Taylor Larimore wrote: ↑
Thu Jun 27, 2019 11:28 am
Factor investors are having a difficult time. Small-cap value (factor) funds are heavily promoted by the fund industry as a way to increase portfolio returns. Nevertheless, small cap value funds have the worst
5-year returns of all Morningstar style categories.
Index Performance Return
Rob Arnott (Godfather of smart beta), and three other researchers, have written about their long-term study of "factors." You can read the study HERE
. This is the Abstract
Factor investing has failed to live up to its many promises. Its success is compromised by three problems that are often underappreciated by investors. First, many investors develop exaggerated expectations about factor performance as a result of data mining, crowding, unrealistic trading cost expectations, and other concerns. Second, for investors using naive risk management tools, factor returns can experience downside shocks far larger than would be expected. Finally, investors are often led to believe their factor portfolio is diversified. Diversification can vanish, however, in certain economic conditions, when factor returns become much more correlated. Factor investing is a powerful tool, but understanding the risks involved is essential before adopting this investment framework.
The Three-Fund Portfolio
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."
Taylor, the S&P 500 had negative returns through much of the 2000's, in fact the index was flat from 2000-2012. I am sure that the S&P 500 Indexes would have made the worst performance lists depending upon when you looked. The thing is, Bogleheads of all people, should know that these secular bear markets happen. We have had a few that I can think of: 1929-1946, 1968-1984, 2000-2012. Flat markets with bear markets in between.
So to say that Small/Value stinks because it trails other stock categories over 5 years is just silly, quite frankly, you ought to know better. The S&P 500 had a few really bad years during the 2000's, should I have concluded that index investing doesn't work? Should I have told people to sell their S&P 500 and Total Stock Market funds? Having International Stocks and tilts towards such things as REITs, Mid/Small-Cap, and Value was not such a bad idea. Value just crushed the S&P 500 from about 2000-2007.
Actually, I recently compared Large Value, Large Growth, Small Value, Small Growth with the S&P 500 using Vanguard indexes over a 10 year period, the time period since the 2008-2009 financial crisis. The S&P 500 underperformed all of them except for Large Value. Would I have said that the S&P 500 didn't "work" over that 10 year period? Did I ever advocate that people sell their S&P 500 funds?
I agree with another poster, Taylor acts like he has a big short on Small Value. He just cranks out post after post every time a factors thread pops up. I also have pointed out the Total Market and S&P 500 Indexes are top heavy with High Tech and Internet, these sectors have been driving the performance of the broad indexes. If Value starts outperforming the indexes again, should I chase Taylor all over the forum and tell him that indexing doesn't work anymore? This is just simply recency bias.
Taylor and his 3 fund portfolio actually has a sizable tilt towards High Tech/Internet just as it had in the late 1990's. He is tilted Large Growth, High Tech/Internet, and the FAANG stocks but won't admit to it. Pretty much High Tech/Internet/FAANG is the sole reason that factors don't "work" anymore.
Value has actually performed fairly well, it is that it hasn't performed as well as the broad S&P 500 and Total Market Indexes. Foggy memory recalls Value Index returned 14% a year compared to the S&P 500 returning 15% a year compared to 16% a year for the Growth Index over 10 years. These things happen, Value and Growth have taken turns leading the market.
I will stick to the advice I have always given here. Factor tilt if you believe in the Academic Research or use a simpler 3-4 fund Index strategy if you do not. Simple as that. I never have said that the 3 fund portfolio doesn't work and I have never said that it isn't a good portfolio. There are good reasons why some folks around here factor tilt. Also want to point out that it doesn't take complex portfolios to do so, I recently showed someone how to Small/Value tilt with 4 funds.
Arnott called factors a powerful tool but also warned investors to be aware of the risks. He also discussed in the short paragraph that in crisis correlations tend to go to 1. Factors would have helped a lot from 2000-2002 but didn't help in 2008-2009. Nothing works all the time and I have posted on these topics pretty extensively.
A fool and his money are good for business.