Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

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willthrill81
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Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by willthrill81 » Fri Nov 15, 2019 8:35 pm

In a recent post at Advisor Perspectives, Larry Swedroe addressed a question that often comes up with regard to factor funds: can investors actually capture factor premia on an after-expense basis with live funds. Larry compares factor funds from several providers, including Bridgeway, Vanguard, and DFA.

Larry's conclusion to this relatively brief post is below.
Well-designed, factor-based funds are able to capture the returns provided by both the size and the value factors. The further good news is that increased competition, in the form of mutual funds and tax efficient ETFs, has led to lower expense ratios, allowing investors to capture more of the available return.
Thoughts?
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

averagedude
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Re: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by averagedude » Fri Nov 15, 2019 9:07 pm

I agree with Larry, but higher fund costs is a hurdle that an investor that tilts to factors must overcome. Over the last 10 years it hasn't paid off, which makes me optimistic that investors that tilt to size and value will be compensated in the future.

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Re: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by danielc » Sat Nov 16, 2019 9:42 pm

As someone with a small-value tilt, I do not think that Larry has proved his point. He has merely shown that some funds can get close to the performance of some indices. But that doesn't tell me anything about the small cap or value PREMIUM, or even whether the fund has roughly the same risk profile as the index he is comparing it to. For example, Larry compares DFSCX against CRSP 9–10, CRSP 10, and CRSP 6-10... So... which of those indices should I pay attention to? If DFSCX does well compared to an index, is that because DFSCX is riskier than the index?

For example, Larry says that DFSCX outperformed CRSP 9-10 and CRSP 10 by 0.7% and 0.9% respectively. So... the smaller the index the better the DFSCX looks? To me that looks like small cap stocks did badly in that time period and DFSCX only did well by comparison by means of a failure to capture the small cap "premium".

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Re: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by willthrill81 » Sat Nov 16, 2019 9:45 pm

danielc wrote:
Sat Nov 16, 2019 9:42 pm
As someone with a small-value tilt, I do not think that Larry has proved his point. He has merely shown that some funds can get close to the performance of some indices. But that doesn't tell me anything about the small cap or value PREMIUM
Larry has had several other recent blog posts on that topic. The issue at hand here was whether the higher costs of implementing a factor strategy result in significant underperformance of the associated index. His conclusion for the major fund providers is that they do not.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by marcopolo » Sat Nov 16, 2019 11:35 pm

willthrill81 wrote:
Sat Nov 16, 2019 9:45 pm
danielc wrote:
Sat Nov 16, 2019 9:42 pm
As someone with a small-value tilt, I do not think that Larry has proved his point. He has merely shown that some funds can get close to the performance of some indices. But that doesn't tell me anything about the small cap or value PREMIUM
Larry has had several other recent blog posts on that topic. The issue at hand here was whether the higher costs of implementing a factor strategy result in significant underperformance of the associated index. His conclusion for the major fund providers is that they do not.
Do you think there was any chance he would have come to a different conclusion?
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: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by willthrill81 » Sun Nov 17, 2019 10:52 am

marcopolo wrote:
Sat Nov 16, 2019 11:35 pm
willthrill81 wrote:
Sat Nov 16, 2019 9:45 pm
danielc wrote:
Sat Nov 16, 2019 9:42 pm
As someone with a small-value tilt, I do not think that Larry has proved his point. He has merely shown that some funds can get close to the performance of some indices. But that doesn't tell me anything about the small cap or value PREMIUM
Larry has had several other recent blog posts on that topic. The issue at hand here was whether the higher costs of implementing a factor strategy result in significant underperformance of the associated index. His conclusion for the major fund providers is that they do not.
Do you think there was any chance he would have come to a different conclusion?
Probably not, but I don't know. The same could be said of most people who are committed to anything.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by jeffyscott » Sun Nov 17, 2019 11:04 am

willthrill81 wrote:
Fri Nov 15, 2019 8:35 pm
Larry's conclusion to this relatively brief post is below.
Well-designed, factor-based funds are able to capture the returns provided by both the size and the value factors. The further good news is that increased competition, in the form of mutual funds and tax efficient ETFs, has led to lower expense ratios, allowing investors to capture more of the available return.
Thoughts?
The other side of that "good news" could be that increased availability in the form of low expense mutual funds and ETFs allows more investors to chase these factors and that leads to them no longer "working".

I believe there is some argument that this is what happened with, formerly touted, commodity funds. I seem to also recall that too many players in the same game is at least part of what also led to the collapse of Long Term Capital Management?
Time is your friend; impulse is your enemy. - John C. Bogle

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Re: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by willthrill81 » Sun Nov 17, 2019 11:07 am

jeffyscott wrote:
Sun Nov 17, 2019 11:04 am
willthrill81 wrote:
Fri Nov 15, 2019 8:35 pm
Larry's conclusion to this relatively brief post is below.
Well-designed, factor-based funds are able to capture the returns provided by both the size and the value factors. The further good news is that increased competition, in the form of mutual funds and tax efficient ETFs, has led to lower expense ratios, allowing investors to capture more of the available return.
Thoughts?
The other side of that "good news" could be that increased availability in the form of low expense mutual funds and ETFs allows more investors to chase these factors and that leads to them no longer "working".
Considering that in the U.S., value has been trailing TSM for years, I find the argument that that space is overcrowded and, more importantly,
overvalued to be very weak. Similarly, I haven't see an argument that the small factor is overvalued relative to TSM.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by YRT70 » Sun Nov 17, 2019 11:25 am

marcopolo wrote:
Sat Nov 16, 2019 11:35 pm
willthrill81 wrote:
Sat Nov 16, 2019 9:45 pm
danielc wrote:
Sat Nov 16, 2019 9:42 pm
As someone with a small-value tilt, I do not think that Larry has proved his point. He has merely shown that some funds can get close to the performance of some indices. But that doesn't tell me anything about the small cap or value PREMIUM
Larry has had several other recent blog posts on that topic. The issue at hand here was whether the higher costs of implementing a factor strategy result in significant underperformance of the associated index. His conclusion for the major fund providers is that they do not.
Do you think there was any chance he would have come to a different conclusion?
I think there is. I think that there are some funds that Larry believes do not outweigh the implementation costs, like some momentum funds.

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Re: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by JoMoney » Sun Nov 17, 2019 11:48 am

My thoughts are...
I would have been shocked if Larry Swedroe came to the conclusion that you couldn't buy funds that capture factors... so no surprise here :wink:
I also thought the question was putting the cart before the horse, if you don't believe the factor strategy has a premia in the first place, whether or not a mutual fund successfully captures it is a silly question.
DFA's fund attempting to capture the small premium (DFSCX) might effectively capture the returns of small-cap stocks over its 38 years of existence, but it's had essentially the same returns (but with much higher risk) than that of a S&P 500 fund.
Image
Maybe the question itself is an attempt to get the customer "thinking past the sale" :confused
"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: Larry Swedroe: Do Implementation Costs Destroy Returns from Factor Portfolios?

Post by David Althaus » Sun Nov 17, 2019 4:36 pm

The chart above seems to reinforce the wisdom of TSM--with the possible exception for the very young. Account for tracking error, account for higher risk profile, and account for (all too often) unfortunate timing. Market is tough enough without adding these three significant variables. And, by the way, what serious investor doesn't already know about these factors?

All the best

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