back when it started in 1981, was a microcap fund.

Will this happen to other factors? If limits to arbitrage allow a behavioral etiology of a factor to persist, no. That doesn't seem to have worked well for the size factor. If there is risk(s) associated with the factor, no. Despite some good arguments for risk with the size factor, that hasn't worked out well either.

For other factors (momentum (long only), profitability, quality), I haven't seen good arguments for risk based explanations for them. As for limits to arbitrage, one would think that small would be more difficult to arbitrage away, due to liquidity constraints. If limits to arbitrage haven't worked well for small, how well will it work for other factors, where liquidity constraints are less of an issue?

If I had to make a bet, I would bet that value would persist. And if I had to make a second bet, I would bet that the increased return of small value over large value would persist. About making 3rd, 4th, 5th bets etc, I think it would be reasonable to make such bets. But due to the greater uncertainty of such bets, I would make such bets small, and only after making the first two bets.

Also, the question of small value vs. multifactor relates to why you are interested in factor investing. If you're interested in factor investing to increase returns, a better argument can be made for multifactor. But that's not the #1 reason that I'm interested in factor investing.

I've seen good data that value investing helped after the secular bear markets that started in the US in 1966 and 2000. I've also seen similar data for the European secular bear market that started in 2000. I believe Larry Swedroe found that small and value mitigated the risk of the secular bear market that started in the US in 1929. Finally, value investing mitigated the effect of the Japanese secular bear market that started in 1990, and from what I understand, still persists 29 years later.

For me, factor investing can mitigate the risk of a secular bear market. And the factor that can decrease that risk is value. I haven't seen evidence of any other factor doing that, with the possible exception of small value.

The addition of other factors may decrease the volatility of the value premium. But as long as my investment horizon is greater than 5 years, that volatility isn't a significant issue.

A valid criticism of what I've written is if I'm sceptical of why nonvalue factors will persist, why do I think differently about value? After all, the risk based explanations for value are weaker than those for small, and look what happened to small. And if I'm uncertain about limits of arbitrage preventing the behavioral component of momentum, profitability and quality being arbitraged away, as it looks like such limits haven't worked with small, why do I think value is different?

The behavior behind value is strong, as evidenced by repeated bubbles throughout history. I doubt that this behavior will change greatly, despite increased awareness of it. When the strength of such behavior is significant, shorting becomes more problematic. How many people made money shorting internet stocks in 1999?

Stock market bubbles are one manifestation of this behavior, but not the only one. Amazon, the second largest stock by market cap in the US, has a PE ratio of 80. Read older Jeremy Siegel articles from the WSJ. When a company with the size of Amazon's market cap has a PE greater than 50-60, long term returns aren't good. This was well known 19 years ago. Despite that, the behavior persists.

People mention that the small value premium will disappear. It's much more well known, and much more easier to invest in. But the increased return of small value is only one side of the coin. The decreased return of large and growth is the other side. As shown above by Amazon, it persists. Does anyone reading this want to arbitrage that decreased return away by shorting Amazon? 0.75% of Amazon's float is shorted, and it's about 1 day to cover the short interest on amazon. Shorting Amazon is not a crowded trade.

Perhaps I will be wrong about value. But even if I am, my guess is that my returns will only suffer modestly as a result. The historical records I've seen of when value underperforms, found that it still does reasonably well on an absolute basis. And I'm willing to take that risk, as I believe it's worth the possible risk mitigation of value.

This assumes that value investing can be done in a cost and tax efficient manner. If that's not true, you're probably better off in a market cap index fund. Regardless of what one thinks about facotr investing, a market cap index strategy is a good way to invest. When it comes to cost and tax efficiency, it's the gold standard for factor strategies.

The following is an interesting digression from Rob Arnott, circa 2005.

https://money.cnn.com/2005/10/14/pf/pro ... /index.htm

"Arnott, 51, traces his tax sensitivity to a late-1980s assessment of his investing record, when he found that he beat the S&P 500 index, on average, by five percentage points on a pretax basis -- but by a mere single point on an after-tax basis."

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Re: Small Value vs Multifactor

Post by DecumulatorDoc » Sun Jun 23, 2019 10:01 pm

Taylor Larimore wrote:
Sat Jun 22, 2019 12:49 pm
nedsaid wrote:Come to think of it, where is Taylor? I guess the thread hasn't gone over the 10 post threshold quite enough. When it gets to 20, Taylor will probably show.
nedsaid:

Here I am; still trying to keep "The Wisdom of Jack Bogle" alive.

Mr. Bogle was right: Although Morningstar does not have a "Multifactor" category, it does have a "Small Value" category--"Small Value" is currently its worst performing category. Small Value has lagged the the total stock market for the last 10-years and its 5-year return is less than half the Vanguard Total Market Index Fund. No one knows when the suffering will end.

http://news.morningstar.com/fund-category-returns/
The Wisdom of 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."
The Three-Fund Portfolio

Best wishes.
Taylor
There we go...what should I do now? Darn, I chose 10 years ago to tilt to SCV. Wait a minute, I've got an Investment Policy Statement..."stay the course, ignore the noise. Rebalance."

Better now.

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Re: Small Value vs Multifactor

Post by Park » Tue Jun 25, 2019 8:52 am

Obviously, just because a stock is a value stock doesn't mean it's underpriced. And just because a stock is a growth stock doesn't mean it's overpriced. To some extent, what a company is worth depends on its present cash flows, and the future growth or decline of those cash flows. Quantitative value investing just takes into account present cash flows. It's certainly possible that present cash flows could be overpriced, and future growth/decline could be underpriced. But historically, future growth/decline has tended to be more overpriced than present cash flows.

I've earlier raised the opinion that the market has more trouble with overpriced stocks than underpriced stocks, and speculated that may be due to the asymmetric difficulty associated with profiting from underpriced stocks (buying) versus overpriced stocks (shorting). It may also be due to simple arithmetic. The least a company can be worth is nothing, but there's no limit on how much a company can be worth. In other words, there's a lower bound on how how much a company is worth, but no upper bound. With a corporate structure in a company having excessive debt, the owners have no obligation to meet those debts. From an owner's point of view, their ownership share of the company cannot be worth less than zero.

I do wonder whether with multifactor funds, by trying to be everything to everyone, dilute out what is important to an investor. If value is important to you, I don't see how multifactor fund could have as strong a value tilt, as a value fund.

I've talked about my concern that factors, such as profitability and quality, may not be important in the future. I've mentioned the small factor, as an example of a factor that stopped becoming important. Someone might make a similar argument for value, as the historical definition of quantitative value has tended to be price book ratio. But price book doesn't work anymore. Similarly, James O'Shaughnessy used to call price to sales "the king of value factors". He doesn't say that now. Will something similar happen in the future to price to cash flow or EBITDA/EV etc? I don't know. If you are going to invest in a value fund, it might be best to invest in one that defines value using multiple criteria.

About the importance of small in small value, it may protect you against extreme overpricing. All other things being equal, an overpriced stock will have a tendency to be a large stock.

The following from Nicolas Rabener is relevant:

"focus on the US, Europe and Japan as these have the largest stock universes, which make the results more meaningful. The long and short portfolios are constructed by taking the top and bottom 10% of the stock universes...we will use the difference in book value multiples between the long and short portfolios to determine how cheap or expensive a factor is...the more negative the spread, the cheaper the factor as it implies that the long portfolio is trading at a lower multiple than the short portfolio, e.g. a spread of -5.0x could be derived from the long portfolio being valued at 1.0x (cheap) versus the short portfolio at 6.0x (expensive)...

https://www.factorresearch.com/research ... lue-factor

The chart below shows the book value spread for the Value factor for the period from 1986 to 2017 and is significantly influenced by the Tech bubble...

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

We can also observe the impact of the Tech bubble on the valuation spreads of the Size factor, which goes long companies with low market capitalizations and short companies with large market capitalizations. The average spread excluding the Tech bubble is close to zero, indicating that the long and short portfolios are valued similarly from a book value perspective."

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

In the tech bubble, both value and small mitigated bubble risk.

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Re: Small Value vs Multifactor

Post by rascott » Tue Jun 25, 2019 9:04 am

FlyingMoose wrote:
Sat Jun 22, 2019 8:41 am
By the way, I’m specifically referring to the Vanguard Small Value fund and the Vanguard Multifactor fund...
I was under the impression that the Vanguard SV fund uses a different index than SLYV/IJS.....and chose the latter for some reason I cannot recall

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Re: Small Value vs Multifactor

Post by vineviz » Tue Jun 25, 2019 10:46 am

rascott wrote:
Tue Jun 25, 2019 9:04 am
FlyingMoose wrote:
Sat Jun 22, 2019 8:41 am
By the way, I’m specifically referring to the Vanguard Small Value fund and the Vanguard Multifactor fund...
I was under the impression that the Vanguard SV fund uses a different index than SLYV/IJS.....and chose the latter for some reason I cannot recall
Vanguard manages three different small cap value index strategies (one each for CRSP, S&P, and Russell indexes), with each strategy available in both ETF and open-end share classes.

Their most popular ETF is Small-Cap Value ETF (VBR) which uses the CRSP index.

IJS and SLYV both use the S&P 600 Value index, which I view as preferable because the value exposure is stronger and the stocks are smaller than the CRSP index. The Vanguard S&P Small-Cap 600 Value ETF (VIOV) tracks this index as well.
"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: Small Value vs Multifactor

Post by MindTheGAAP » Tue Jun 25, 2019 11:03 am

vineviz wrote:
Tue Jun 25, 2019 10:46 am
rascott wrote:
Tue Jun 25, 2019 9:04 am
FlyingMoose wrote:
Sat Jun 22, 2019 8:41 am
By the way, I’m specifically referring to the Vanguard Small Value fund and the Vanguard Multifactor fund...
I was under the impression that the Vanguard SV fund uses a different index than SLYV/IJS.....and chose the latter for some reason I cannot recall
Vanguard manages three different small cap value index strategies (one each for CRSP, S&P, and Russell indexes), with each strategy available in both ETF and open-end share classes.

Their most popular ETF is Small-Cap Value ETF (VBR) which uses the CRSP index.

IJS and SLYV both use the S&P 600 Value index, which I view as preferable because the value exposure is stronger and the stocks are smaller than the CRSP index. The Vanguard S&P Small-Cap 600 Value ETF (VIOV) tracks this index as well.
Unless I'm severely mistaken, the S&P index also screens for Quality which I would view as beneficial/preferable.
"One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute" - William Feather

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Re: Small Value vs Multifactor

Post by CULater » Tue Jun 25, 2019 11:45 am

typical.investor wrote:
Sun Jun 23, 2019 2:22 am
vineviz wrote:
Sat Jun 22, 2019 1:28 pm
YRT70 wrote:
Sat Jun 22, 2019 12:47 pm
How do you mean 'better diversification'? I thought the factor regression shows IJS is more diversified over the factors?
Yes, IJS does have a higher total factor load than VFMF.

I was referring to the fact that the factor loads of IJS are more concentrated (i.e. RMF and SMB account for 72% of the total factor load for IJS, versus 61% for VFMF). The factor exposures of VFM, while lower in aggregate, are more evenly spread across the factors I measured.

I'm not sure it's enough to represent a significant difference (the factor concentration index of IJS is only about 18% higher than VFMF, whereas VTI is about 4x the concentration of VFMF). I just noticed it.
Mind too that unless IJS and VFMF have the same volatility, then the loading isn't entirely comparable.

See https://pdfs.semanticscholar.org/d59d/0 ... e1f049.pdf

(note: "beta" in the follow quote refers to the factor loading and not Market Beta).
Because volatility varies considerably across portfolios, comparisons of betas can be misleading. Using the preceding equation, we can see that for the same level of correlation, the higher a portfolio’s volatility, the higher its beta. Let’s see why this matters.
Suppose an investor is comparing value exposure for two different portfolios: Portfolio A is a defensive equity portfolio (with lower volatility), and portfolio B is a levered equity portfolio (with higher volatility). It could be the case that portfolio B has a higher value beta, which would seem to indicate that it has higher value exposure. However, the higher beta could be a result of portfolio B’s higher volatility rather than more meaningful value exposure (assuming the same level of correlation between both portfolios and the value factor). When investors fail to account for different levels of volatilities between portfolios, they may conclude that one portfolio is providing more value exposure than another—it does in notional terms, but that may not be the case in terms of exposure per unit of risk.
Another interesting point from that article is how different loading are when using HML Devil. The model portfolio is 50% HML 50% MOM (UMD), but you really can't see the MOM (UMD) loading well. When not using HML Devil, excess returns from MOM (UMD) were about 1/3 of excess returns from value. When using it, they were greater.

Anyway, based on performance MFUS looks better than IJS or VFMF (albeit a brief period). It has the lowest volatility of the three, but I am not sure exactly how much that affects loadings - only that it does. Factor weight itself is adjusted based on factor momentum. Given it's lack of size exposure, I'd probably combine it with a small value fund. It's supposed to target value, quality, low volatility. momentum and size.

https://www.portfoliovisualizer.com/fac ... e&total1=0
MFUS looks like a closet TSM fund. Has tracked VTI pretty closely since inception as shown on StockCharts. Also, loadings on FF 4-factor look about like VTI
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Re: Small Value vs Multifactor

Post by comeinvest » Wed Jun 26, 2019 7:06 am

MindTheGAAP wrote:
Tue Jun 25, 2019 11:03 am
vineviz wrote:
Tue Jun 25, 2019 10:46 am
rascott wrote:
Tue Jun 25, 2019 9:04 am
FlyingMoose wrote:
Sat Jun 22, 2019 8:41 am
By the way, I’m specifically referring to the Vanguard Small Value fund and the Vanguard Multifactor fund...
I was under the impression that the Vanguard SV fund uses a different index than SLYV/IJS.....and chose the latter for some reason I cannot recall
Vanguard manages three different small cap value index strategies (one each for CRSP, S&P, and Russell indexes), with each strategy available in both ETF and open-end share classes.

Their most popular ETF is Small-Cap Value ETF (VBR) which uses the CRSP index.

IJS and SLYV both use the S&P 600 Value index, which I view as preferable because the value exposure is stronger and the stocks are smaller than the CRSP index. The Vanguard S&P Small-Cap 600 Value ETF (VIOV) tracks this index as well.
Unless I'm severely mistaken, the S&P index also screens for Quality which I would view as beneficial/preferable.
VIOV has 0.2% ER, VBR has 0.07%. Is VIOV worth it for the bigger tilt?

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Re: Small Value vs Multifactor

Post by stan1 » Wed Jun 26, 2019 7:31 am

comeinvest wrote:
Wed Jun 26, 2019 7:06 am

VIOV has 0.2% ER, VBR has 0.07%. Is VIOV worth it for the bigger tilt?
No one knows, but I prefer to convert to dollars. Difference is $130 per year per $100K invested in small cap value. If you believe the theory that's not a high implementation cost. I pay a lot more than $130 per year for a variety of insurance products I'll probably never need but buy anyways "just in case". If you just want to dip your toes in the water I'd stick with Total Stock Market.

If the difference was $500 per year such as maybe with a DFA fund I definitely would think about it harder.

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Re: Small Value vs Multifactor

Post by typical.investor » Wed Jun 26, 2019 7:33 am

CULater wrote:
Tue Jun 25, 2019 11:45 am


MFUS looks like a closet TSM fund. Has tracked VTI pretty closely since inception as shown on StockCharts. Also, loadings on FF 4-factor look about like VTI
The AQR data looks much different:

https://www.portfoliovisualizer.com/fac ... e&total1=0

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Re: Small Value vs Multifactor

Post by CULater » Wed Jun 26, 2019 7:38 am

typical.investor wrote:
Wed Jun 26, 2019 7:33 am
CULater wrote:
Tue Jun 25, 2019 11:45 am


MFUS looks like a closet TSM fund. Has tracked VTI pretty closely since inception as shown on StockCharts. Also, loadings on FF 4-factor look about like VTI
The AQR data looks much different:

https://www.portfoliovisualizer.com/fac ... e&total1=0
So what does that mean? I've often wondered which dataset to use for factor regressions and why? How does one reconcile the results when different datasets disagree?
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Re: Small Value vs Multifactor

Post by Taylor Larimore » Wed Jun 26, 2019 7:57 am

comeinvest wrote: VIOV has 0.2% ER, VBR has 0.07%. Is VIOV worth it for the bigger tilt?
comeinvest:

Annualized returns for VIOV and VBR plus VTI (Vanguard Total Stock Market ETF):

FUND----5-years-------10-years--------15-years

VIOV------6.20%----------n.a.-----------not available
VBR-------6.24%---------13.92%---------8.59%
VTI--------9.99%---------14.59%---------8.95%

What Experts Say About Total Market Index Funds

Best wishes.
Taylor
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Re: Small Value vs Multifactor

Post by vineviz » Wed Jun 26, 2019 9:52 am

comeinvest wrote:
Wed Jun 26, 2019 7:06 am
VIOV has 0.2% ER, VBR has 0.07%. Is VIOV worth it for the bigger tilt?
Almost certainly.

The way you'd answer this question this is to calculate the difference in exposure to each factor, multiply each one by the expected return for that factor, then see if the sum is greater than zero. If VIOV is higher, the extra tilt is worth it.

Here are the factor loadings for the two funds for a recent period.

Code: Select all

Name	Ticker	AQR-MKT-RF	AQR-SMB	AQR-HML	AQR-MOM	AQR-QMJ	Annual Alpha
Vanguard Small-Cap Value ETF	VBR	1.06	0.68	0.26	-0.09	0.22	-1.71%
Vanguard S&P Small-Cap 600 Value ETF	VIOV	1.14	1.15	0.39	-0.07	0.48	-0.46%
Just subtract VBR from VIOV:

Code: Select all

	AQR-MKT-RF	AQR-SMB	AQR-HML	AQR-MOM	AQR-QMJ
VIOV minus VBR	0.08	0.47	0.13	0.02	0.26
Multiply each factor by the expected return. Lots of ways to do this, but an easy and highly pessimistic approach would be to take the long-term average (since 1964) and cut each in half except for market beta. That gives you the following:

Code: Select all

	AQR-MKT-RF	AQR-SMB	AQR-HML	AQR-MOM	AQR-QMJ
Expected factor return	5.1%	0.7%	1.4%	3.7%	2.2%
So the extra expected return of VIOV over VBR is:

(0.08 * 0.051) + (0.47 * 0.007) + (0.13 * 0.014) + (0.02 * 0.037) + (0.26 * 0.022) = 1.57%

Finally add the difference in alpha (1.25%) and you get a total expected excess return of 2.83% for VIOV over VBR. Alpha already includes the ER, so no need to factor that in separately,

But remember, this is a long-term expected return. In any given period, the return could be higher or lower. And in periods where VIOV's biggest factors (size, value, quality) are doing poorly then you should expect VIOV to have LOWER returns than VBR.
"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: Small Value vs Multifactor

Post by Park » Thu Jun 27, 2019 8:40 am

About multifactor funds, consider the following. Joel Greenblatt's Magic Formula is multifactor investing, and is an example of intersectional multifactor investing. A value metric (EBIT/EV) is combined with a quality metric (return on equity), and stocks are chosen based on the optimum of that combination.

The formula beats the market, and Wes Gray and James Montier confirmed that. But both individuals found that if you used EBIT/EV alone, results were better than if you used the combination.

Increased complexity is not always in an investor's best interest.

comeinvest
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Re: Small Value vs Multifactor

Post by comeinvest » Fri Jun 28, 2019 5:02 am

vineviz wrote:
Wed Jun 26, 2019 9:52 am
comeinvest wrote:
Wed Jun 26, 2019 7:06 am
VIOV has 0.2% ER, VBR has 0.07%. Is VIOV worth it for the bigger tilt?
Almost certainly.

The way you'd answer this question this is to calculate the difference in exposure to each factor, multiply each one by the expected return for that factor, then see if the sum is greater than zero. If VIOV is higher, the extra tilt is worth it.

Here are the factor loadings for the two funds for a recent period.

Code: Select all

Name	Ticker	AQR-MKT-RF	AQR-SMB	AQR-HML	AQR-MOM	AQR-QMJ	Annual Alpha
Vanguard Small-Cap Value ETF	VBR	1.06	0.68	0.26	-0.09	0.22	-1.71%
Vanguard S&P Small-Cap 600 Value ETF	VIOV	1.14	1.15	0.39	-0.07	0.48	-0.46%
Just subtract VBR from VIOV:

Code: Select all

	AQR-MKT-RF	AQR-SMB	AQR-HML	AQR-MOM	AQR-QMJ
VIOV minus VBR	0.08	0.47	0.13	0.02	0.26
Multiply each factor by the expected return. Lots of ways to do this, but an easy and highly pessimistic approach would be to take the long-term average (since 1964) and cut each in half except for market beta. That gives you the following:

Code: Select all

	AQR-MKT-RF	AQR-SMB	AQR-HML	AQR-MOM	AQR-QMJ
Expected factor return	5.1%	0.7%	1.4%	3.7%	2.2%
So the extra expected return of VIOV over VBR is:

(0.08 * 0.051) + (0.47 * 0.007) + (0.13 * 0.014) + (0.02 * 0.037) + (0.26 * 0.022) = 1.57%

Finally add the difference in alpha (1.25%) and you get a total expected excess return of 2.83% for VIOV over VBR. Alpha already includes the ER, so no need to factor that in separately,

But remember, this is a long-term expected return. In any given period, the return could be higher or lower. And in periods where VIOV's biggest factors (size, value, quality) are doing poorly then you should expect VIOV to have LOWER returns than VBR.
Thanks a lot for sharing your assumptions. Can you please elaborate on what you call "alpha"? Is it ER, implementation cost, and securities lending? I think the combination of those are much less than your numbers (1.71% / 0.46%), I know VBR tracks its index very closely. Curious how you obtained your numbers.

On another note, while I understand your rationale, I feel that a higher weight for the expense ratio might be justified, depending on an individual's model and stochastic assumptions. The validity of the whole factor theory, which is largely based on extrapolating past data gathered from data mining into the future, is highly debated here on this forum. (I'm torn myself and don't want to repeat the arguments here.) If the theory fails in the future and factors keep "disappearing" or "not showing up" as some currently do, or the market otherwise doesn't do what it's "supposed to do" (which it often doesn't in the history of financial markets), you don't lose much with a low cost vehicle (unless the theory reverses of course), but you still outperform if some factors decide to indeed "show up" as they are supposed to. Likewise, I'm not convinced if maximizing tilt reduces or increases risk (in the future). For example looking at QVAL since inception, it seems not so clear if they can catch up in our lifetimes - I think the ER has been the least of the problems of QVAL investors. I guess it comes down to weighing the risk of not participating in factor diversification (if one believes in factors and if they decide to show up) vs. the risk of underperforming the market cap based index if things don't work out as predicted. We are basically at the mercy of the factors "showing up", lol :)

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vineviz
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Re: Small Value vs Multifactor

Post by vineviz » Fri Jun 28, 2019 8:51 am

comeinvest wrote:
Fri Jun 28, 2019 5:02 am
Thanks a lot for sharing your assumptions. Can you please elaborate on what you call "alpha"? Is it ER, implementation cost, and securities lending? I think the combination of those are much less than your numbers (1.71% / 0.46%), I know VBR tracks its index very closely. Curious how you obtained your numbers.
Technically, alpha is just the constant term (or y-axis intercept) from the regression: it's the average return that can't be explained by the independent variables. In practice, it includes management expenses, trading expenses, timing error, security lending revenue, etc.

In other words alpha definitely includes tracking error but it includes other expenses (explicit and implicit) and income as well.
comeinvest wrote:
Fri Jun 28, 2019 5:02 am
On another note, while I understand your rationale, I feel that a higher weight for the expense ratio might be justified, depending on an individual's model and stochastic assumptions. The validity of the whole factor theory, which is largely based on extrapolating past data gathered from data mining into the future, is highly debated here on this forum.
I encourage you to not mistake the level of debate on this forum as an indication of the actual validity of modern portfolio theory.

But more to the point, I think you definitely should be careful NOT to double count the expenses of the funds when comparing them. I see no reasonable basis for doing so, either theoretical or empirical, especially since the long-term trend on most costs (i.e. expense ratios and transaction costs both) is toward lower costs and not higher costs.

On the other hand, the procedure I outlined definitely DOES require a formation of some estimate of future expected factor returns and it seems entirely reasonable to assume that they could be higher or lower in the future than they have been in the past. I accounted for that in my example by assuming that future returns are 50% of historical returns. That seems extreme to me, but I'm sure good arguments could be made for 30% or 70% as well. 100% of historical returns is probably an extremely optimistic expectation, but 0% is probably an extremely pessimistic expectation.

However, even the most cynical counterargument against the persistence of factor premia would be be that they lose all of their explanatory power in the future. In that case, the excess factor returns should be zero and not negative. This would leave you with a single factor (market beta) and costs (i.e. alpha) as your inputs for expected return. And even in this extreme conspiracy theory environment, there may STILL be diversification benefits from owning funds with factor exposures that differ from the market.
"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: Small Value vs Multifactor

Post by Park » Fri Jun 28, 2019 10:41 pm

vineviz wrote:
Fri Jun 28, 2019 8:51 am
However, even the most cynical counterargument against the persistence of factor premia would be be that they lose all of their explanatory power in the future. In that case, the excess factor returns should be zero and not negative. This would leave you with a single factor (market beta) and costs (i.e. alpha) as your inputs for expected return. And even in this extreme conspiracy theory environment, there may STILL be diversification benefits from owning funds with factor exposures that differ from the market.
Vineviz, wouldn't it be possible that if enough people bought small cap value, that the excess factors returns could be negative? Please correct me on that, as I sense you know more than me, although I may be damning you with faint praise :happy . And since I tilt in my portfolio, I hope you say I'm wrong.

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Re: Small Value vs Multifactor

Post by typical.investor » Fri Jun 28, 2019 10:55 pm

Park wrote:
Fri Jun 28, 2019 10:41 pm
vineviz wrote:
Fri Jun 28, 2019 8:51 am
However, even the most cynical counterargument against the persistence of factor premia would be be that they lose all of their explanatory power in the future. In that case, the excess factor returns should be zero and not negative. This would leave you with a single factor (market beta) and costs (i.e. alpha) as your inputs for expected return. And even in this extreme conspiracy theory environment, there may STILL be diversification benefits from owning funds with factor exposures that differ from the market.
Vineviz, wouldn't it be possible that if enough people bought small cap value, that the excess factors returns could be negative? Please correct me on that, as I sense you know more than me, although I may be damning you with faint praise :happy . And since I tilt in my portfolio, I hope you say I'm wrong.
There is certainly no indication of that now.

“value is currently trading at the biggest discount ever, and offers the largest premium over the last 30 years.” -J.P. Morgan’s chief U.S. equity strategist

Park
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Re: Small Value vs Multifactor

Post by Park » Sat Jun 29, 2019 5:42 am

typical.investor wrote:
Fri Jun 28, 2019 10:55 pm
Park wrote:
Fri Jun 28, 2019 10:41 pm
vineviz wrote:
Fri Jun 28, 2019 8:51 am
However, even the most cynical counterargument against the persistence of factor premia would be be that they lose all of their explanatory power in the future. In that case, the excess factor returns should be zero and not negative. This would leave you with a single factor (market beta) and costs (i.e. alpha) as your inputs for expected return. And even in this extreme conspiracy theory environment, there may STILL be diversification benefits from owning funds with factor exposures that differ from the market.
Vineviz, wouldn't it be possible that if enough people bought small cap value, that the excess factors returns could be negative? Please correct me on that, as I sense you know more than me, although I may be damning you with faint praise :happy . And since I tilt in my portfolio, I hope you say I'm wrong.
There is certainly no indication of that now.

“value is currently trading at the biggest discount ever, and offers the largest premium over the last 30 years.” -J.P. Morgan’s chief U.S. equity strategist
I'll play devil's advocate. Assume that there is no risk behind the value premium. Assume it is all due to mispricing. Assume that the market has become more efficient. Assume that the mispricing is gone.

Under those assumptions, the spread between value and growth stocks is no longer relevant.

typical.investor
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Re: Small Value vs Multifactor

Post by typical.investor » Sat Jun 29, 2019 6:17 am

Park wrote:
Sat Jun 29, 2019 5:42 am
typical.investor wrote:
Fri Jun 28, 2019 10:55 pm
Park wrote:
Fri Jun 28, 2019 10:41 pm
vineviz wrote:
Fri Jun 28, 2019 8:51 am
However, even the most cynical counterargument against the persistence of factor premia would be be that they lose all of their explanatory power in the future. In that case, the excess factor returns should be zero and not negative. This would leave you with a single factor (market beta) and costs (i.e. alpha) as your inputs for expected return. And even in this extreme conspiracy theory environment, there may STILL be diversification benefits from owning funds with factor exposures that differ from the market.
Vineviz, wouldn't it be possible that if enough people bought small cap value, that the excess factors returns could be negative? Please correct me on that, as I sense you know more than me, although I may be damning you with faint praise :happy . And since I tilt in my portfolio, I hope you say I'm wrong.
There is certainly no indication of that now.

“value is currently trading at the biggest discount ever, and offers the largest premium over the last 30 years.” -J.P. Morgan’s chief U.S. equity strategist
I'll play devil's advocate. Assume that there is no risk behind the value premium. Assume it is all due to mispricing. Assume that the market has become more efficient. Assume that the mispricing is gone.

Under those assumptions, the spread between value and growth stocks is no longer relevant.
First, in that situation I wouldn't expect a negative premium which is what you asked about. I'd expect zero premium as vineviz mentioned.

Second, even those conditions may not be sufficient to ensure no premium. Value stocks returns are negatively skewed with more kurtosis. Most investors don't like those things and will avoid value stocks even if it costs them a premium to do so. That's not mispricing. That's investors with an s-shaped utility function making choices that best satisfy themselves, and you earning that premium for holding the stocks other people avoid.

There is also research showing part of the value premium is from value investors abandoning their portfolio when value struggles. Is that risk or mis-pricing or people just being sick and tired of their holdings not doing as well as alternatives (impatience/doubt)?

To me the question isn't if value will offer a premium, it's whether or not I will see a premium in my holding period. No guarantees of course, but I will take the chance.

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Re: Small Value vs Multifactor

Post by Call_Me_Op » Sat Jun 29, 2019 6:48 am

Park wrote:
Sat Jun 22, 2019 10:18 am
A stock, or stocks in general, can be underpriced or overpriced. Eventually, the market gets it right.
Overpriced or underpriced with respect to what? The market price is the best estimate we have of market value at any point in time. Just because a stock tanks today does not mean it was "over-priced" (or "wrong") yesterday.

If you state that the "true" value is the "instrinsic value," I will ask which one. There are many formulas for intrinsic value.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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