Why factor investing isn't working

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CULater
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Why factor investing isn't working

Post by CULater » Sat Jul 06, 2019 11:55 am

Asset owners have increasingly incorporated factor-based funds into their portfolios in an attempt to earn equity premiums at a low cost. But they are ending up bearing currency, country, sector, and other risks that are going uncompensated.

... there are decades of academic research that offers evidence that a handful of factors can generate higher risk-adjusted returns than the market. However, this research “doesn’t tell you how to extract that premium in the best possible manner,” he said. “No way.”
Yogi Berra said "In theory there's no difference between theory and practice, but in practice there is." Is this the case with factor investing?

https://www.institutionalinvestor.com/a ... -t-Working
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Re: Why factor investing isn't working

Post by larryswedroe » Sat Jul 06, 2019 1:04 pm

What the article emphasizes is that the implementation has been horrible.
Cannot blame the tools if fools are using them in wrong way.
Larry

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Re: Why factor investing isn't working

Post by DecumulatorDoc » Sat Jul 06, 2019 1:10 pm

CULater wrote:
Sat Jul 06, 2019 11:55 am
Asset owners have increasingly incorporated factor-based funds into their portfolios in an attempt to earn equity premiums at a low cost. But they are ending up bearing currency, country, sector, and other risks that are going uncompensated.

... there are decades of academic research that offers evidence that a handful of factors can generate higher risk-adjusted returns than the market. However, this research “doesn’t tell you how to extract that premium in the best possible manner,” he said. “No way.”
Yogi Berra said "In theory there's no difference between theory and practice, but in practice there is." Is this the case with factor investing?

https://www.institutionalinvestor.com/a ... -t-Working
Another Yogi-ism may work equally well regarding factor investing, at least based on many posts here recently:

“Nobody ever goes there anymore — it’s too crowded.”

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nedsaid
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Re: Why factor investing isn't working

Post by nedsaid » Sat Jul 06, 2019 1:11 pm

Presumably, the pension funds and endowments ought to be able to hire experts that would tell them how to tilt the portfolios properly. If the experts are fools then it calls into question the ability of individuals to do this for themselves. You not only need to right factor products, but you need the right experts to tell you which factor products are the right ones.

My "wrong" Vanguard Small-Cap Value Index ETF has been outperforming the "right" DFA Small-Value product. Not surprising in a Large Cap Growth environment and also not surprising in that Vanguard tends to have larger market caps and less value loading than DFA.
A fool and his money are good for business.

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patrick013
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Re: Why factor investing isn't working

Post by patrick013 » Sat Jul 06, 2019 1:18 pm

Well it's nice they have so many loads. Some use 3 others as many as 7 possible loads.
Bound to get confusing. The article mentions 21 factor strategies.

Simplifying a bit...if I have total returns for 20 or 30 years and post a TR/SD ratio for each factor looked at isn't that a hit or miss regarding compensated risk ? It's an interesting metric. Some metrics are too complex others too simple. A ratio near or above 1 tells that volatility is clearly on the positive side. Rarely hear this metric used. Their factor efficiency ratio was mentioned but not explained in the article.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Why factor investing isn't working

Post by mcraepat9 » Sat Jul 06, 2019 2:33 pm

larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
What the article emphasizes is that the implementation has been horrible.
Cannot blame the tools if fools are using them in wrong way.
Larry
This is spot on.
Amateur investors are not cool-headed logicians.

heyyou
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Re: Why factor investing isn't working

Post by heyyou » Sat Jul 06, 2019 3:48 pm

Sounds like the better performance will return as soon as the shine is gone.
Are we surprised about cyclical returns and/or performance chasing in the stock markets? Careful study of history shows some evidence of a specific return, then greedy investors want to soon harvest the long term average of that return.
Stock market investing with its random, variable returns, just doesn't work that way.

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Re: Why factor investing isn't working

Post by willthrill81 » Sat Jul 06, 2019 10:00 pm

CULater wrote:
Sat Jul 06, 2019 11:55 am
Asset owners have increasingly incorporated factor-based funds into their portfolios in an attempt to earn equity premiums at a low cost. But they are ending up bearing currency, country, sector, and other risks that are going uncompensated.

... there are decades of academic research that offers evidence that a handful of factors can generate higher risk-adjusted returns than the market. However, this research “doesn’t tell you how to extract that premium in the best possible manner,” he said. “No way.”
Yogi Berra said "In theory there's no difference between theory and practice, but in practice there is." Is this the case with factor investing?

https://www.institutionalinvestor.com/a ... -t-Working
When I compare the equity sides of the 3-fund portfolio to Merriman's ultimate buy-and-hold portfolio, which is tilted toward small and value, since 2001 (available data in Portfolio Visualizer), the latter has had a 1.29% higher return with almost identical volatility. That seems to have worked fine to me.

A lot of the recent opining about factors not working seems to be due to the outperformance of large-cap growth over the last decade.
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TropikThunder
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Re: Why factor investing isn't working

Post by TropikThunder » Sun Jul 07, 2019 2:19 am

Title should say “hasn’t been working”, not “isn’t working” since we can only see what has happened already, not what will continue to happen. OP should know better.

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FIREchief
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Re: Why factor investing isn't working

Post by FIREchief » Sun Jul 07, 2019 2:35 am

larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
Cannot blame the tools if fools are using them in wrong way.
Larry
Wow.... :oops:
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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nedsaid
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Re: Why factor investing isn't working

Post by nedsaid » Sun Jul 07, 2019 10:42 am

FIREchief wrote:
Sun Jul 07, 2019 2:35 am
larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
Cannot blame the tools if fools are using them in wrong way.
Larry
Wow.... :oops:
That was my reaction. See above.
A fool and his money are good for business.

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Re: Why factor investing isn't working

Post by Forester » Sun Jul 07, 2019 10:50 am

Hasn’t low vol & momentum outperformed in the 2010s? The other factors basically haven’t hurt. As others said, the way factors are implemented is often in a pedestrian way.

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Re: Why factor investing isn't working

Post by averagedude » Sun Jul 07, 2019 11:10 am

Tilting to factors, such as value, is a long term trade. It may take 20+ years to receive a higher return. There also is no guarantee that you will be rewarded for your patience to receive a premium from doing so. Sectors could play a larger role than people think. If financials and energy sectors struggle while technology and healthcare sectors continue their performance over the next several decades, investors who tilt to value will have lower rates of returns to show for it. I do tilt to value slightly, but im not betting the farm on it.

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Re: Why factor investing isn't working

Post by bertilak » Sun Jul 07, 2019 3:08 pm

FIREchief wrote:
Sun Jul 07, 2019 2:35 am
larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
Cannot blame the tools if fools are using them in wrong way.
Larry
Wow.... :oops:
Looking for the instruction manual...
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Re: Why factor investing isn't working

Post by nisiprius » Sun Jul 07, 2019 5:42 pm

From the article:
“The whole exercise of factor investing is delineating between the risks you get paid for and the risks those you don’t,” said Michael Hunstad, head of quantitative strategies at NTAM. “The challenge is you want to define the value, quality, or other factor in such a way that you get the good stuff and eliminate all the uncompensated risks. That’s really hard to do.”
That sounds amazingly like stock-picking.
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Re: Why factor investing isn't working

Post by stan1 » Sun Jul 07, 2019 5:47 pm

nisiprius wrote:
Sun Jul 07, 2019 5:42 pm
From the article:
“The whole exercise of factor investing is delineating between the risks you get paid for and the risks those you don’t,” said Michael Hunstad, head of quantitative strategies at NTAM. “The challenge is you want to define the value, quality, or other factor in such a way that you get the good stuff and eliminate all the uncompensated risks. That’s really hard to do.”
That sounds amazingly like stock-picking.
With momentum it probably is, but its one thing to pay 200 basis points for it (advisor fees plus expenses and maybe a load on top of that) vs 13 basis points for Vanguard's VFMO momentum ETF. So now the question becomes can stock picking beat the 10 basis point difference with Total Stock Market? I don't know, but its definitely easier than overcoming 197 basis points of headwind.

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Re: Why factor investing isn't working

Post by dumbmoney » Sun Jul 07, 2019 6:10 pm

CULater wrote:
Sat Jul 06, 2019 11:55 am
Asset owners have increasingly incorporated factor-based funds into their portfolios in an attempt to earn equity premiums at a low cost. But they are ending up bearing currency, country, sector, and other risks that are going uncompensated.

... there are decades of academic research that offers evidence that a handful of factors can generate higher risk-adjusted returns than the market. However, this research “doesn’t tell you how to extract that premium in the best possible manner,” he said. “No way.”
Yogi Berra said "In theory there's no difference between theory and practice, but in practice there is." Is this the case with factor investing?

https://www.institutionalinvestor.com/a ... -t-Working
It may not be obvious, but the "uncompensated risk" they're talking about isn't the risk of losing money. It's the risk of being different in a random way from some benchmark, and therefore having more to explain to your clients so they don't fire you when the random difference works to your disadvantage.
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Re: Why factor investing isn't working

Post by nedsaid » Sun Jul 07, 2019 6:15 pm

A big reason that factor investing doesn't seem to be working is that we have been in a Large Growth market since the 2008-2009 financial crisis and bear market. So the Small and Value factors have been trailing the broad market indexes. You would think this environment would favor Momentum and Quality but I can't really speak to that as my tilts are primarily Small/Value. I do own some aggressive growth funds from American Century that employ Earnings and Price Momentum techniques, I have noticed that their Large Growth funds (Ultra, Growth, Select) using this discipline have outperformed the S&P 500 by a bit over the last decade. Their Mid-Cap Growth fund (Heritage) which also uses Earnings and Price momentum has trailed the Mid-Cap Growth index over the last decade but has been on fire in 2019.

I did some checking, probably a month or two ago, looking at the Vanguard factor indexes. The Value Index did 14% a year, the S&P 500 did 15%, and the Growth Index did 16%. Small Value, Small Growth, and Large Growth all beat the S&P 500. The Value (Large Cap) Index was the only one of the four indexes that trailed the S&P 500. It appears to me that most of the problem is with Large Value. My portfolio has had a larger tilt with Large Value than with Small Value and that seems to be the biggest factor in my portfolio underperforming the 3 fund portfolio.

Some factor products are better than others. I have read comments that the iShares S&P 600 Small-Cap Value Index ETF loads on the Size and Value factors better than the Vanguard Small-Value Index ETF. The iShares product is more expensive that the Vanguard product, from memory the expense ratio is 0.25% for iShares compared to 0.10% for Vanguard. I own both and have been very satisfied with both.

Expense is another factor particularly if you go through an advisor. The folks at Merriman wanted a 1% Assets Under Management fee and the costs of the underlying DFA funds were 0.34%, making a total 1.34% expense ratio. The 1% seemed like a high hurdle. Also as I said above, some factor products are more expensive than others.

Larry's comments above were telling as you would expect that endowments and pension funds could hire the best factor consultants. Hiring experts obviously does not guarantee success.
A fool and his money are good for business.

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Re: Why factor investing isn't working

Post by larryswedroe » Sun Jul 07, 2019 6:22 pm

Nisi
The whole exercise of factor investing is delineating between the risks you get paid for and the risks those you don’t,” said Michael Hunstad, head of quantitative strategies at NTAM. “The challenge is you want to define the value, quality, or other factor in such a way that you get the good stuff and eliminate all the uncompensated risks. That’s really hard to do.”
That sounds amazingly like stock-picking.
Well depends on definition of stock-picking. I like no INDIVIDUAL stock selection.
So for example, in small caps you can buy all of them or use the knowledge from the historical evidence that certain small stocks perform poorly-IPOs, penny stocks, stocks in bankruptcy and small growth with high investment and low profitability.
Now you can either decide to be "pure" in theory and buy all small and suffer the lousy returns for sake of "religious" purity, or do as DFA has done for decades, and others as well, and exclude the stocks with those traits from eligible universe and don't buy them.

That's one example. There are also ways to minimize risk of value traps (screening for P/E and P/CF not just p/B).

Hope that is helpful
Larry

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Re: Why factor investing isn't working

Post by schooner » Mon Jul 08, 2019 1:33 pm

larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
What the article emphasizes is that the implementation has been horrible.
Cannot blame the tools if fools are using them in wrong way.
Larry
Mr. Swedroe, I respectfully disagree with your conclusion. I'd point to a factor portfolio you suggested in 2009 in Kiplinger Magazine:

https://www.kiplinger.com/article/inves ... olios.html

An ordinary investor who followed your advice over the next 10 years would have underperformed both the Vanguard 2020 Target Date Fund as well as a 60/40 passive index. The investor also would have experienced lower risk-adjusted returns and larger max draw-down.

The result:
https://www.portfoliovisualizer.com/bac ... total3=100

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Re: Why factor investing isn't working

Post by larryswedroe » Mon Jul 08, 2019 4:28 pm

Schooner
Feel free to disagree, But there are problems with the analysis in that first it is short term and second not apples to apples as holdings are different in terms of allocations and even on bond side. And of course that would not be the funds I would have recommended anyway but was limited by Kiplinger to those available to general public so I chose to stick with low cost Vanguard funds.

But here are the facts, returns since inception of the major DFA "factor based" funds, through June 2019. So much longer time frames and apples to apples in that compares the factor fund to the total market fund. Note the period of inception of all is either before or right around the time my first book was published in 1998.

DFSVX (3/93) vs VTSMX 10.9 vs. 9.5
DFUVX (3/95) vs VSTMX 10.4 vs. 9.7
DFSCX 11.3 vs. 9.6 (5/92)
DFIVX 5.4 (9/99) vs. VTMGX 4.0
DFISX 7.9 (9/99) vs VTMGX 4.0
DISVX 8.5 (9/99) vs. VTMGX 4.0
DFEVX (4/98) 9.7 vs. VEIEX 6.8 (4/98)
DEMSX (4/98) 10.5 vs VEIEX 6.8


So we have 8 examples of live factor funds and basically at least 20 years of data and in each case the factor fund produced higher returns ranging from 0.7 percent to as much as 4.5 percent. The average outperformance of the 8 was 2.5 percent. Surely even you would agree that is not horrible (:-))
What is interesting is that not a single diehard who espouses the simple three fund portfolio has even acknowledge this outperformance. At least to my knowledge. They just tout the benefits of the three fund portfolio (which I agree with of course). Just noting IMO there is another way to consider building portfolios which historically has been more efficient.

I would add that even in last 10 years the factor based funds have outperformed internationally, though not domestically. Of course all strategies are likely to underperform for some periods as TSM has done, underperforming totally riskless tbills from 29-42, 66-81 and 2000-12. Those three periods are almost half the 90 years since 1929. Yet not one diehard talks about that fact or that concentration risk. On other hand don't think you can find such long periods for value stocks.

Best wishes
Larry

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Re: Why factor investing isn't working

Post by 9-5 Suited » Mon Jul 08, 2019 4:46 pm

The implementation challenge of getting small and value exposure without undesirable exposures coming along for the ride is a real one. Take international value investing as example. Assuming an investor wants to keep ERs below 50 basis points, you've got a handful of choices:

- EFV (significantly overweight in financials)
- IVLU (significantly overweight in Japan)
- FNDF (overweight in Japan, bad factor loading on pure F/F model)

There are a few others that are either active funds or have higher ERs that solve some issues, but nevertheless it is a challenge for many retail investors who prefer low-cost, DIY portfolios.

Same kind of thing can come up on domestic side ... VBR has too many mid caps, etc.

This isn't a knock on the theory behind factor investing (I tilt fairly heavily to small and value globally), just a first hand observation that the OP has identified a meaningful challenge that many will face.

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Re: Why factor investing isn't working

Post by larryswedroe » Mon Jul 08, 2019 5:55 pm

9-5
Just noting that value funds (unless made sector neutral) have always "overweighted" whatever sector had done poorly recently. IN past it had been things like autos for example. that's just the nature of value investing
Larry

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 6:48 am

larryswedroe wrote:
Mon Jul 08, 2019 4:28 pm
Schooner
Feel free to disagree, But there are problems with the analysis in that first it is short term and second not apples to apples as holdings are different in terms of allocations and even on bond side. And of course that would not be the funds I would have recommended anyway but was limited by Kiplinger to those available to general public so I chose to stick with low cost Vanguard funds.

But here are the facts, returns since inception of the major DFA "factor based" funds, through June 2019. So much longer time frames and apples to apples in that compares the factor fund to the total market fund. Note the period of inception of all is either before or right around the time my first book was published in 1998.

DFSVX (3/93) vs VTSMX 10.9 vs. 9.5
DFUVX (3/95) vs VSTMX 10.4 vs. 9.7
DFSCX 11.3 vs. 9.6 (5/92)
DFIVX 5.4 (9/99) vs. VTMGX 4.0
DFISX 7.9 (9/99) vs VTMGX 4.0
DISVX 8.5 (9/99) vs. VTMGX 4.0
DFEVX (4/98) 9.7 vs. VEIEX 6.8 (4/98)
DEMSX (4/98) 10.5 vs VEIEX 6.8


So we have 8 examples of live factor funds and basically at least 20 years of data and in each case the factor fund produced higher returns ranging from 0.7 percent to as much as 4.5 percent. The average outperformance of the 8 was 2.5 percent. Surely even you would agree that is not horrible (:-))
What is interesting is that not a single diehard who espouses the simple three fund portfolio has even acknowledge this outperformance. At least to my knowledge. They just tout the benefits of the three fund portfolio (which I agree with of course). Just noting IMO there is another way to consider building portfolios which historically has been more efficient.

I would add that even in last 10 years the factor based funds have outperformed internationally, though not domestically. Of course all strategies are likely to underperform for some periods as TSM has done, underperforming totally riskless tbills from 29-42, 66-81 and 2000-12. Those three periods are almost half the 90 years since 1929. Yet not one diehard talks about that fact or that concentration risk. On other hand don't think you can find such long periods for value stocks.

Best wishes
Larry
Mr. Swedroe,

You published your advice in Kiplinger Magazine - which is geared towards folks near retirement age. I’d argue that 10 years is long term.

I am simply measuring your performance based on an actual recommendation you made in the past.

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Re: Why factor investing isn't working

Post by larryswedroe » Tue Jul 09, 2019 7:38 am

Schooner
But you miss the point, that
a) first 10 years is not a long time at all, that's one of the most common and worst mistakes investors make. 10 years with risky assets is just NOISE. Again I point out for you that the US TSM underperformed totally riskless Treasury bills (not underperformed value or small stocks, but riskless tbills) for three periods longer than 10 years. Do you decide TSM is a bad strategy or investing in stocks is bad strategy after each of those periods? I would hope not. But that is the problem with your line of thinking. 10 years is noise. If you don't think so then you would have abandoned TSM in each of those three periods.

B) As I showed over the much longer period in every single case the funds I have actually been recommending (not had to contrive to recommend) have outperformed TSM in each of the three markets, US, international and EM.

C) Also making the mistake of confusing strategy with outcome. The fact that it might have slightly underperformed over the period does not mean the strategy was wrong, just that the risks happened to show up. When stocks collapse do you believe investing in stocks was the wrong strategy? Investing is about putting odds in your favor and historically diversifying risks has led to more efficient outcomes. You have one period here that isn't even very long. There were others like it. But there were also far longer periods where TSM underperformed and by MUCH LARGER margins.

Now I would still recommend that same type portfolio as it at least provides some diversification of the sources of risk for those who insist on using Vanguard --though I cannot understand why anyone would limit the fund manager if there are superior alternatives.

The failure of investors to understand that 10 years with risky assets is just likely noise is why so many underperform the very funds they invest in. And it is also why diversification is hard and why so few are good at it.

One more very important thing. The higher returns (expected and realized) of the factor based returns over the 20+ year period allowed investors to hold less equity risk as the equities they held had higher expected returns. That allowed them to hold more safe bonds, and that dramatically cut the tail risks in 2000-02 and again in 2007-08, helping reduce sequence risk and allowing investors to sleep better, enjoying their lives, and stay disciplined, less likely to abandon their strategy, and also more likely to rebalance and buy stocks in down markets. TSM requires one to hold more equity risk and thus even more concentrated risk in market beta.

BTW, I note that you completely ignored the fact that the factor based funds have significantly outperformed over the longer term, not even acknowledging it. As Sherlock Holmes would say, it's the dog that didn't bark.

Best wishes



Larry

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 8:22 am

larryswedroe wrote:
Tue Jul 09, 2019 7:38 am
Schooner
But you miss the point, that
a) first 10 years is not a long time at all, that's one of the most common and worst mistakes investors make. 10 years with risky assets is just NOISE. Again I point out for you that the US TSM underperformed totally riskless Treasury bills (not underperformed value or small stocks, but riskless tbills) for three periods longer than 10 years. Do you decide TSM is a bad strategy or investing in stocks is bad strategy after each of those periods? I would hope not. But that is the problem with your line of thinking. 10 years is noise. If you don't think so then you would have abandoned TSM in each of those three periods.

B) As I showed over the much longer period in every single case the funds I have actually been recommending (not had to contrive to recommend) have outperformed TSM in each of the three markets, US, international and EM.

C) Also making the mistake of confusing strategy with outcome. The fact that it might have slightly underperformed over the period does not mean the strategy was wrong, just that the risks happened to show up. When stocks collapse do you believe investing in stocks was the wrong strategy? Investing is about putting odds in your favor and historically diversifying risks has led to more efficient outcomes. You have one period here that isn't even very long. There were others like it. But there were also far longer periods where TSM underperformed and by MUCH LARGER margins.

Now I would still recommend that same type portfolio as it at least provides some diversification of the sources of risk for those who insist on using Vanguard --though I cannot understand why anyone would limit the fund manager if there are superior alternatives.

The failure of investors to understand that 10 years with risky assets is just likely noise is why so many underperform the very funds they invest in. And it is also why diversification is hard and why so few are good at it.

One more very important thing. The higher returns (expected and realized) of the factor based returns over the 20+ year period allowed investors to hold less equity risk as the equities they held had higher expected returns. That allowed them to hold more safe bonds, and that dramatically cut the tail risks in 2000-02 and again in 2007-08, helping reduce sequence risk and allowing investors to sleep better, enjoying their lives, and stay disciplined, less likely to abandon their strategy, and also more likely to rebalance and buy stocks in down markets. TSM requires one to hold more equity risk and thus even more concentrated risk in market beta.

BTW, I note that you completely ignored the fact that the factor based funds have significantly outperformed over the longer term, not even acknowledging it. As Sherlock Holmes would say, it's the dog that didn't bark.

Best wishes



Larry
Mr. Swedroe,

I am not comparing your recommendation to TSM. Your recommendation was a 60/40 with a factor tilt toward small cap value.

I showed how this recommendation had a lower return and higher draw down compared to a market cap 60/40 and a Vanguard 2020 (which was a 60/40 w international).

Again, this is a recommendation you made in Kiplingers, which has a less sophisticated audience. Should older folks be playing around w factors like this in a retirement account?

I’m not sure what is more Apples to Apples.

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Re: Why factor investing isn't working

Post by marcopolo » Tue Jul 09, 2019 8:36 am

nedsaid wrote:
Sun Jul 07, 2019 6:15 pm

Larry's comments above were telling as you would expect that endowments and pension funds could hire the best factor consultants. Hiring experts obviously does not guarantee success.
Well, presumably they hired "fools". Although, it was not clear to me if it is the endowments and pension funds that are the "fools", or the experts they hired that were the "fools".

It is also not clear to me how us mere mortals are supposed to differentiate between the "fools" and the more enlightened money managers that will overcome their fees when making such selections.
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Re: Why factor investing isn't working

Post by nisiprius » Tue Jul 09, 2019 8:44 am

schooner wrote:
Tue Jul 09, 2019 8:22 am
larryswedroe wrote:
Tue Jul 09, 2019 7:38 am
...a) first 10 years is not a long time at all, that's one of the most common and worst mistakes investors make. 10 years with risky assets is just NOISE...
...Mr. Swedroe, You published your advice in Kiplinger Magazine - which is geared towards folks near retirement age. I’d argue that 10 years is long term.
Almost everyone, including me, tends to be selectively inconsistent about appealing to long-term or short-term results, depending on which favors their argument. In 2013, in Buiding your own hedge fund, Larry Swedroe sharply criticized four funds, none more than four years old, saying
We don't yet have much data, as the funds are fairly new. Still, it's worth taking a look to see how they have performed since inception. In other words, we'll hold them accountable.
So, sometimes short-term performance is "worth taking a look at," and sometimes it is even appropriate to "hold them accountable" for short-term performance.

(Just the record, the actual funds he was looking at were Natixis ASG Global Alternatives Fund (GAFAX), IQ Alpha Hedge Strategy Fund (IQHOX), AQR Multi-Strategy Alternatives Fund (ASAIX), Ramius Dynamic Replication Fund (RDRIX). I'm not sure what's happened to the Ramius fund. The others, now with ten years of data behind them, have continued to justify Larry Swedroe's low opinion of them. But perhaps the managers of these funds would say that the first 10 years is not a long time at all.)

Morningstar growth chart for GAFAX, IQHOX, ASAIX, and Vanguard Balanced Index (VBINX) for comparison
Last edited by nisiprius on Tue Jul 09, 2019 9:11 am, edited 1 time in total.
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Re: Why factor investing isn't working

Post by larryswedroe » Tue Jul 09, 2019 8:50 am

Schooner, TSM is the portfolio you are comparing it to, just global TSM. And why compare to a target date fund anyway, one that is changing allocations over time. That's certainly not appropriate. But again, 10 years is NOISE and thinking otherwise and making decisions based on that leads to bad conclusions and poor investor outcomes.

Also as I have explained, for retirees the risks of TSM vs tilted are even worse, the thinking is exactly backward because sequence risk increases. And sequence risk increases with concentration in any factor or asset class. Diversification reduces sequence risk, it's that simple. Just think if you were retiree in 1929, 1966 or 2000 and your entire equity portfolio underperforms for at least 12 years totally riskless tbills, and suffers dramatic drawdowns at the worst time, drawdowns that would have been reduced with a portfolio with lower equity allocation allowed by the equities you do hold having higher expected returns.

As Taleb noted, only fools judge strategies solely by outcomes without considering what alternative universes might have shown up. Diversifying is like buying insurance. Sometimes the insurance doesn't pay off (you don't die, but don't complain about it or think it was wrong to buy the insurance). The insurance is against having all your eggs in one wrong basket.

I suggest you try reading Reducing the Risk of Black Swans

Best wishes
Larry

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Re: Why factor investing isn't working

Post by larryswedroe » Tue Jul 09, 2019 8:55 am

Marco
FWIW, I've met with many pension plans and they do many dumb things. Even seen one hold both R1k fund and R2k fund, which makes no sense as they are inefficient relative to a R3k fund which doesn't have the turnover. But they were "filling in the style boxes"
Larry

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Re: Why factor investing isn't working

Post by larryswedroe » Tue Jul 09, 2019 9:00 am

Nisi,
Very different as those were HEDGE funds (not systematic factor based funds and much higher fees), not the type of funds we are talking about. And also as you did state, I noted it was only four years so not a long time.
Larry

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 9:01 am

nisiprius wrote:
Tue Jul 09, 2019 8:44 am
schooner wrote:
Tue Jul 09, 2019 8:22 am
larryswedroe wrote:
Tue Jul 09, 2019 7:38 am
...a) first 10 years is not a long time at all, that's one of the most common and worst mistakes investors make. 10 years with risky assets is just NOISE...
...Mr. Swedroe, You published your advice in Kiplinger Magazine - which is geared towards folks near retirement age. I’d argue that 10 years is long term. I am simply measuring your performance based on an actual recommendation you made in the
past... Your recommendation was a 60/40 with a factor tilt toward small cap value. I showed how this recommendation had a lower return and higher draw down compared to a market cap 60/40 and a Vanguard 2020 (which was a 60/40 w international).
Almost everyone tends to be selectively inconsistent about appealing to long-term or short-term results, depending on which favors their argument. In 2013, in Buiding your own hedge fund, Larry Swedroe sharply criticized four funds, none more than four years old, saying
We don't yet have much data, as the funds are fairly new. Still, it's worth taking a look to see how they have performed since inception. In other words, we'll hold them accountable.
So, sometimes short-term performance is "worth taking a look at," and sometimes it is even appropriate to "hold them accountable" for short-term performance.

(Just the record, the actual funds he was looking at were Natixis ASG Global Alternatives Fund (GAFAX), IQ Alpha Hedge Strategy Fund (IQHOX), AQR Multi-Strategy Alternatives Fund (ASAIX), Ramius Dynamic Replication Fund (RDRIX). I'm not sure what's happened to the Ramius fund. The others, now with ten years of data behind them, have continued to justify Larry Swedroe's low opinion of them. But perhaps the managers of these funds would say that the first 10 years is not a long time at all.)

Morningstar growth chart for GAFAX, IQHOX, ASAIX, and Vanguard Balanced Index (VBINX) for comparison
We can play around with white papers and counter factuals all day.

I’m just comparing an actual recommendation with actual results.

“It’s tough to make predictions, especially about the future.”

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 9:16 am

larryswedroe wrote:
Tue Jul 09, 2019 8:50 am
Schooner, TSM is the portfolio you are comparing it to, just global TSM. And why compare to a target date fund anyway, one that is changing allocations over time. That's certainly not appropriate. But again, 10 years is NOISE and thinking otherwise and making decisions based on that leads to bad conclusions and poor investor outcomes.

Also as I have explained, for retirees the risks of TSM vs tilted are even worse, the thinking is exactly backward because sequence risk increases. And sequence risk increases with concentration in any factor or asset class. Diversification reduces sequence risk, it's that simple. Just think if you were retiree in 1929, 1966 or 2000 and your entire equity portfolio underperforms for at least 12 years totally riskless tbills, and suffers dramatic drawdowns at the worst time, drawdowns that would have been reduced with a portfolio with lower equity allocation allowed by the equities you do hold having higher expected returns.

As Taleb noted, only fools judge strategies solely by outcomes without considering what alternative universes might have shown up. Diversifying is like buying insurance. Sometimes the insurance doesn't pay off (you don't die, but don't complain about it or think it was wrong to buy the insurance). The insurance is against having all your eggs in one wrong basket.

I suggest you try reading Reducing the Risk of Black Swans

Best wishes
Larry
I’m not a professional but sometimes “long term” seems to be defined as “long enough for everyone to forget what I said.”

I know that is a snide comment but you made this recommendation when ordinary people were really hurting back in January 2009 and looking for sound, safe guidance.

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Re: Why factor investing isn't working

Post by marcopolo » Tue Jul 09, 2019 9:21 am

larryswedroe wrote:
Tue Jul 09, 2019 8:55 am
Marco
FWIW, I've met with many pension plans and they do many dumb things. Even seen one hold both R1k fund and R2k fund, which makes no sense as they are inefficient relative to a R3k fund which doesn't have the turnover. But they were "filling in the style boxes"
Larry
I don't doubt that at all. But, we are not talking about individual anecdotal mistakes here. The NTAM report the article references supposedly looked at 500 institutional portfolios. So, there seems to be a larger systemic problem with the implementation (i am not arguing the benefits in theory). Either most of them are "fools", hiring "fools", or there is a deeper problem in actually reaping the benefits that seem to be there in theory.

My real point is, if the vast majority of institutional investors, with their resources, can't get this right, how are us mere mortals supposed to reap the benefits, rather than just be stuck paying higher fees for uncompensated risks?
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Re: Why factor investing isn't working

Post by rascott » Tue Jul 09, 2019 9:36 am

schooner wrote:
Mon Jul 08, 2019 1:33 pm
larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
What the article emphasizes is that the implementation has been horrible.
Cannot blame the tools if fools are using them in wrong way.
Larry
Mr. Swedroe, I respectfully disagree with your conclusion. I'd point to a factor portfolio you suggested in 2009 in Kiplinger Magazine:

https://www.kiplinger.com/article/inves ... olios.html

An ordinary investor who followed your advice over the next 10 years would have underperformed both the Vanguard 2020 Target Date Fund as well as a 60/40 passive index. The investor also would have experienced lower risk-adjusted returns and larger max draw-down.

The result:
https://www.portfoliovisualizer.com/bac ... total3=100


Larry's equity portfolio is 50% international. Could have something to do with it.

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 9:43 am

rascott wrote:
Tue Jul 09, 2019 9:36 am
schooner wrote:
Mon Jul 08, 2019 1:33 pm
larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
What the article emphasizes is that the implementation has been horrible.
Cannot blame the tools if fools are using them in wrong way.
Larry
Mr. Swedroe, I respectfully disagree with your conclusion. I'd point to a factor portfolio you suggested in 2009 in Kiplinger Magazine:

https://www.kiplinger.com/article/inves ... olios.html

An ordinary investor who followed your advice over the next 10 years would have underperformed both the Vanguard 2020 Target Date Fund as well as a 60/40 passive index. The investor also would have experienced lower risk-adjusted returns and larger max draw-down.

The result:
https://www.portfoliovisualizer.com/bac ... total3=100


Sigh.... it's quite clear why it underperformed.....Larry's equity portfoio is 50% international. While your other comparisons are not.
His recommendation was 30% international. Similar to the Vanguard 2020 at the time.

His underperformance came from the factor tilt. And the reason it didn’t blow up was because these tilts still hug the index, just like Bogle observed...just with higher fees

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Re: Why factor investing isn't working

Post by White Coat Investor » Tue Jul 09, 2019 9:56 am

Lots of shaking out of people who can't stay the course with their tilts this year. In 30 years we'll know if bailing out now was the right move or not. I think it probably isn't, but don't know for sure. What we do know is that even if the tilts work out, lots of people will bail out due to tracking error in times like these and those folks should never have tilted in the first place.

Same thing with an aggressive AA in a market downturn.
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Re: Why factor investing isn't working

Post by 9-5 Suited » Tue Jul 09, 2019 10:00 am

This debate is like baseball trades. Two teams with different objectives and evaluations exchange players, and fans look to immediate subsequent performance to judge the success of the trade. It doesn't make for very interesting conversation, but the subsequent performance has little to do with anything - the trade was wise or not the moment it was made based on best available information. It's just hard to undo the mental wiring of judging success by outcome.

On this topic, no amount of recent return data is going to persuade the other side to change minds. Of this much I'm sure. And that's as it should be.

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 10:01 am

White Coat Investor wrote:
Tue Jul 09, 2019 9:56 am
Lots of shaking out of people who can't stay the course with their tilts this year. In 30 years we'll know if bailing out now was the right move or not. I think it probably isn't, but don't know for sure. What we do know is that even if the tilts work out, lots of people will bail out due to tracking error in times like these and those folks should never have tilted in the first place.

Same thing with an aggressive AA in a market downturn.
The problem with investing is it’s second order chaos. Unlike the weather, prediction is a variable of results.

There may have been a small factor advantage, but the fact that people are chasing it will make it go away.

The only guarantee is higher fees

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Re: Why factor investing isn't working

Post by willthrill81 » Tue Jul 09, 2019 10:07 am

White Coat Investor wrote:
Tue Jul 09, 2019 9:56 am
Lots of shaking out of people who can't stay the course with their tilts this year. In 30 years we'll know if bailing out now was the right move or not. I think it probably isn't, but don't know for sure. What we do know is that even if the tilts work out, lots of people will bail out due to tracking error in times like these and those folks should never have tilted in the first place.
I entirely agree, and I'm on record saying that all of the people declaring the death of the SCV premium, for instance, probably means that it will begin outperforming in the near future.
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Re: Why factor investing isn't working

Post by vineviz » Tue Jul 09, 2019 10:09 am

schooner wrote:
Tue Jul 09, 2019 8:22 am
Again, this is a recommendation you made in Kiplingers, which has a less sophisticated audience. Should older folks be playing around w factors like this in a retirement account?
No investor should be "playing around w(ith) factors" but ALL investors can benefit from diversifying across multiple factors, especially retirees.
"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: Why factor investing isn't working

Post by rascott » Tue Jul 09, 2019 10:10 am

schooner wrote:
Tue Jul 09, 2019 9:43 am
rascott wrote:
Tue Jul 09, 2019 9:36 am
schooner wrote:
Mon Jul 08, 2019 1:33 pm
larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
What the article emphasizes is that the implementation has been horrible.
Cannot blame the tools if fools are using them in wrong way.
Larry
Mr. Swedroe, I respectfully disagree with your conclusion. I'd point to a factor portfolio you suggested in 2009 in Kiplinger Magazine:

https://www.kiplinger.com/article/inves ... olios.html

An ordinary investor who followed your advice over the next 10 years would have underperformed both the Vanguard 2020 Target Date Fund as well as a 60/40 passive index. The investor also would have experienced lower risk-adjusted returns and larger max draw-down.

The result:
https://www.portfoliovisualizer.com/bac ... total3=100


Sigh.... it's quite clear why it underperformed.....Larry's equity portfoio is 50% international. While your other comparisons are not.
His recommendation was 30% international. Similar to the Vanguard 2020 at the time.

His underperformance came from the factor tilt. And the reason it didn’t blow up was because these tilts still hug the index, just like Bogle observed...just with higher fees


The portfolio you linked to on Kiplingers is 30% US equity, 30% intl equity, 40% bonds. That is a 50/50 equity split. Then you compared it to a 100% SP500 equity portfolio. Definitely not apples to apples.

SLYV (SP600 small cap value index) returned 17.6% CAGR March 2009-March 2019.

TSMI (VTSMX) returned 16.74% for the same period.

It wasn't the SCV tilt that caused the underperformance.

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 10:12 am

willthrill81 wrote:
Tue Jul 09, 2019 10:07 am
White Coat Investor wrote:
Tue Jul 09, 2019 9:56 am
Lots of shaking out of people who can't stay the course with their tilts this year. In 30 years we'll know if bailing out now was the right move or not. I think it probably isn't, but don't know for sure. What we do know is that even if the tilts work out, lots of people will bail out due to tracking error in times like these and those folks should never have tilted in the first place.
I entirely agree, and I'm on record saying that all of the people declaring the death of the SCV premium, for instance, probably means that it will begin outperforming in the near future.
That may be true, but it’s also possible the underlying data for the Fama French model is not representative.

If 10 years of data cannot be reliable, what makes 100 years reliable?

The problem is we’ve wrapped a very unscientific profession in the cloak of scientific language. It gives pure guesses the certitude of physical theories such as gravity.

And it is a disservice to ordinary folks, imho

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 10:16 am

vineviz wrote:
Tue Jul 09, 2019 10:09 am
schooner wrote:
Tue Jul 09, 2019 8:22 am
Again, this is a recommendation you made in Kiplingers, which has a less sophisticated audience. Should older folks be playing around w factors like this in a retirement account?
No investor should be "playing around w(ith) factors" but ALL investors can benefit from diversifying across multiple factors, especially retirees.
I agree! It’s called a market-cap weighted index. I think Bogle talked a lot about it and how it could benefit ordinary investors by exploiting price discovery and lowering fees.
Last edited by schooner on Tue Jul 09, 2019 10:19 am, edited 1 time in total.

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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 10:18 am

rascott wrote:
Tue Jul 09, 2019 10:10 am
schooner wrote:
Tue Jul 09, 2019 9:43 am
rascott wrote:
Tue Jul 09, 2019 9:36 am
schooner wrote:
Mon Jul 08, 2019 1:33 pm
larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
What the article emphasizes is that the implementation has been horrible.
Cannot blame the tools if fools are using them in wrong way.
Larry
Mr. Swedroe, I respectfully disagree with your conclusion. I'd point to a factor portfolio you suggested in 2009 in Kiplinger Magazine:

https://www.kiplinger.com/article/inves ... olios.html

An ordinary investor who followed your advice over the next 10 years would have underperformed both the Vanguard 2020 Target Date Fund as well as a 60/40 passive index. The investor also would have experienced lower risk-adjusted returns and larger max draw-down.

The result:
https://www.portfoliovisualizer.com/bac ... total3=100


Sigh.... it's quite clear why it underperformed.....Larry's equity portfoio is 50% international. While your other comparisons are not.
His recommendation was 30% international. Similar to the Vanguard 2020 at the time.

His underperformance came from the factor tilt. And the reason it didn’t blow up was because these tilts still hug the index, just like Bogle observed...just with higher fees


The portfolio you linked to on Kiplingers is 30% US equity, 30% intl equity, 40% bonds. That is a 50/50 equity split. Then you compared it to a 100% SP500 equity portfolio. Definitely not apples to apples.

SLYV (SP600 small cap value index) returned 17.6% CAGR March 2009-March 2019.

TSMI (VTSMX) returned 16.74% for the same period.

It wasn't the SCV tilt that caused the underperformance.
And I compared it to the Vanguard 2020 fund, which has a substantially similar international allocation

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Re: Why factor investing isn't working

Post by vineviz » Tue Jul 09, 2019 10:19 am

schooner wrote:
Tue Jul 09, 2019 10:16 am
vineviz wrote:
Tue Jul 09, 2019 10:09 am
schooner wrote:
Tue Jul 09, 2019 8:22 am
Again, this is a recommendation you made in Kiplingers, which has a less sophisticated audience. Should older folks be playing around w factors like this in a retirement account?
No investor should be "playing around w(ith) factors" but ALL investors can benefit from diversifying across multiple factors, especially retirees.
I agree! It’s called a market-weighted index. I think Bogle talked a lot about it and how it could benefit ordinary investors by exploiting price discovery and lowering fees.
I think you missed my meaning: a market-weighted index is (by definition) NOT diversified across multiple factors. A fund like Vanguard Total Stock Market Index Fund is a concentrated bet on one single factor: market beta.
"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: Why factor investing isn't working

Post by willthrill81 » Tue Jul 09, 2019 10:24 am

schooner wrote:
Tue Jul 09, 2019 10:12 am
willthrill81 wrote:
Tue Jul 09, 2019 10:07 am
White Coat Investor wrote:
Tue Jul 09, 2019 9:56 am
Lots of shaking out of people who can't stay the course with their tilts this year. In 30 years we'll know if bailing out now was the right move or not. I think it probably isn't, but don't know for sure. What we do know is that even if the tilts work out, lots of people will bail out due to tracking error in times like these and those folks should never have tilted in the first place.
I entirely agree, and I'm on record saying that all of the people declaring the death of the SCV premium, for instance, probably means that it will begin outperforming in the near future.
That may be true, but it’s also possible the underlying data for the Fama French model is not representative.

If 10 years of data cannot be reliable, what makes 100 years reliable?

The problem is we’ve wrapped a very unscientific profession in the cloak of scientific language. It gives pure guesses the certitude of physical theories such as gravity.

And it is a disservice to ordinary folks, imho
I won't dispute any of that. But OTOH, post publication of the Fama-French data, Vanguard's VISVX has outperformed VTSMX significantly. That may have been a fluke, but we don't know. But tilting to factors like small and value across the U.S. and ex-U.S. has not really cost investors anything over the last decade, as the chart below depicts. Portfolio 1 is the equity portion of the 3-fund portfolio (50/50), portfolio 2 is the equity portion of Merriman's UBH portfolio.

Image
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Re: Why factor investing isn't working

Post by schooner » Tue Jul 09, 2019 10:25 am

vineviz wrote:
Tue Jul 09, 2019 10:19 am
schooner wrote:
Tue Jul 09, 2019 10:16 am
vineviz wrote:
Tue Jul 09, 2019 10:09 am
schooner wrote:
Tue Jul 09, 2019 8:22 am
Again, this is a recommendation you made in Kiplingers, which has a less sophisticated audience. Should older folks be playing around w factors like this in a retirement account?
No investor should be "playing around w(ith) factors" but ALL investors can benefit from diversifying across multiple factors, especially retirees.
I agree! It’s called a market-weighted index. I think Bogle talked a lot about it and how it could benefit ordinary investors by exploiting price discovery and lowering fees.
I think you missed my meaning: a market-weighted index is (by definition) NOT diversified across multiple factors. A fund like Vanguard Total Stock Market Index Fund is a concentrated bet on one single factor: market beta.
The idea that a total stock market index is not diversified is weird. It literally holds every stock by definition. If small caps do better, great, you have some. If large caps do better, you got them too.

Diversifying across multiple factors is really just stock picking. Nothing wrong with that, but it’s a risky strategy in my opinion. And the jury is still out if it actually works in the first place. So far, it hasn’t (based on actual recommendations and actual results).

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Re: Why factor investing isn't working

Post by rascott » Tue Jul 09, 2019 10:26 am

schooner wrote:
Tue Jul 09, 2019 9:43 am
rascott wrote:
Tue Jul 09, 2019 9:36 am
schooner wrote:
Mon Jul 08, 2019 1:33 pm
larryswedroe wrote:
Sat Jul 06, 2019 1:04 pm
What the article emphasizes is that the implementation has been horrible.
Cannot blame the tools if fools are using them in wrong way.
Larry
Mr. Swedroe, I respectfully disagree with your conclusion. I'd point to a factor portfolio you suggested in 2009 in Kiplinger Magazine:

https://www.kiplinger.com/article/inves ... olios.html

An ordinary investor who followed your advice over the next 10 years would have underperformed both the Vanguard 2020 Target Date Fund as well as a 60/40 passive index. The investor also would have experienced lower risk-adjusted returns and larger max draw-down.

The result:
https://www.portfoliovisualizer.com/bac ... total3=100


Sigh.... it's quite clear why it underperformed.....Larry's equity portfoio is 50% international. While your other comparisons are not.
His recommendation was 30% international. Similar to the Vanguard 2020 at the time.

His underperformance came from the factor tilt. And the reason it didn’t blow up was because these tilts still hug the index, just like Bogle observed...just with higher fees

A proper "apples to apples" comparison would be

30% VTSMX (TSMI)
30% VTIAX (TISMI)
40% VBMFX (TBM)

From March 2009-March 2019 this returned 9.8%

Larry's Kiplinger portfolio returned 10.31% during the same time frame.

(I used these dates, as article was written in late Jan, 2009).

Where again is this underperformance?
Last edited by rascott on Tue Jul 09, 2019 10:38 am, edited 3 times in total.

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Re: Why factor investing isn't working

Post by rascott » Tue Jul 09, 2019 10:30 am

schooner wrote:
Tue Jul 09, 2019 10:18 am
rascott wrote:
Tue Jul 09, 2019 10:10 am
schooner wrote:
Tue Jul 09, 2019 9:43 am
rascott wrote:
Tue Jul 09, 2019 9:36 am
schooner wrote:
Mon Jul 08, 2019 1:33 pm


Mr. Swedroe, I respectfully disagree with your conclusion. I'd point to a factor portfolio you suggested in 2009 in Kiplinger Magazine:

https://www.kiplinger.com/article/inves ... olios.html

An ordinary investor who followed your advice over the next 10 years would have underperformed both the Vanguard 2020 Target Date Fund as well as a 60/40 passive index. The investor also would have experienced lower risk-adjusted returns and larger max draw-down.

The result:
https://www.portfoliovisualizer.com/bac ... total3=100


Sigh.... it's quite clear why it underperformed.....Larry's equity portfoio is 50% international. While your other comparisons are not.
His recommendation was 30% international. Similar to the Vanguard 2020 at the time.

His underperformance came from the factor tilt. And the reason it didn’t blow up was because these tilts still hug the index, just like Bogle observed...just with higher fees


The portfolio you linked to on Kiplingers is 30% US equity, 30% intl equity, 40% bonds. That is a 50/50 equity split. Then you compared it to a 100% SP500 equity portfolio. Definitely not apples to apples.

SLYV (SP600 small cap value index) returned 17.6% CAGR March 2009-March 2019.

TSMI (VTSMX) returned 16.74% for the same period.

It wasn't the SCV tilt that caused the underperformance.
And I compared it to the Vanguard 2020 fund, which has a substantially similar international allocation

Vanguard was 30% intl in their target date funds until recent years. So again, poor comparison.

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