The Bottom Line on Factor Investing

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simplesauce
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The Bottom Line on Factor Investing

Post by simplesauce »

I would like to explore both sides of the aisle, but on a more “personal“ level than many topics before this. Your answers can be brief.

For those in favor of Factor Investing:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs for using factor investing? Also, how did you decide which factors to use? (small, value, momentum, etc.)

For those skeptical:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs that factor investing is not necessary?

EDIT

Wow, this thread really took off and I truly benefited from all of the discussion! If I were to “conclude” anything from it, here are my main “bottom line” takeaways:

1. Avoid single-factor bets:
From Dr. Burton Malkiel’s 2020 edition of “A Random Walk Down Wall Street:” “Smart beta investing with single-factor products has not turned out to be smart investing"...however "Multifactor "smart beta" funds appear to have produced better results by taking advantage of the low or negative correlations between the factors. Especially if they can be obtained with low expense ratios, they could supplement a broad-based core index portfolio"..."And if you do want to add additional risk factors in the pursuit of extra return, I recommend a low-expense multifactor offering rather than a fund concentrating on one risk factor."

2. You should plan to stick with your bet for decades or even for life, otherwise you could “permanently lock in” the underperformance when you sell:
Here was the post by Rick Ferri: “If you wish to use factor investing such as small-value in a portfolio, or you decide to tilt a portfolio away from the total market for any reason, then the portfolio will no longer track the market. Sometimes that will work in your favor and sometimes it will not. When it doesn't, if you abandon the strategy, then you permanently lock in the underperformance.

I believe if your prone to do that, then you should have never invested in the factors or tilt from the beginning. How long should you stick with a factor strategy or tilt? The answer that Wes Grey and I agreed on in THIS PODCAST https://rickferri.com/podcast/episode-0 ... ick-ferri/ was 25 years. That's how long it could take to see any benefit from a factor tilted portfolio.

In my view, if you're not going to be a factor investor for life, then don't do it at all because the probability is high you will capitulate eventually and that means you'll underperform the market.”


3. Buying the market-cap weighted index is the only strategy that guarantees you will do better than the majority of investors:
From Investorguy1: “There is something very appealing, maybe even elegant about holding the market. You are guaranteed to beat the majority of investors (no other strategy offers this), costs and taxes are minimized and so is time, effort and tracking error regret.”

4. If you are going to tilt, you need to have a serious conviction in your bet. And from my perspective, a Boglehead is a Boglehead because we have come to realize we do not know more than the market.
From Nisiprius: My conviction is far too feeble for that. I couldn't personally stick it out though a decade of underperformance. And smart beta costs money... and if I committed to smart beta flavor X and I didn't happen to pick one that started out well, not only would I need to be ignoring underperformance, I'd need to ignore a dozen other voices saying "you didn't pick the right one."

From Intrepyd: I spent a long time thinking about introducing factor tilts into my portfolio. For me, I am pretty sure that I'd either dump my tilts or feel like an idiot if they underperformed for 20 years. I don't believe enough in the narrative of factor outperformance to resist the urge to eventually abandon the factor strategy. In fact, maybe there are compelling narratives suggesting why the factors of times past may not persist. After all, as pervasive and persistent as factors have been, maybe when the economy changes in such fundamental ways, the old factors might not matter. Secular low or negative interest rates, huge growth companies completely changing the nature of centuries-old industries, ever increasing concentration of wealth, etc, etc. The world 50 years from now will look a lot different, and I wouldn't be at all surprised if "value" and "size" aren't what they were in the 20th century.

Basically, I can't predict any of this, but I have a hunch that the past may not predict the future. That's obviously nothing to trade on, but it's enough to avoid the folly of making a bet on factors knowing I don't believe in them enough to stick with them while they underperform the market portfolio. If there are those that have examined the research and have the discipline to make big dollar bets on its predictive power, I salute them and won't begrudge them if they achieve a premium over beta.
Last edited by simplesauce on Mon May 11, 2020 8:31 am, edited 3 times in total.
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Noobvestor
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Re: The Bottom Line on Factor Investing

Post by Noobvestor »

My thoughts on this are really rather simple, as someone who tilts small and value:

1) If small/value provide exposure to unique risk factors, then they should offer an advantage in boosting risk-adjusted returns

2) If they don't, then they at least provide some correlation benefit vis a vis TSM - this was my 'ah hah' moment

If they go down and stay down forever, I lose. If they go down and bounce back up, I win whether or not the factors are 'real' as such, because I'll have bought more than they were low, just like I'll buy more of TSM when its low. Basically, for factor investing to really fail, you need to have a 'negative' belief about factors - that they are riskier and that risk will not be rewarded. It's possible, but would ironically mean that investors should actually be tilting, just in the opposite direction. From posts I've seen about investing in tech, many seem to be doing just that. A lot of threads too about bailing on SCV. IDK, it's very anecdotal, but one might conclude that SCV is falling out of favor, and thus primed to outperform.

As for how I decided, I took the cheap and easy way by tilting using Vanguard's Small Cap Value Index fund. I didn't stress the loadings too much, even though I'm well aware one can get higher small and value loadings via certain funds/ETFs. A combination of tilting + simplicity.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe
DonIce
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Re: The Bottom Line on Factor Investing

Post by DonIce »

I had never heard of factor investing until I started reading Bogleheads. Shortly after I joined the forum, I ran into factors. Factor proponents here seemed almost religious in their adherence, with admonitions like "you have to believe in them" and "never sell out even if the factor premium doesn't appear for decades, because it's a long term commitment". Then I looked at what is actually in factor funds and realized it is just nothing more than stock picking based on a few simple screens. There are countless studies robustly demonstrating that stock picking, statistically, is unlikely to outperform the market.
whereskyle
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Re: The Bottom Line on Factor Investing

Post by whereskyle »

simplesauce wrote: Sat Apr 25, 2020 5:22 pm I would like to explore both sides of the aisle, but on a more “personal“ level than many topics before this. Your answers can be brief.

For those in favor of Factor Investing:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs for using factor investing? Also, how did you decide which factors to use? (small, value, momentum, etc.)

For those skeptical:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs that factor investing is not necessary?

For me, I am not convinced that factor premiums will persist far into the future. I’m concerned that many factors will be (or already have been) arbitraged away. There were two “A-Ha” moments for me recently that I would like to share:

1. The first is a quote from Investorguy1 on this forum. He wrote something that has stuck with me:

“There is something very appealing, maybe even elegant about holding the market. You are guaranteed to beat the majority of investors (no other strategy offers this), costs and taxes are minimized and so is time, effort and tracking error regret.”

2. The second is an article link provided by Taylor Larimore in a previous post. I found this to be a highly entertaining and informative read: https://www.institutionalinvestor.com/a ... egist-sick
The Betterment portfolio leans toward value of all sizes. After serious underperformance of a total-market portfolio last year, I read up on value and learned about correlations between its outperformance and much higher interest rates than we see today. I basically told myself, I'll hold onto these funds, but it's just performance chasing, and I'll focus on total-market funds from here on out.

The article is a joyous read. Thanks for sharing.
"I am better off than he is – for he knows nothing and thinks that he knows. I neither know nor think that I know." - Socrates. "Nobody knows nothing." - Jack Bogle
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simplesauce
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

whereskyle wrote: Sat Apr 25, 2020 6:00 pm
simplesauce wrote: Sat Apr 25, 2020 5:22 pm I would like to explore both sides of the aisle, but on a more “personal“ level than many topics before this. Your answers can be brief.

For those in favor of Factor Investing:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs for using factor investing? Also, how did you decide which factors to use? (small, value, momentum, etc.)

For those skeptical:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs that factor investing is not necessary?

For me, I am not convinced that factor premiums will persist far into the future. I’m concerned that many factors will be (or already have been) arbitraged away. There were two “A-Ha” moments for me recently that I would like to share:

1. The first is a quote from Investorguy1 on this forum. He wrote something that has stuck with me:

“There is something very appealing, maybe even elegant about holding the market. You are guaranteed to beat the majority of investors (no other strategy offers this), costs and taxes are minimized and so is time, effort and tracking error regret.”

2. The second is an article link provided by Taylor Larimore in a previous post. I found this to be a highly entertaining and informative read: https://www.institutionalinvestor.com/a ... egist-sick
The Betterment portfolio leans toward value of all sizes. After serious underperformance of a total-market portfolio last year, I read up on value and learned about correlations between its outperformance and much higher interest rates than we see today. I basically told myself, I'll hold onto these funds, but it's just performance chasing, and I'll focus on total-market funds from here on out.

The article is a joyous read. Thanks for sharing.
Absolutely. Thank Taylor!
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tetractys
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Re: The Bottom Line on Factor Investing

Post by tetractys »

I like rebalancing bonuses.
Elysium
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Re: The Bottom Line on Factor Investing

Post by Elysium »

DonIce wrote: Sat Apr 25, 2020 5:42 pm Then I looked at what is actually in factor funds and realized it is just nothing more than stock picking based on a few simple screens. There are countless studies robustly demonstrating that stock picking, statistically, is unlikely to outperform the market.
You get the Goldstar award for the week :sharebeer

All you have to do is look under the hood of some of these products to learn the truth about them.
dbr
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Re: The Bottom Line on Factor Investing

Post by dbr »

Two things:

1) The Fama-French model impresses me as a legitimate breakthrough in the academic analysis of equity returns. The various elaborations and details over time are interesting.

I enjoy looking at that kind of analysis of "stuff" whatever that stuff might be.

2) My own situation simply does not need to utilize any results of factor behavior even assuming those results are robust and persistent. What I want and need can be met with simple total market index funds appropriately chosen. That is combined with simply not being interested in pursuing actual investing into that level of nuance. The short statement is "No, because I don't need to and I don't want to."

I am neutral on what other people want to do.
All Seasons
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Re: The Bottom Line on Factor Investing

Post by All Seasons »

The bottom line on factor investing is that everyone should be doing it. Like how everyone should be investing globally.
The market portfolio is always a legitimate portfolio.
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Re: The Bottom Line on Factor Investing

Post by Taylor Larimore »

simplesauce wrote: Sat Apr 25, 2020 5:22 pm I would like to explore both sides of the aisle, but on a more “personal“ level than many topics before this. Your answers can be brief.

For those in favor of Factor Investing:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs for using factor investing? Also, how did you decide which factors to use? (small, value, momentum, etc.)

For those skeptical:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs that factor investing is not necessary?

For me, I am not convinced that factor premiums will persist far into the future. I’m concerned that many factors will be (or already have been) arbitraged away. There were two “A-Ha” moments for me recently that I would like to share:

1. The first is a quote from Investorguy1 on this forum. He wrote something that has stuck with me:

“There is something very appealing, maybe even elegant about holding the market. You are guaranteed to beat the majority of investors (no other strategy offers this), costs and taxes are minimized and so is time, effort and tracking error regret.”

2. The second is an article link provided by Taylor Larimore in a previous post. I found this to be a highly entertaining and informative read: https://www.institutionalinvestor.com/a ... egist-sick
Simplesauce:

When I am unsure about an investing topic, I find out what what Jack Bogle recommends. In my opinion, the inventor of the index fund, founder of Vanguard, and author of 10 books, knew more about personal investing than anybody -- certainly more than any of us on this forum.

These are excerpts that Mr. Bogle wrote in The 10th Anniversary Edition of "The Little Book of Common Sense Investing (2017):
"Popular fads are driving product creation in the fund industry. These products are great for fund sponsors, but almost always awful for fund investors."

"Today's winning factors are all too likely to be tomorrow's losing factors."

"Recent events confirm skepticism about the power of smart beta."

"The greatest enemy of a good plan is the dream of a perfect plan. Stick to the good plan."

"I urge you not to be tempted by the siren song of paradigms that promise the accumulation of wealth that are far beyond the rewards of the traditional index fund."

"Put your dreaming away, pull out your common sense, and stick to the good plan represented by the traditional index fund. -- I feel strongly on this point."
Thank you, Jack.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "By and large I do not approve of factor funds."
"Simplicity is the master key to financial success." -- Jack Bogle
Dominic
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Re: The Bottom Line on Factor Investing

Post by Dominic »

I tilt very slightly to small and value. In the US, I use Vanguard's S&P 600 Value ETF. Internationally, I use Vanguard's ex-US Small-Cap ETF.

We know that the identified factors drive returns. Whether they actually exhibit a positive return isn't necessarily important. If HmL and SmB have 0% returns over the long term, then in theory I should benefit via a rebalancing bonus.

I chose value and small specifically because they're very cheap to implement (decreases my chances of underperforming in the long-run), and the risk-based explanations behind them are intuitive.
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vineviz
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Re: The Bottom Line on Factor Investing

Post by vineviz »

Elysium wrote: Sat Apr 25, 2020 7:19 pm
DonIce wrote: Sat Apr 25, 2020 5:42 pm Then I looked at what is actually in factor funds and realized it is just nothing more than stock picking based on a few simple screens. There are countless studies robustly demonstrating that stock picking, statistically, is unlikely to outperform the market.
You get the Goldstar award for the week :sharebeer

All you have to do is look under the hood of some of these products to learn the truth about them.
Some people can look straight at an apple and be 100% confident that they’re staring at an orange.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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simplesauce
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

Taylor Larimore wrote: Sat Apr 25, 2020 7:48 pm Simplesauce:

When I am unsure about an investing topic, I find out what what Jack Bogle recommends. In my opinion, the inventor of the index fund, founder of Vanguard, and author of 10 books, knew more about personal investing than anybody -- certainly more than any of us on this forum.

These are excerpts that Mr. Bogle wrote in The 10th Anniversary Edition of "The Little Book of Common Sense Investing (2017):
"Popular fads are driving product creation in the fund industry. These products are great for fund sponsors, but almost always awful for fund investors."

"Today's winning factors are all too likely to be tomorrow's losing factors."

"Recent events confirm skepticism about the power of smart beta."

"The greatest enemy of a good plan is the dream of a perfect plan. Stick to the good plan."

"I urge you not to be tempted by the siren song of paradigms that promise the accumulation of wealth that are far beyond the rewards of the traditional index fund."

"Put your dreaming away, pull out your common sense, and stick to the good plan represented by the traditional index fund. -- I feel strongly on this point."
Thank you, Jack.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "By and large I do not approve of factor funds."
Thank you Taylor. Very wise statements indeed! Hope you are staying safe and healthy.
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Re: The Bottom Line on Factor Investing

Post by nisiprius »

I don't know that there was a single Aha! moment, but I would say that that I started to experience budding conviction in factors in the early 2000's--which was then nipped in the bud long before it could flower into action.

My original idea was to own the whole market, which to me originally meant the S&P 500. My convictions about owning the whole market gradually strengthened over time. John C. Bogle's observations that holding the whole market cancels out your participation on speculative trades within the market were particularly convincing.

I started to buy into the idea of the "small-cap premium," based mostly on many charts that all traced back to Ibbotson Associates. My conviction faded as I gradually realized that most of the premium is just commensurate with risk, and that the risk-adjusted return of small-caps has not been hugely different from the market as a whole. My skepticism rose as I discovered various papers by e.g. Tyler and Shumway which strongly suggested that there were methodological problems in the data set used by Banz in 1981, in the paper that introduced the "small firm effect."

An aha! moment of sorts was the seemingly obvious discovery that the DFA Micro Cap Portfolio, after three years of outperforming the S&P 500, lost the lead and underperformed for a full 17 years. In the past, Morningstar had limited growth charts to ten years, and I think that I "discovered" the 17-year period of underperformance when the Morningstar website, one day, began showing growth charts back to inception.

I used to say that it had finally regained that ground and pulled ahead of the S&P 500... but as I write this, since inception the DFA Micro Cap Portfolio has lost again. From inception to date, over 38 years and several market cycles, the DFA Micro Cap Portfolio has underperformed an S&P 500 index fund, and has done so despite having considerably higher risk by most measures.

Source

Blue: small-cap fund.
Orange: S&P 500 fund.

Image

I had already lost my conviction when I read John C. Bogle's essay, "The Telltale Chart," but it certainly put a few more nails in the coffin.

With the emergence of the "factor zoo" (the announcements of the discovery of literally dozens of new factors) I said "this has just become silly. This is just numerology, overfitting, and pareidolia (seeing the illusion of pattern in random images)."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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simplesauce
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

nisiprius wrote: Sat Apr 25, 2020 8:56 pm I don't know that there was a single Aha! moment, but I would say that that I started to experience budding conviction in factors in the early 2000's--which was then nipped in the bud long before it could flower into action.

My original idea was to own the whole market, which to me originally meant the S&P 500. My convictions about owning the whole market gradually strengthened over time. John C. Bogle's observations that holding the whole market cancels out your participation on speculative trades within the market were particularly convincing.

I started to buy into the idea of the "small-cap premium," based mostly on many charts that all traced back to Ibbotson Associates. My conviction faded as I gradually realized that most of the premium is just commensurate with risk, and that the risk-adjusted return of small-caps has not been hugely different from the market as a whole. My skepticism rose as I discovered various papers by e.g. Tyler and Shumway which strongly suggested that there were methodological problems in the data set used by Banz in 1981, in the paper that introduced the "small firm effect."

An aha! moment of sorts was the seemingly obvious discovery that the DFA Micro Cap Portfolio, after three years of outperforming the S&P 500, lost the lead and underperformed for a full 17 years. In the past, Morningstar had limited growth charts to ten years, and I think that I "discovered" the 17-year period of underperformance when the Morningstar website, one day, began showing growth charts back to inception.

I used to say that it had finally regained that ground and pulled ahead of the S&P 500... but as I write this, since inception the DFA Micro Cap Portfolio has lost again. From inception to date, over 38 years and several market cycles, the DFA Micro Cap Portfolio has underperformed an S&P 500 index fund, and has done so despite having considerably higher risk by most measures.

Source

Blue: small-cap fund.
Orange: S&P 500 fund.

Image

I had already lost my conviction when I read John C. Bogle's essay, "The Telltale Chart," but it certainly put a few more nails in the coffin.

With the emergence of the "factor zoo" (the announcements of the discovery of literally dozens of new factors) I said "this has just become silly. This is just numerology, overfitting, and pareidolia (seeing the illusion of pattern in random images)."
Thank you so much for this post. I highly value your feedback on these forums. That chart comparing the two funds is especially eye opening. I also learned a new word from you: pareidolia.
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

All Seasons wrote: Sat Apr 25, 2020 7:31 pm The bottom line on factor investing is that everyone should be doing it. Like how everyone should be investing globally.
If everyone invests in value or size, it’s no longer value or size, it’s market. This is impossible.
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grabiner
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Re: The Bottom Line on Factor Investing

Post by grabiner »

I am a long-time factor investor, but only in the most established factors. Since 2000, and even more since 2002, I have overweighted small-cap, value, and emerging markets.

I don't believe that I am necessarily getting a free lunch. Instead, I believe that I am taking a risk, and am being compensated for this risk. I increase my portfolio risk by holding riskier stocks, rather than by holding more in stocks and less in bonds. Thus, while I am 88% stock, I believe I lost more than a 100%-stock portfolio in the March decline, as this particular decline hit value stocks especially hard. (My first bear market, in 2000-2002, went the other way, as it was technology that led the decline.)
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Re: The Bottom Line on Factor Investing

Post by aristotelian »

grabiner wrote: Sat Apr 25, 2020 9:49 pm I am a long-time factor investor, but only in the most established factors. Since 2000, and even more since 2002, I have overweighted small-cap, value, and emerging markets.

I don't believe that I am necessarily getting a free lunch. Instead, I believe that I am taking a risk, and am being compensated for this risk. I increase my portfolio risk by holding riskier stocks, rather than by holding more in stocks and less in bonds. Thus, while I am 88% stock, I believe I lost more than a 100%-stock portfolio in the March decline, as this particular decline hit value stocks especially hard. (My first bear market, in 2000-2002, went the other way, as it was technology that led the decline.)
Ah, but if it is truly risky then it is not a sure thing that you will be compensated for the risk, even over a long timeframe.
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

Reading The Fundamental Index I had an ah ha moment loosely with regards to factor investing: the idea that a market cap weighted index by design overweights overvalued companies and underweights undervalued companies unless they’re perfectly priced was compelling. I don’t believe anyone can tell which stocks are mispriced but I believe many are, so using an index decoupled from price makes a lot of sense to me. It also could explain why tilts to smaller or more valuey companies could outperform. This is now how I invest much of my large-cap domestic and all small-cap ex-US, but domestic small-value I use more traditional market weighted SCV funds.

I also believe risk is compensated for, and size is especially more risky.
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Re: The Bottom Line on Factor Investing

Post by Triple digit golfer »

The Telltale Chart is one.

I believe that if Company A has 100x the market cap of Company B, then it likely has additional product lines, capital, resources, innovation, growth potential, customer base, etc. that net to 100x the value of Company B.

Take Amazon vs. Starbucks.

One is one of the largest retailers in the world, owns a grocery chain, cloud computing, provides streaming services, a leader in AI, and so on. The other sells coffee. Of course Amazon is worth more and of course I want to invest more money in it than Starbucks. It could easily be several separate companies. Just because it's under one umbrella doesn't mean I should own less of it.

So, I don't think of cap weighing as putting 18% of my investment in ten companies. I think of it as investing proportionately.

And to go back to basics, the stock market has delivered good returns over time. Why try to outguess it?
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Re: The Bottom Line on Factor Investing

Post by nedsaid »

DonIce wrote: Sat Apr 25, 2020 5:42 pm I had never heard of factor investing until I started reading Bogleheads. Shortly after I joined the forum, I ran into factors. Factor proponents here seemed almost religious in their adherence, with admonitions like "you have to believe in them" and "never sell out even if the factor premium doesn't appear for decades, because it's a long term commitment". Then I looked at what is actually in factor funds and realized it is just nothing more than stock picking based on a few simple screens. There are countless studies robustly demonstrating that stock picking, statistically, is unlikely to outperform the market.
I am so old that I remember when they called this investing styles. You have always had Value oriented strategies, Mid/Small-Cap strategies, Growth at a Reasonable Price, Aggressive Growth, Defensive (Low Volatility) strategies, and others. The Academics more clearly defined and provided evidence for things that investors had known or suspected for decades. What you find is that different segments of the stock market have their own performance characteristics over time. Certain economic environments favor some strategies over others. You will see times when certain sections of the market will take turns outperforming each other. This happens with Small vs Large, Value vs Growth, US vs International. By investing across investing styles or factors, you may boost returns a bit while reducing volatility in a portfolio. I say "may" because sometimes diversification across factors works great and sometimes it doesn't work out so well.
A fool and his money are good for business.
redbarn
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Re: The Bottom Line on Factor Investing

Post by redbarn »

Due to the name "factor," I was always under the impression that beta, value and size factors were uncovered using the statistical method called "factor analysis." I assumed that applying factor analysis to the stock market data uncovered three robust factors, and these happened to line up well with beta, value and size. While factor analysis has its issues, this always struck me as being a pretty impressive finding, since factor analysis does not entail feeding in potential explanatory variables at all.

When I later read the original Fama and French article and some other seminal papers in this literature, it turned out they were using "factor" in a more normal sense of the term (i.e. a factor that determines returns) rather than in the factor analysis sense. Reading this research was particularly deflating from where I started out because it amounted to noting that small and value tended to outperform the market and then constructing variables to capturing this in a regression. It amounted to documenting that certain subsets of the stock market had better past performance using a regression.

A corollary of this is that the idea of factors being "risk factors" was not something that directly emerged from their analysis. Instead, they used financial theory to infer that size and value must have higher returns because they are riskier, and basically speculated on what the risks were. The stories -- like the behavioral stories that other financial economists preferred -- are all plausible but hardly something that emerges directly from their analysis. If in their data period growth had outperformed, they could have just as easily come up with a plausible story about the special risks of growth stocks that lead to their strong long-term performance.

More broadly, the whole theory strikes me as being rather un-falsifiable. If value does well, it obviously supports the idea of a value premium. If value does poorly, that also supports the theory because it shows that value is risky. The value premium, after all, "only shows up during specific times," which sounds like a much more scientific and theoretically grounded claim than saying it as it is: "value only does better sometimes."

At the end of the day, there are infinitely many ways of cutting the data and there will necessarily be characteristics ("factors") that consistently beat the market even in a long data period, and it will always be possible to come up with plausible risk and/or behavioral reasons for why any subset of the market outperforms ex-post.

It all sounds like a rather doubtful basis for investing IMO. The fact that active investors have such a difficult time beating the market also suggests that just identifying what did better in the past and coming up with a story for that will not suffice to beat the market.
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Re: The Bottom Line on Factor Investing

Post by whereskyle »

nisiprius wrote: Sat Apr 25, 2020 8:56 pm I don't know that there was a single Aha! moment, but I would say that that I started to experience budding conviction in factors in the early 2000's--which was then nipped in the bud long before it could flower into action.

My original idea was to own the whole market, which to me originally meant the S&P 500. My convictions about owning the whole market gradually strengthened over time. John C. Bogle's observations that holding the whole market cancels out your participation on speculative trades within the market were particularly convincing.

I started to buy into the idea of the "small-cap premium," based mostly on many charts that all traced back to Ibbotson Associates. My conviction faded as I gradually realized that most of the premium is just commensurate with risk, and that the risk-adjusted return of small-caps has not been hugely different from the market as a whole. My skepticism rose as I discovered various papers by e.g. Tyler and Shumway which strongly suggested that there were methodological problems in the data set used by Banz in 1981, in the paper that introduced the "small firm effect."

An aha! moment of sorts was the seemingly obvious discovery that the DFA Micro Cap Portfolio, after three years of outperforming the S&P 500, lost the lead and underperformed for a full 17 years. In the past, Morningstar had limited growth charts to ten years, and I think that I "discovered" the 17-year period of underperformance when the Morningstar website, one day, began showing growth charts back to inception.

I used to say that it had finally regained that ground and pulled ahead of the S&P 500... but as I write this, since inception the DFA Micro Cap Portfolio has lost again. From inception to date, over 38 years and several market cycles, the DFA Micro Cap Portfolio has underperformed an S&P 500 index fund, and has done so despite having considerably higher risk by most measures.

Source

Blue: small-cap fund.
Orange: S&P 500 fund.

Image

I had already lost my conviction when I read John C. Bogle's essay, "The Telltale Chart," but it certainly put a few more nails in the coffin.

With the emergence of the "factor zoo" (the announcements of the discovery of literally dozens of new factors) I said "this has just become silly. This is just numerology, overfitting, and pareidolia (seeing the illusion of pattern in random images)."
http://johncbogle.com/speeches/JCB_Morningstar_6-02.pdf

A great read!
"I am better off than he is – for he knows nothing and thinks that he knows. I neither know nor think that I know." - Socrates. "Nobody knows nothing." - Jack Bogle
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Re: The Bottom Line on Factor Investing

Post by DonIce »

redbarn wrote: Sat Apr 25, 2020 11:41 pm ...

At the end of the day, there are infinitely many ways of cutting the data and there will necessarily be characteristics ("factors") that consistently beat the market even in a long data period, and it will always be possible to come up with plausible risk and/or behavioral reasons for why any subset of the market outperforms ex-post.
Excellent post!
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Re: The Bottom Line on Factor Investing

Post by dmcmahon »

My observation regarding factor investing is similar to the epiphany I had regarding active funds.

If you divide the participants in the market into two groups, one group that accepts the average market return, and another group that attempts to outperform the market, then the second group, as a group, cannot produce more than the average return. That means that for every winner there's a loser. Now subtract the fund expenses. Yeah, that. It's obvious that indexing is the way to go.

Now regarding tilts, the issues are more subtle, but in the end for me it came down to tax efficiency. If one assumes that there's a premium to be had for smaller companies or out-of-favor companies to come into favor, then to the extent that this happens, they will be blended in to the average. In particular, if one looks at small companies, they will either become big, or they will fail, but either way, their investors will reap some transient premium after which they transition into the S&P 500 if successful. The tax effects of this transition are enough to mostly offset any gain you're likely to see. Same for most other tilts. The game is not worth the candle.
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Re: The Bottom Line on Factor Investing

Post by Uncorrelated »

dmcmahon wrote: Sun Apr 26, 2020 1:05 am My observation regarding factor investing is similar to the epiphany I had regarding active funds.

If you divide the participants in the market into two groups, one group that accepts the average market return, and another group that attempts to outperform the market, then the second group, as a group, cannot produce more than the average return. That means that for every winner there's a loser. Now subtract the fund expenses. Yeah, that. It's obvious that indexing is the way to go.
That is not true at all. If there are two classes of stocks, let's call them 'domestic' and 'international', and international has higher average returns but more risk, then the market average will drift towards an all-world portfolio. But those who tilt towards international receive higher returns.

If more people start to tilt towards international, then the performance gap will become smaller. but it will never be eliminated. As soon as E(domestic) == E(international), everybody will dump their international stock because it it more risky.

There won't only be people that tilt towards international. There will also be domestic titers, because they prefer to take less risk.

Your statement is only true in a single-factor model. Anyone that believes in multi-factor models must believe that tilting is useful for some subset of investors (not for everyone, but some some subset). I don't think there is any doubt in the academic world that CAPM (single factor model) is thoroughly broken, with numerous anomalies such as size, value, high-beta. Some of which have very plausible risk-based explanations. Risk based explanations cannot be arbitraged away, as can be clearly observed in the example above.
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Re: The Bottom Line on Factor Investing

Post by dmcmahon »

The issue is one of bucketing. It's the exceptional fund that buckets US and international together. Whereas bucketing US small, medium, and large together is quite common. Even within international, there's the problem of bucketing into "developed" versus "emerging" markets. So what happens when an entire country (like South Korea) transitions? The total-market investor doesn't notice a thing, the EM market investor gets a tax hit. Same with companies transitioning in and out of the cap weight buckets. Owning the haystack seems the only logical course, at least within the US bucket. I see anti-tilts as being preferable right now, i.e. US large over small, US over international by market weight, and the like. That's the real world we've lived in for decades and that seems likely to continue.

Ultimately the tilts boil down to the preponderance of evidence based on historical data, so please don't tell me the data is irrelevant. The data is telling us it's a large-cap, growth, US-centered world. Theoretical arguments based on outdated metrics such as price-to-book fall flat. I could just as easily argue that large cap growth, by virtue of both size (it's harder to grow fast as you get large) and P/E ratios, are riskier than average and thus justify a return premium.
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Re: The Bottom Line on Factor Investing

Post by Tellurius »

From reading on this forum, some advocates presented it as some kind of “basic truth”.

For me, when hearing about the effect that deregulation of commissions had in the 70s, when the standard 3% commission was abolished, did the trick. Suddenly, small stocks were not so expensive to trade and the period of outperformance can be traced to 1975-85, I believe.

It was also interesting to read the Larry Swedroe vs Rick Ferri thread on commodities, from ten years ago, where Larry Swedroe mentions small-cap value in a “it’s simple, this is IT” way.
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Re: The Bottom Line on Factor Investing

Post by Uncorrelated »

dmcmahon wrote: Sun Apr 26, 2020 2:08 am The issue is one of bucketing. It's the exceptional fund that buckets US and international together. Whereas bucketing US small, medium, and large together is quite common. Even within international, there's the problem of bucketing into "developed" versus "emerging" markets. So what happens when an entire country (like South Korea) transitions? The total-market investor doesn't notice a thing, the EM market investor gets a tax hit. Same with companies transitioning in and out of the cap weight buckets. Owning the haystack seems the only logical course, at least within the US bucket. I see anti-tilts as being preferable right now, i.e. US large over small, US over international by market weight, and the like. That's the real world we've lived in for decades and that seems likely to continue.

Ultimately the tilts boil down to the preponderance of evidence based on historical data, so please don't tell me the data is irrelevant. The data is telling us it's a large-cap, growth, US-centered world. Theoretical arguments based on outdated metrics such as price-to-book fall flat. I could just as easily argue that large cap growth, by virtue of both size (it's harder to grow fast as you get large) and P/E ratios, are riskier than average and thus justify a return premium.
The data tells us that over the longest time period we have data for, South-Africa and Australia outperforms US, value outperforms growth, small outperforms large, robust outperforms weak, and winners outperform losers. If you choose to ignore everything older than 15 years because it fits your anchored beliefs better, I suggest an amazon centered portfolio.

FF is an empirical model, not a theoretical one. A theory can be tested with empirical data. If you think that large growth stocks are more risky, go test it on empirical data. Or if you're in a hurry, read "The cross section of expected stock returns", 1992, Fama & French, which did the testing for you.
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Re: The Bottom Line on Factor Investing

Post by DonIce »

Uncorrelated wrote: Sun Apr 26, 2020 3:04 am The data tells us that over the longest time period we have data for, South-Africa and Australia outperforms US, value outperforms growth, small outperforms large, robust outperforms weak, and winners outperform losers. If you choose to ignore everything older than 15 years because it fits your anchored beliefs better, I suggest an amazon centered portfolio.

FF is an empirical model, not a theoretical one.
So should factor tilters also be tilting to South Africa and Australia? I don't think many of them are...

"Winners outperform losers". Ok. I'll just buy winners then. It's so obvious when you put it like that! :)
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Re: The Bottom Line on Factor Investing

Post by Uncorrelated »

DonIce wrote: Sun Apr 26, 2020 3:48 am
Uncorrelated wrote: Sun Apr 26, 2020 3:04 am The data tells us that over the longest time period we have data for, South-Africa and Australia outperforms US, value outperforms growth, small outperforms large, robust outperforms weak, and winners outperform losers. If you choose to ignore everything older than 15 years because it fits your anchored beliefs better, I suggest an amazon centered portfolio.

FF is an empirical model, not a theoretical one.
So should factor tilters also be tilting to South Africa and Australia? I don't think many of them are...

"Winners outperform losers". Ok. I'll just buy winners then. It's so obvious when you put it like that! :)
Winners outperform losers is a reference to the momentum factor (WmL).

The statistical evidence for South Africa and Australia is weak. My point is that if you are willing to accept the weak evidence for US outperformance, you should really be tilting towards South Africa and Australia instead.

Factor investing is not a question whether factors are real or not, but how much evidence you require to be convinced. If your standard of proof is so high that you even reject the value factor, then you should be rejecting all other tilts with weaker evidence as well. Such as country tilts.
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Re: The Bottom Line on Factor Investing

Post by Forester »

dmcmahon wrote: Sun Apr 26, 2020 2:08 am The data is telling us it's a large-cap, growth, US-centered world. Theoretical arguments based on outdated metrics such as price-to-book fall flat. I could just as easily argue that large cap growth, by virtue of both size (it's harder to grow fast as you get large) and P/E ratios, are riskier than average and thus justify a return premium.
The data (multiple expansion) tells us that's where the sentiment is but growth stocks are no more profitable today than pre-2010s.
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Re: The Bottom Line on Factor Investing

Post by Alchemist »

The lack of a 'why'. Some Factor proponents say it is a risk-based premium, some say behavior, and others still that it is some combination of the two. This lack of a real explanation for the expected premium makes it abundantly clear that the only real answer is "because it did great over the time period FF looked at".

Like Nisiprius and another poster put it more eloquently than I can, past factor premiums have no real reason to be expected in the future based on any fundamental nature of the factors themselves except enthusiastically pointing at back-tests.

Also the level of defensiveness (even displayed in this good natured thread!) of some of the proponents is really off putting. Sort of a "who you trying to convince?" kind of thing.

With the latest bear market there is one more piece of interesting data. In the entire post-publication period the SCV factor premium is a no show using the very fund invented to capture it with the help of the academic researches that created the model. From inception in March of 1993 until market close last Friday it is tied with the Vanguard 500 Index fund at 9% CAGR.

Image
Uncorrelated wrote: Sun Apr 26, 2020 4:41 am Factor investing is not a question whether factors are real or not, but how much evidence you require to be convinced. If your standard of proof is so high that you even reject the value factor, then you should be rejecting all other tilts with weaker evidence as well. Such as country tilts.
It should be noted that one can accept the model's definition of 'value' without accepting a prediction of outperformance vs the market as a whole.
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Re: The Bottom Line on Factor Investing

Post by Uncorrelated »

Alchemist wrote: Sun Apr 26, 2020 4:53 am With the latest bear market there is one more piece of interesting data. In the entire post-publication period the SCV factor premium is a no show using the very fund invented to capture it with the help of the academic researches that created the model. From inception in March of 1993 until market close last Friday it is tied with the Vanguard 500 Index fund at 9% CAGR.
Since 1993 HLM posted a positive return of 2.2% per year, and SMB posted 0.9% per year. The reason you don't see that in your graph is that the factor exposure caused higher volatility and higher volatility decay. However, users with a modest tilt were able to capitalize on these premiums, after expenses. For example see this PV benchmark with a 30% SVC tilt.

It also shouldn't be forgotten that factors have delivered positive returns in out-of-sample (both pre and post-publication) international data. In the US, the raw value and size premia have been negative for the last 18 and 16 years respectively. For developed ex-us 13 and 3 years. For emerging only 1 and 10 years, respectively. (data from Ken French).

None of this means you should invest in factors, but the myth that factor premia has not shown up since publication is simply not true.
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Re: The Bottom Line on Factor Investing

Post by nisiprius »

simplesauce wrote: Sat Apr 25, 2020 9:46 pm ...Thank you so much for this post. I highly value your feedback on these forums. That chart comparing the two funds is especially eye opening. I also learned a new word from you: pareidolia...
For the record, I was posting a personal reminiscence, not an objective survey. If you were to read it as an argument against factors, factor advocates would have "answers" to every point I made.

(Incidentally, until I checked, I actually assumed that DFA Micro Cap had outperformed the market--higher returns, lower only in risk-adjusted return. But as you'd expect regardless of whether you are a factor investor or not, the higher risk of small-caps showed up as a deeper dive recently.)
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Re: The Bottom Line on Factor Investing

Post by Uncorrelated »

For what it is worth, AQR (a factor shop) doesn't believe in the size premium. Stating that the original study suffered from a desisting bias, most of the alpha of SMB being explained by higher CAPM beta, failure to confirm the size effect in international markets, and correlation with liquidity. Interestingly, with a 5-factor model the size factor suddenly becomes statistically significant, but with large negative exposure on RMW and CMA.

You can read their arguments here: https://www.aqr.com/Insights/Research/J ... ize-Effect (download the paper). I personally recommend against using pure size funds. Multi-factor funds (or SCV) that gain size factor exposure as a byproduct of targeting other factors work just fine.
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Re: The Bottom Line on Factor Investing

Post by dcabler »

Not really an a-ha moment. I was doing random stuff until 2008. Fortunately, the random things I did didn't end up biting me all that much. At that point I started reading, but hadn't heard about "factors", at least not in terms of the factor-zoo one can read about today. But I had read about both style and size. Arrived on bogleheads, learned more, backtested, tried to understand the context of the past and not just seemingly random sequences of returns. Ultimately arrived at a portfolio I'm happy with, which is mid-cap centric with a small amount of small cap value. But also some Emerging Markets and International small cap. Bonds are intermediate treasuries. I generally don't care how other portfolios are performing as I'm happy with my results as they suit me.

There is always a portfolio that's better than the one you have, even for the situation you live in. Problem is, you can't really know that in advance. I've also come to believe that investing is a small portion math and a large hunk of philosophy. It's something that I have to continually remind myself about because the engineer in me would prefer that it be more math/less philosophy. Because of the philosophical aspect, there is no right answer, just varying shades of grey. And I'm continually amazed by some posters here who believe that the choice they made is the one, true choice for everybody else...

Cheers.
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Re: The Bottom Line on Factor Investing

Post by reln »

simplesauce wrote: Sat Apr 25, 2020 5:22 pm I would like to explore both sides of the aisle, but on a more “personal“ level than many topics before this. Your answers can be brief.

For those in favor of Factor Investing:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs for using factor investing? Also, how did you decide which factors to use? (small, value, momentum, etc.)

For those skeptical:

Can you share one or two “A-Ha” moments you had that confirmed your beliefs that factor investing is not necessary?

For me, I am not convinced that factor premiums will persist far into the future. I’m concerned that many factors will be (or already have been) arbitraged away. There were two “A-Ha” moments for me recently that I would like to share:

1. The first is a quote from Investorguy1 on this forum. He wrote something that has stuck with me:

“There is something very appealing, maybe even elegant about holding the market. You are guaranteed to beat the majority of investors (no other strategy offers this), costs and taxes are minimized and so is time, effort and tracking error regret.”

2. The second is an article link provided by Taylor Larimore in a previous post. I found this to be a highly entertaining and informative read: https://www.institutionalinvestor.com/a ... egist-sick
I'm both a believer in factor investing and not.

From a theoretical perspective, Fama and French 5 factor model is as robust a theory as you can have in financial economics.

From a practical perspective, implementation and cost is prohibitive. Vanguard does not do a good job at getting consistently deep and balanced factor exposure where the factors actually matter for their factor tilted funds. And although DFA does implementation very well, the total cost to access DFA is too high imo. Charles Schwab factor funds are not on as sound a theoretical footing as DFA so it's unclear what you're actually getting in terms of legitimate factors for the extra cost. And a brief review of other factor funds land them in worse spots on the spectrum (from no significant exposure to the factors or too expensive to matter).
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Re: The Bottom Line on Factor Investing

Post by dbr »

The Fama-French model is a model for investment returns. You have to do a lot more work to understand how much and what kind of risk you are taking in a factor tilt and why there is a benefit in doing so. I personally am not interested in wandering around in that and trying to eke out some possible advantage or not while trying to figure out if it even actually works as an investment strategy. If my concern is to get more return I am content to allocate more to stocks and less to bonds.

One of the few hypothetical suggestions for using the higher return of, for example, small cap value (if there is indeed a higher return) and assuming that also brings greater volatility, is that one might attempt the "Larry Portfolio" of a high tilt and more in bonds to get a better profile for risk. Supposedly this sort of portfolio would, for example, somewhat increase safe withdrawal rates over using total stock and total bond portfolios, but I have not ever seen a model that shows an effect worth pursuing.
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

In a number of times, I've asked why SMB and HML factors are risky in this forum. I didn't get many responses. The few replies were "they are more volatile" and that was it. Apparently, they can't explain the nature of the risk yet okay with investing in them.
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Re: The Bottom Line on Factor Investing

Post by rascott »

The aha moment was that even if there is ZERO premium going forward.... diversification across different factors.... including a health amount of beta.... is a better "bet" in my view than putting 100% of your portfolio in market only.

The folks who denigrate factors don't understand them.... and as such shouldn't invest in them....as they won't stick to them.

In the same breath these people will happily hold huge % of money in international funds..... even as they're performed much worse than US factor funds in the recent decade. For some reason that diversification is valid.... but factor diversification isn't. This is rather bizarre behavior in my view, but whatever people can understand enough to stick with is probably best for them.
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

Forester wrote: Sun Apr 26, 2020 4:51 am
dmcmahon wrote: Sun Apr 26, 2020 2:08 am The data is telling us it's a large-cap, growth, US-centered world. Theoretical arguments based on outdated metrics such as price-to-book fall flat. I could just as easily argue that large cap growth, by virtue of both size (it's harder to grow fast as you get large) and P/E ratios, are riskier than average and thus justify a return premium.
The data (multiple expansion) tells us that's where the sentiment is but growth stocks are no more profitable today than pre-2010s.
I saw a graph recently showing the P/E of IVW (growth) / IVE (value); it came down from 3.5 to ~1.5 from 2004-2009 but since then has remained essentially flat. Seems that value expansion has been equal, value stocks have just stunk it up on earnings growth.
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Re: The Bottom Line on Factor Investing

Post by rascott »

acegolfer wrote: Sun Apr 26, 2020 7:43 am In a number of times, I've asked why SMB and HML factors are risky in this forum. I didn't get many responses. The few replies were "they are more volatile" and that was it. Apparently, they can't explain the nature of the risk yet okay with investing in them.
Smaller companies have much higher capital costs than large ones, less geographical focus, less product diversification..... much higher failure/ BK rate.

So do down and out companies and industries
...aka "value".

Look at the energy industry right now....a deep value play if there ever was one. Likely to be a lot of BKs.... but on the other side the survivors will consolidate, gain market share... and prosper on the other side.

These cycles happen over and over again.... and why small and value indexes typically fall hard going into recessions.... but can often hugely outperform coming out of them as the clouds clear from the storm.... and investors can more clearly see who survived. But riding head first into that storm is most certainly more risky.
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Re: The Bottom Line on Factor Investing

Post by rkhusky »

Two points for why I don't explicitly invest in factors:

1) The Fama-French model doesn't predict the out-performance of any factor. Factor investors must look to historical performance data to convince themselves that the factors will out-perform, which they could do without the Fama-French model.

2) Investors in risky investments should demand that they provide a higher premium than for less risky investments. But I have no way of influencing stock prices. On the other hand, I can look at CD's and bonds and demand higher interest/dividends for taking more risk in terms of term and rating.
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

rkhusky wrote: Sun Apr 26, 2020 8:01 am
2) Investors in risky investments should demand that they provide a higher premium than for less risky investments. But I have no way of influencing stock prices. On the other hand, I can look at CD's and bonds and demand higher interest/dividends for taking more risk in terms of term and rating.
Isn’t a higher E/P (earnings yield) synonymous to the increased yield of riskier fixed income investments?
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

rkhusky wrote: Sun Apr 26, 2020 8:01 am Two points for why I don't explicitly invest in factors:

1) The Fama-French model doesn't predict the out-performance of any factor. Factor investors must look to historical performance data to convince themselves that the factors will out-perform, which they could do without the Fama-French model.

2) Investors in risky investments should demand that they provide a higher premium than for less risky investments. But I have no way of influencing stock prices. On the other hand, I can look at CD's and bonds and demand higher interest/dividends for taking more risk in terms of term and rating.
Right. The reward for the risk isn’t quite guaranteed and I cannot justify overexposing our hard earned savings to riskier stocks without truly knowing if there will be a premium someday.

Look at the recent Covid-19 downturn. The “tilters” were hammered with deep losses compared to the broad market. I understand investing is a long-term quest, but the only way you can truly stick with a strategy like that is to firmly believe in your allocation, not tinker when newer factors and funds come out, and know in your heart that you picked the correct factors to overweight.

Based on the conflicting research and lack of future guarantee, I cannot be confident enough in getting that premium over the long-run. And I couldn’t convince my family to allow me to invest our earnings in a strategy like this. Whereas with the Total Market approach, you are guaranteed to beat most investors, and you are guaranteed to get your fair share. Isn’t that a sensible and prudent approach?

The only piece here that gives me some pause is the notion of “diversifying across factors” and how investing in the Total Market might only expose you to “one factor.” I do see the intrigue of this discussion and I am open to learning more about it. But I am unlikely to act on it unless I could be convinced wholeheartedly that this diversification was critical.
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

simplesauce wrote: Sun Apr 26, 2020 8:39 am
rkhusky wrote: Sun Apr 26, 2020 8:01 am Two points for why I don't explicitly invest in factors:

1) The Fama-French model doesn't predict the out-performance of any factor. Factor investors must look to historical performance data to convince themselves that the factors will out-perform, which they could do without the Fama-French model.

2) Investors in risky investments should demand that they provide a higher premium than for less risky investments. But I have no way of influencing stock prices. On the other hand, I can look at CD's and bonds and demand higher interest/dividends for taking more risk in terms of term and rating.
Right. The reward for the risk isn’t quite guaranteed and I cannot justify overexposing our hard earned savings to riskier stocks without truly knowing if there will be a premium someday.

Look at the recent Covid-19 downturn. The “tilters” were hammered with deep losses compared to the broad market. I understand investing is a long-term quest, but the only way you can truly stick with a strategy like that is to firmly believe in your allocation, not tinker when newer factors and funds come out, and know in your heart that you picked the correct factors to overweight.

Based on the conflicting research and lack of future guarantee, I cannot be confident enough in getting that premium over the long-run. And I couldn’t convince my family to allow me to invest our earnings in a strategy like this. Whereas with the Total Market approach, you are guaranteed to beat most investors, and you are guaranteed to get your fair share. Isn’t that a sensible and prudent approach?

The only piece here that gives me some pause is the notion of “diversifying across factors” and how investing in the Total Market might only expose you to “one factor.” I do see the intrigue of this discussion and I am open to learning more about it. But I am unlikely to act on it unless I could be convinced wholeheartedly that this diversification was critical.
I agree it’s important to have conviction. I have infinitely more conviction for my fundamental index holdings (which naturally tilt to value) then my pure value holdings. I think there’s a lot of anchoring out there to market cap weighting being the baseline when economic weighting makes sense to me (there are obviously pros and cons to each, but in the modern world of tax-efficient ETFs many of fundamental indexes cons are all but eliminated).
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Re: The Bottom Line on Factor Investing

Post by vineviz »

simplesauce wrote: Sun Apr 26, 2020 8:39 am Right. The reward for the risk isn’t quite guaranteed and I cannot justify overexposing our hard earned savings to riskier stocks without truly knowing if there will be a premium someday.
You understand the "reward for the risk isn’t quite guaranteed" for ANY stocks, right?

There is no "guarantee" that stocks will outperform bonds over any particular span of time. Does a lack of a "guarantee" prevent investors from owning stocks? Of course not.

And if there was a set of stocks that had a HIGHER chance of outperforming bonds than YOUR stocks, that'd be interesting right?
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Re: The Bottom Line on Factor Investing

Post by Triple digit golfer »

I have a theory and I have no idea if it's true and I can't even pinpoint why I think this. My theory is that on this forum, the factor tilters are a lower average age than the non-tilters.
rkhusky
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Joined: Thu Aug 18, 2011 8:09 pm

Re: The Bottom Line on Factor Investing

Post by rkhusky »

MotoTrojan wrote: Sun Apr 26, 2020 8:07 am
rkhusky wrote: Sun Apr 26, 2020 8:01 am
2) Investors in risky investments should demand that they provide a higher premium than for less risky investments. But I have no way of influencing stock prices. On the other hand, I can look at CD's and bonds and demand higher interest/dividends for taking more risk in terms of term and rating.
Isn’t a higher E/P (earnings yield) synonymous to the increased yield of riskier fixed income investments?
Good point. Perhaps E/P doesn't seem as stable to me as a CD interest rate.
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