One Reason Why Factor Investing May Continue To Work

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One Reason Why Factor Investing May Continue To Work

Post by Park »

Some factors, such value, have both behavioral and risk arguments to support them. Others, such as momentum and quality, are thought to be primarily behavioral in origin. This raises the question, that if markets become more efficient with time, factor investing will be less successful. ... mentation/

Above is a link to a review of a paper about factor investing.

"this paper focuses on the relative performance of factor funds versus traditional active funds and does not focus on a horserace between factor funds and passive index funds.

Do mutual funds focused on factors earn excess returns over their stock-picking counterparts?

YES. Factors funds do generate excess returns relative to their actively managed mutual fund counterparts. However, these returns are lower than the theoretical premiums identified in academic empirical asset pricing studies.

Do investors invested in these factor funds earn excess returns?

NO. Investors seem to be performance chasers and not buy-and-hold investors, which degrades the theoretical performance they could achieve if they were long-term holders of the underlying factor funds. The authors suggest that investors buy multi-factor funds and focus on a buy-and-hold approach versus a factor performance chasing approach."

If factor funds were successful, that would eventually cause problems for factor funds. Due to outperformance, they would become an increasingly large part of the marketplace. As they became a larger part of the marketplace, outperformance would become more difficult.

But due to performance chasing by individual investor, factor funds will have lower returns. This will help preserve any ability to outperform, which will benefit buy and hold investors in factor funds.
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Re: One Reason Why Factor Investing May Continue To Work

Post by Forester »

In other words systematic stock picking & systematic sell rules, beats humans :sharebeer

This is also why a low vol S&P 500 with the most volatile decile/quintile sliced off would beat the vanilla S&P 500 - the most volatile stocks represent the greed & story-telling of humans.
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Re: One Reason Why Factor Investing May Continue To Work

Post by JoMoney »

The title begs the question that factor investing has ever really worked.
The original "factor" fund, DFA's small cap DFSCX since inception has had the same returns as Vanguard's 500 fund, but with more risk.
Sure it worked in back-testing before people could easily implement it... but implementing a strategy is a different story.
One reason why factor investing may fail, is they are explicitly rules based strategies, which would allow for traders who know the rules "factor" followers are using, and front-run them.
Abnormal Trading Around Common Factor Pricing Models ... id=2492953
...I argue that the evidence is consistent with the idea that
there are a sufficient number of active market participants employing the common size and value factor
methodology with which to have repercussive effects on firms’ stock returns and volume.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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Re: One Reason Why Factor Investing May Continue To Work

Post by patrick013 »

I think it's almost sector investing disguised. Several factors are high AA for tech sector. If I took stocks with growth higher than mean but with debt equity ratio lower than mean and limited sector AA to a reasonable number it would be better diversified and safer from bubbles than an extra heavy AA to any one sector. Like a momentum and quality factor index in one fund. Point is factor funds could be loading up on one sector which long term could limit diversification. Each sector should have ample representation even if a quality factor index is desired, for example. MHO. If not we might get stuck with a tech fund.
age in bonds, buy-and-hold, 10 year business cycle
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