The Bottom Line on Factor Investing

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simplesauce
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

vineviz wrote: Sun Apr 26, 2020 8:51 am
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?
Of course, it would be extremely interesting, but I am not convinced I have the talent to actively select the correct set of stocks, and then have the conviction to stick with that selection of stocks for a lifetime.

Diversifying a portfolio using simply Total Market Stocks/Bonds seems to be “good enough” for me, since I am guaranteed to get my fair share, paying almost nothing in fees. I have browsed this forum and read countless books to help me try to “do better,” but I have yet to enhance my portfolio.

Again, the notion that still intrigues me is the discussion on “diversifying across factors.” And I welcome more education on that topic. Although to make a change in my portfolio, I would need to meet my criteria of believing I have the talent and conviction.
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vineviz
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Re: The Bottom Line on Factor Investing

Post by vineviz »

Triple digit golfer wrote: Sun Apr 26, 2020 8:52 am 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.
It's likely that investors who built their mental models of how finance works before, say, 1995 did so with very different information than investors who did so after that.

You could have taken an investments 101 college course in 1990 and come out believing that a single factor model (i.e. CAPM) was a reasonable approximation of the world. I don't think that would be possible today.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
acegolfer
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

simplesauce wrote: Sun Apr 26, 2020 8:39 am 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.
There are some misconceptions on the diversification effect across factors in BH.

1. From theoretical perspective, by adding SMB and HML, it's possible to lower overall volatility. This is the "diversification" benefit that ppl claim. But unlike SMB, HML, all factor funds have idiosyncratic volatility, which will add to the overall volatility. This may negate the diversification benefit.

2. Moreover, even if there's net positive diversification effect, it only lowers stdev. But the average investor is not a mean-variance investor. We can't measure risk by stdev alone. By diversifying across risk factors, you are increasing non-volatility risks.
MotoTrojan
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

rkhusky wrote: Sun Apr 26, 2020 9:03 am
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.
Fair enough. Both have unknowns: stocks may not generate that level of earnings while bonds may default.
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vineviz
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Re: The Bottom Line on Factor Investing

Post by vineviz »

simplesauce wrote: Sun Apr 26, 2020 9:09 am Again, the notion that still intrigues me is the discussion on “diversifying across factors.” And I welcome more education on that topic. Although to make a change in my portfolio, I would need to meet my criteria of believing I have the talent and conviction.
The only "talent" necessary is the ability to understand that being being exposed to just one source of risk is less diversified than being exposed to multiple independent sources of risk.

And any investor who is understands the diversification benefits of owning both stocks and bonds has already demonstrated this "talent".

FWIW, I'm not sure "conviction" is exactly the right word to describe the quality needed to own - say - small cap value stocks. Honestly, I think it's more about "comfort".

Holding a more diversified portfolio than Total Stock Market requires holding a portfolio that looks DIFFERENT from Total Stock Market, and not every investor has the appropriate temperament to be different from consensus through periods of bad luck. Having a strong conviction is probably PART of having the comfort needed to be different, but I don't think it's only about conviction.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Taylor Larimore
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"Predicting the Past"

Post by Taylor Larimore »

Triple digit golfer wrote: Sun Apr 26, 2020 8:52 am 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.
Triple digit golfer:

Older investors have seen fads rise and fall. This post on the old Morningstar Forum explains:
PREDICTING THE PAST:

"If you feel you can improve your portfolio's asset allocation by running the portfolio through various computer programs, measuring and grading various risk/reward relationships, feel free. It's okay with me. Honest. For myself, I'm not interested.

I'm also not interested in running reams of data through a computer program in order to discover how much I can withdraw yearly from my portfolio and never go broke.

Without having studied it, I'm willing to assume the Risk Grades deal is similar to the well known Efficient Frontier concept: Invest in a mix of assets that will give the best return for the least risk.

Wonderful. The problem in execution is this; both these approaches would seem to be limited to looking at PAST risk/return relationships, in order to predict FUTURE such relationships.

This approach hasn't worked very well and it never will.

There's lots of stuff we can learn by studying the past. One thing we can't learn, though, is how much the future will resemble the past.

There really is an Efficient Frontier. There really is a withdrawal rate that will allow my wife and I to spend all our money during our life-times, but never go broke.

But these things are unknown and unknowable, going forward. Such things are only knowable looking backward.

Given that such things are only knowable looking backward, academics with more letters after their names than I have money in the bank, have spent unconscionable amounts of time goobering through the past. They thus invented Modern Portfolio Theory---Beta, Alpha, R-Squared, and the crowning achievement, Sharpe Ratio. These accomplishments were celebrated and awards were given. Yes.

And then...a funny thing happened on the way to the bank. These numbers turned out to have little or no predictive value, regarding returns. And since they couldn't predict returns, they also failed to predict risk/return ratios.

Joining in the fun, M* invented their first Star Rating system, a system that graded...yep...risk- adjusted, past performance.

I wish I had 10 bucks for every post I've read where the poster said, essentially, "I have a balanced portfolio, made up entirely of 4 and 5 star funds." Too late, these jokers discovered what M* eventually discovered; past risk-adjusted performance doesn't predict future risk-adjusted performance.

I don't want to discover the Sharpe Ratio of my portfolio. I don't want to discover its Beta. I don't want to discover its Risk Grade. I have absolutely no confidence that adjusting the portfolio so that these numbers become more favorable will improve future risk/reward.

If others do want to do that, that's okay with me. I seriously doubt, though, that many successful mutual fund managers select securities in that manner. If any do, or if any money managers set their asset allocations in that manner, I'd be interested in their long-term results---results over periods of, say, 10 years, or more.

In short, computers are wonderous tools, but that's all they are. Every computer on Earth, all linked up and working 24/7, from now on, won't tell me my survivable withdrawal rate. Neither will they tell me what asset allocation would give me the best risk/reward ratio.

In my opinion, these things can't be calculated (using past performance). We have to forge ahead without knowing these things. Deal with it. -- Ozark"
Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."
"Simplicity is the master key to financial success." -- Jack Bogle
Topic Author
simplesauce
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

acegolfer wrote: Sun Apr 26, 2020 9:22 am
simplesauce wrote: Sun Apr 26, 2020 8:39 am 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.
There are some misconceptions on the diversification effect across factors in BH.

1. From theoretical perspective, by adding SMB and HML, it's possible to lower overall volatility. This is the "diversification" benefit that ppl claim. But unlike SMB, HML, all factor funds have idiosyncratic volatility, which will add to the overall volatility. This may negate the diversification benefit.

2. Moreover, even if there's net positive diversification effect, it only lowers stdev. But the average investor is not a mean-variance investor. We can't measure risk by stdev alone. By diversifying across risk factors, you are increasing non-volatility risks.
Very interesting perspective, thank you.
acegolfer
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

rascott wrote: Sun Apr 26, 2020 7:56 am and why small and value indexes typically fall hard going into recessions
This is one explanation for small and value risk factors. These stocks suffer more in recessions than other stocks. From the investor's perspective, these stocks are correlated with the state variable in Merton's intertemporal-CAPM hence are required a higher E(r).
acegolfer
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

simplesauce wrote: Sun Apr 26, 2020 9:32 am
acegolfer wrote: Sun Apr 26, 2020 9:22 am
simplesauce wrote: Sun Apr 26, 2020 8:39 am 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.
There are some misconceptions on the diversification effect across factors in BH.

1. From theoretical perspective, by adding SMB and HML, it's possible to lower overall volatility. This is the "diversification" benefit that ppl claim. But unlike SMB, HML, all factor funds have idiosyncratic volatility, which will add to the overall volatility. This may negate the diversification benefit.

2. Moreover, even if there's net positive diversification effect, it only lowers stdev. But the average investor is not a mean-variance investor. We can't measure risk by stdev alone. By diversifying across risk factors, you are increasing non-volatility risks.
Very interesting perspective, thank you.
If you want to read more, try "Portfolio advice for a multifactor world"
https://faculty.chicagobooth.edu/john.c ... 3Q99_4.pdf
whereskyle
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Re: The Bottom Line on Factor Investing

Post by whereskyle »

Uncorrelated wrote: Sun Apr 26, 2020 3:04 am
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.
In 1992, before the Y2K crash, large-cap growth had not for a long time experienced the extreme volatility it would experience less than a decade later when frankly it was completely demolished. I'm not saying I think large growth is necessarily riskier. I'm saying much of history since approximately 1992 has upended the clarity of the value/small risk premium. I think Jack would say Reversion to the Mean had been lurking all along. Nearly all the data since the 90s has challenged the points in your post. Large growth can rage like fire, making investors rich, and it can crash like hell, making investors poor. I think large-cap growth is still typically more stable (it has been through this downturn), but the bears will say it's all overpriced and is therefore riskier than it seems.
"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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grabiner
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Re: The Bottom Line on Factor Investing

Post by grabiner »

dmcmahon wrote: Sun Apr 26, 2020 1:05 am 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.
The development of ETFs has changed this issue. Factors other than value can be held tax-efficiently, since ETFs eliminate the capital gains when small-cap stocks become large-cap or positive-momentum stocks become negative-momentum. Value still benefits from tax-deferral because value stocks have higher dividend yields.

And this has affected my factor investing. For years, I had a target weight for value stocks, but I did not hold that weight because I would hold them only in my Roth IRA and HSA (and in some employer plans, including one which I rolled over to the Roth IRA), which was not large enough. Now, it is just barely large enough, with my entire Roth IRA and HSA in value stocks and REITs.
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oldfort
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Re: The Bottom Line on Factor Investing

Post by oldfort »

nisiprius wrote: Sat Apr 25, 2020 8:56 pm 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)."
Yes, this paper documents over 400 factors. The more factors, which are added to the factor zoo, the more this looks like data mining, or a poor man's quant hedge fund.

https://papers.ssrn.com/sol3/papers.cfm ... id=3341728
Last edited by oldfort on Sun Apr 26, 2020 11:34 am, edited 1 time in total.
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simplesauce
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

grabiner wrote: Sun Apr 26, 2020 10:32 am
dmcmahon wrote: Sun Apr 26, 2020 1:05 am 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.
The development of ETFs has changed this issue. Factors other than value can be held tax-efficiently, since ETFs eliminate the capital gains when small-cap stocks become large-cap or positive-momentum stocks become negative-momentum. Value still benefits from tax-deferral because value stocks have higher dividend yields.

And this has affected my factor investing. For years, I had a target weight for value stocks, but I did not hold that weight because I would hold them only in my Roth IRA and HSA (and in some employer plans, including one which I rolled over to the Roth IRA), which was not large enough. Now, it is just barely large enough, with my entire Roth IRA and HSA in value stocks and REITs.
Thank you for this point. Always appreciate your posts. Can you share which value fund you are using and how you chose it? Also, how did you decide to just focus on the value factor?
BigJohn
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Re: The Bottom Line on Factor Investing

Post by BigJohn »

Not a factor investor. My two a-ha moments

1) Reading Bill Bernstein’s “Skating were the Puck Was”

2) Doing some simple math that showed a small tilt (ie 5-10%) even if true would not make a huge change in my total return. It takes a true believers to tilt at 4-5 times that amount and so I discovered I was not a true believer.
rkhusky
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Re: The Bottom Line on Factor Investing

Post by rkhusky »

vineviz wrote: Sun Apr 26, 2020 9:29 am And any investor who is understands the diversification benefits of owning both stocks and bonds has already demonstrated this "talent".
There is a difference between adding bonds to a stock portfolio and factor investing.

In the traditional sense of diversification, different assets are added to the portfolio. Start with a US stock portfolio, then add International stocks, add bonds, add physical real estate, add physical precious metals, add commodities, etc., until the portfolio has many types of investments.

In the factor sense of diversification, start with a US stock portfolio, then subtract growth stocks, subtract large stocks, subtract low quality stocks, subtract low momentum stocks, etc., until all the stocks in the portfolio have the same characteristics.
redbarn
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Re: The Bottom Line on Factor Investing

Post by redbarn »

simplesauce wrote: Sun Apr 26, 2020 8:39 am
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.
This argument is made frequently but there are several layers of theorizing between the actual evidence and what would be needed to make this argument. The evidence Fama and French provide just documents that value and small size did better over their sample period. The evidence does not say anything about risk factors or diversifying among these factors. That is all a theoretical interpretation of the data. Furthermore, the only real "evidence" for the theory seems to be the very evidence that the theory is being used to interpret.
BrooklynInvest
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Re: The Bottom Line on Factor Investing

Post by BrooklynInvest »

I can't articulate the difference between past factor outperformance and, admittedly sophisticated, backtesting so I go with Buffett's doctrine of "If I don't understand it I don't invest in it."
Elysium
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Re: The Bottom Line on Factor Investing

Post by Elysium »

vineviz wrote: Sat Apr 25, 2020 8:24 pm
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.
Most quant funds look like rotten apples to me.

Vanguard especially does have a stinking record running quant funds, some of them have been liquidated, others just muddle along.
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vineviz
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Re: The Bottom Line on Factor Investing

Post by vineviz »

rkhusky wrote: Sun Apr 26, 2020 11:47 am
vineviz wrote: Sun Apr 26, 2020 9:29 am And any investor who is understands the diversification benefits of owning both stocks and bonds has already demonstrated this "talent".
There is a difference between adding bonds to a stock portfolio and factor investing.
They are both "factor investing", the only difference is the factors in which you are investing.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
stan1
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Re: The Bottom Line on Factor Investing

Post by stan1 »

Some (many) will be uncomfortable with this but the "bottom line" is that it is a personal preference. I know some will want something more rigorous and factual and will cite experts who agree with them but at the end of the day a lot of it is about each individual's human behavior and emotion which is neither rigorous or factual.

Too much revolves around a view that there can only be one right answer and all others must therefore be wrong. Maybe some people even need to build their own confidence that their answer is right by arguing against any other possible answer.
index245
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Re: The Bottom Line on Factor Investing

Post by index245 »

Follow whatever path you can stick to.

It is very easy to be a market based (ie Total Stock Market) only investor the past 10-ish years. Top performing category (large cap).

Can you stick to it when it underperforms multiple categories? From 2000 to 2010, when TSM trailed Emerging Markets....and Small Cap Value....and REITS, etc. How did it turn out for those who chased the top category at the end of that run?

If you chase returns, easy to get burned.
Last edited by index245 on Sun Apr 26, 2020 12:16 pm, edited 1 time in total.
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vineviz
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Re: The Bottom Line on Factor Investing

Post by vineviz »

redbarn wrote: Sun Apr 26, 2020 11:53 am The evidence does not say anything about risk factors or diversifying among these factors. That is all a theoretical interpretation of the data.
This is only true if you don't listen to the evidence, I'm afraid.

If the evidence of systematic differences in the returns of cheap and expensive stocks are only theoretical, how do you explain the very real underperformance of value stocks over the past decade?

Either there are real difference in risk exposure between cheap and expensive stocks, or else financial markets are WILDLY inefficient. Which do you think is more likely?
"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: The Bottom Line on Factor Investing

Post by IndexCore »

I've read numerous investment books, including a few by Larry Swedroe on factor investing. I'd struggled with the difference I saw in small cap/value and the historical performance, and was ripe for a change.

On another forum, I got fed up with all the people chasing performance - it actually annoyed me. And I took that annoyance, and said if they're all chasing performance, I might as well buy a momentum fund to profit off it. Not greed, but annoyance. I think that's the right combination for me - break from passive investment when poor behavior in the markets annoys me so much, I have to change. Momentum did really well historically, and has done really well for me.

And if enough people join me.... well, it will break. Hopefully I'll get annoyed before then.
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

IndexCore wrote: Sun Apr 26, 2020 12:49 pm I've read numerous investment books, including a few by Larry Swedroe on factor investing. I'd struggled with the difference I saw in small cap/value and the historical performance, and was ripe for a change.

On another forum, I got fed up with all the people chasing performance - it actually annoyed me. And I took that annoyance, and said if they're all chasing performance, I might as well buy a momentum fund to profit off it. Not greed, but annoyance. I think that's the right combination for me - break from passive investment when poor behavior in the markets annoys me so much, I have to change. Momentum did really well historically, and has done really well for me.

And if enough people join me.... well, it will break. Hopefully I'll get annoyed before then.
Why will it break? More ppl using momentum, more profitable. What am I missing?
redbarn
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Re: The Bottom Line on Factor Investing

Post by redbarn »

vineviz wrote: Sun Apr 26, 2020 12:16 pm
redbarn wrote: Sun Apr 26, 2020 11:53 am The evidence does not say anything about risk factors or diversifying among these factors. That is all a theoretical interpretation of the data.
This is only true if you don't listen to the evidence, I'm afraid.

If the evidence of systematic differences in the returns of cheap and expensive stocks are only theoretical, how do you explain the very real underperformance of value stocks over the past decade?

Either there are real difference in risk exposure between cheap and expensive stocks, or else financial markets are WILDLY inefficient. Which do you think is more likely?
You could make the exact same arguments you are making with respect to different sectors (for example) rather than cheap vs. expensive stocks. I fail to see why the relative under-performance of one subset of stocks implies any kind of inefficiency, let alone wild inefficiency. Even if you believe that expected returns are literally equalized across all stocks in equilibrium, this does not mean the actual returns have to be the same or even similar.
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Taylor Larimore
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"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 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:

Several years ago I posted my thoughts about "Factor Investing." This is the link:

FACTOR INVESTING

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
oldfort
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Re: The Bottom Line on Factor Investing

Post by oldfort »

Out of Fama's three original factors, the size effect has almost been discredited. It's believed to have been overstated due to errors in the data set Fama used related to delisted stocks. It hasn't held up internationally. The excess return disappears entirely if you exclude the January effect.

https://papers.ssrn.com/sol3/papers.cfm ... id=3177539
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simplesauce
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Re: "Factor Investing"

Post by simplesauce »

Taylor Larimore wrote: Sun Apr 26, 2020 1:39 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 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:

Several years ago I posted my thoughts about "Factor Investing." This is the link:

FACTOR INVESTING

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "By and large I do not approve of factor funds."
Thanks Taylor. I am very familiar with that thread! That is where I discovered an article you linked: https://www.institutionalinvestor.com/a ... egist-sick
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grabiner
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Re: The Bottom Line on Factor Investing

Post by grabiner »

simplesauce wrote: Sun Apr 26, 2020 11:32 am
grabiner wrote: Sun Apr 26, 2020 10:32 am And this has affected my factor investing. For years, I had a target weight for value stocks, but I did not hold that weight because I would hold them only in my Roth IRA and HSA (and in some employer plans, including one which I rolled over to the Roth IRA), which was not large enough. Now, it is just barely large enough, with my entire Roth IRA and HSA in value stocks and REITs.
Thank you for this point. Always appreciate your posts. Can you share which value fund you are using and how you chose it? Also, how did you decide to just focus on the value factor?
I have long overweighted small-cap and value, in both taxable and tax-deferred.

For a long time, I used Vanguard's Value Index and Small-Cap Value Index, and I held S&P 600 Pure Value ETF (RZV) in my HSA Now, I use Vanguard Factor Value ETF (VFVA) because it gives better value exposure.

I also use MSCI EAFE Factor Value ETF (IVLU) In my taxable account; it has been relatively tax-efficient.
Wiki David Grabiner
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

grabiner wrote: Sun Apr 26, 2020 3:39 pm
simplesauce wrote: Sun Apr 26, 2020 11:32 am
grabiner wrote: Sun Apr 26, 2020 10:32 am And this has affected my factor investing. For years, I had a target weight for value stocks, but I did not hold that weight because I would hold them only in my Roth IRA and HSA (and in some employer plans, including one which I rolled over to the Roth IRA), which was not large enough. Now, it is just barely large enough, with my entire Roth IRA and HSA in value stocks and REITs.
Thank you for this point. Always appreciate your posts. Can you share which value fund you are using and how you chose it? Also, how did you decide to just focus on the value factor?
I have long overweighted small-cap and value, in both taxable and tax-deferred.

For a long time, I used Vanguard's Value Index and Small-Cap Value Index, and I held S&P 600 Pure Value ETF (RZV) in my HSA Now, I use Vanguard Factor Value ETF (VFVA) because it gives better value exposure.

I also use MSCI EAFE Factor Value ETF (IVLU) In my taxable account; it has been relatively tax-efficient.
Thank you for sharing! I will look at all of these funds. But for me, this would probably be too much to manage. And I am not sure I can stick with a strategy that looks much different than the overall market return.
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Re: The Bottom Line on Factor Investing

Post by grabiner »

simplesauce wrote: Sun Apr 26, 2020 4:11 pm
grabiner wrote: Sun Apr 26, 2020 3:39 pm I have long overweighted small-cap and value, in both taxable and tax-deferred.

For a long time, I used Vanguard's Value Index and Small-Cap Value Index, and I held S&P 600 Pure Value ETF (RZV) in my HSA Now, I use Vanguard Factor Value ETF (VFVA) because it gives better value exposure.

I also use MSCI EAFE Factor Value ETF (IVLU) In my taxable account; it has been relatively tax-efficient.
Thank you for sharing! I will look at all of these funds. But for me, this would probably be too much to manage. And I am not sure I can stick with a strategy that looks much different than the overall market return.
One of my standard pieces of advice is that I never recommend anyone match my portfolio. If a portfolio like mine is right for you, then you know enough to ignore that advice.

And you have to stick with the portfolio, as there will be long times in which it doesn't work that well. The basic design of my portfolio, overweighting small-cap, value, and emerging markets, has not changed since 2002, although I have changed the stock/bond allocation as my risk tolerance changed, and have added new funds as they became available (VFVA and IVLU are both recent additions).
Wiki David Grabiner
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Re: The Bottom Line on Factor Investing

Post by oldfort »

Although I don't believe in factor investing, this paper makes the best counter-argument out there. A multi-factor, multi-asset class approach has better returns than any individual factor. The title is something of an exaggeration, as the international stock data starts in the 1980s.

https://www.aqr.com/Insights/Research/W ... f-Evidence
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Re: The Bottom Line on Factor Investing

Post by simplesauce »

oldfort wrote: Sun Apr 26, 2020 4:52 pm Although I don't believe in factor investing, this paper makes the best counter-argument out there. A multi-factor, multi-asset class approach has better returns than any individual factor. The title is something of an exaggeration, as the international stock data starts in the 1980s.

https://www.aqr.com/Insights/Research/W ... f-Evidence
Thank you. For a similar sentiment, this Christine Benz interview states that using one MultiFactor Fund is the best approach for the individual investor, should they choose to invest using factors: https://youtu.be/6EFl3cFe4A8
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Re: The Bottom Line on Factor Investing

Post by Elysium »

oldfort wrote: Sun Apr 26, 2020 4:52 pm Although I don't believe in factor investing, this paper makes the best counter-argument out there. A multi-factor, multi-asset class approach has better returns than any individual factor. The title is something of an exaggeration, as the international stock data starts in the 1980s.

https://www.aqr.com/Insights/Research/W ... f-Evidence
Unfortunately for investors in AQR funds no such luck. All of AQR's multi-style multi-factor funds are having negative returns for the past five years. They were negative when market cap weighted equity index funds were positive and they are again negative when same index funds are negative, very consistent in that regard, the only constant is the high fees they charge, upwards of 1.5% to 2.5% depending on the fund. This has made AQR founders very rich and their investors very poor.
Last edited by Elysium on Sun Apr 26, 2020 5:10 pm, edited 1 time in total.
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Re: The Bottom Line on Factor Investing

Post by fatFIRE »

oldfort wrote: Sun Apr 26, 2020 2:10 pm Out of Fama's three original factors, the size effect has almost been discredited. It's believed to have been overstated due to errors in the data set Fama used related to delisted stocks. It hasn't held up internationally. The excess return disappears entirely if you exclude the January effect.

https://papers.ssrn.com/sol3/papers.cfm ... id=3177539
viewtopic.php?t=252355
That paper is from AQR. It's not objective by any means.
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Re: The Bottom Line on Factor Investing

Post by fatFIRE »

Personally I use small-value tilt to about 40-50% of my stock portfolio.

Yes, it is belief that the SV benefits will persist, but I have decades to work on it. Yes, I know it's more volatile, but I'm only focused on the final numbers.

I personally don't understand the double standard between holding international vs holding small-value. It seems that many here do international "tilt" but won't do SV-tilt.

Just as I'm not sure if the US or ex-US will produce better returns, I am not sure if TSM (which is mostly large growth) will produce better returns than SV (which is like an opposite of TSM).
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Re: The Bottom Line on Factor Investing

Post by palaheel »

I found Paul Merriman before BH. I was impressed that he had data going back to 1970. I remember the inflation pain of the late 70s and early 80s, and I'd been looking for just that sort of data for years.

I went with small & value tilts around 2012, maybe(?). I was always at least 40% international, and increased that to 50% around the same time. It seems it was just as US large growth was taking off :oops:

I'm making a small bet, and the odds are only very slightly in my favor. It might or might not pay off. If it doesn't pay off, I'll still be ok.
Markets crash. Markets recover. Inflation takes your money FOREVER.
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Re: The Bottom Line on Factor Investing

Post by fatFIRE »

palaheel wrote: Sun Apr 26, 2020 5:32 pm I found Paul Merriman before BH. I was impressed that he had data going back to 1970. I remember the inflation pain of the late 70s and early 80s, and I'd been looking for just that sort of data for years.

I went with small & value tilts around 2012, maybe(?). I was always at least 40% international, and increased that to 50% around the same time. It seems it was just as US large growth was taking off :oops:

I'm making a small bet, and the odds are only very slightly in my favor. It might or might not pay off. If it doesn't pay off, I'll still be ok.
Same here, I'm literally slicing and dicing at 50:50 because I cannot predict who will win.

My stocks are actually
US TSM: 25%
US SV: 25%
ex-US TSM: 25%
ex-US SV: 25%

My ex-US is further 50:50 into developed:emerging.
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Re: The Bottom Line on Factor Investing

Post by Triple digit golfer »

fatFIRE wrote: Sun Apr 26, 2020 5:35 pm
palaheel wrote: Sun Apr 26, 2020 5:32 pm I found Paul Merriman before BH. I was impressed that he had data going back to 1970. I remember the inflation pain of the late 70s and early 80s, and I'd been looking for just that sort of data for years.

I went with small & value tilts around 2012, maybe(?). I was always at least 40% international, and increased that to 50% around the same time. It seems it was just as US large growth was taking off :oops:

I'm making a small bet, and the odds are only very slightly in my favor. It might or might not pay off. If it doesn't pay off, I'll still be ok.
Same here, I'm literally slicing and dicing at 50:50 because I cannot predict who will win.

My stocks are actually
US TSM: 25%
US SV: 25%
ex-US TSM: 25%
ex-US SV: 25%
What if growth wins?

Wouldn't a true 50/50 be 25% LG, 25% LV, 25% SG, 25% SV? Or, more simply, 50/50 large blend/small blend?
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Re: The Bottom Line on Factor Investing

Post by oldfort »

As to why I don't invest in factors, I can't get past the factor zoo. Given the strong temptation for data mining, I think a t-stat of 4 should be considered the minimum at which a factor is considered statistically significant.
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Re: The Bottom Line on Factor Investing

Post by DonIce »

vineviz wrote: Sun Apr 26, 2020 9:29 am Holding a more diversified portfolio than Total Stock Market requires holding a portfolio that looks DIFFERENT from Total Stock Market, and not every investor has the appropriate temperament to be different from consensus through periods of bad luck. Having a strong conviction is probably PART of having the comfort needed to be different, but I don't think it's only about conviction.
I think most people have a hard enough time just staying the course even with total stock market funds when it comes to periods of market downturn. The amount of panic there was even here on this forum during the recent very brief and relatively minor downturn was impressive. Realistically, I think holding TSM and not panic selling during drops is already quite "different" from your typical investor.
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Re: The Bottom Line on Factor Investing

Post by DonIce »

fatFIRE wrote: Sun Apr 26, 2020 5:17 pm Personally I use small-value tilt to about 40-50% of my stock portfolio.

Yes, it is belief that the SV benefits will persist, but I have decades to work on it. Yes, I know it's more volatile, but I'm only focused on the final numbers.

I personally don't understand the double standard between holding international vs holding small-value. It seems that many here do international "tilt" but won't do SV-tilt.

Just as I'm not sure if the US or ex-US will produce better returns, I am not sure if TSM (which is mostly large growth) will produce better returns than SV (which is like an opposite of TSM).
Are you sure you understand factors any better than you understood USO?

More volatile includes more uncertainty in your "final number", too.

A "tilt" to international would be holding more than ~50% international, which almost no one here does. In fact, most have a strong US tilt, because of home country bias.
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Re: The Bottom Line on Factor Investing

Post by redbarn »

fatFIRE wrote: Sun Apr 26, 2020 5:17 pm
I personally don't understand the double standard between holding international vs holding small-value. It seems that many here do international "tilt" but won't do SV-tilt.

Just as I'm not sure if the US or ex-US will produce better returns, I am not sure if TSM (which is mostly large growth) will produce better returns than SV (which is like an opposite of TSM).
You are presumably also not sure whether any subset of TSM will do better or worse than TSM. So if this the argument, then why not also have equal parts REITS, healthcare, utilities, tech, quality, momentum, stocks with tickers that start with "A", etc.? (Unlike these other options, international is not a subset of TSM.)
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Re: The Bottom Line on Factor Investing

Post by dbr »

redbarn wrote: Sun Apr 26, 2020 11:20 pm (Unlike these other options, international is not a subset of TSM.)
Right. If there is a "tilt" involving international it would mean that the US TSM is a tilt to US, etc. But I don't think I have seen anyone identify a "country" factor in the same sense as small and value, etc. The relevant portfolio that would be neutral on that factor would be a world capitalization.
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

dbr wrote: Mon Apr 27, 2020 7:28 am
redbarn wrote: Sun Apr 26, 2020 11:20 pm (Unlike these other options, international is not a subset of TSM.)
Right. If there is a "tilt" involving international it would mean that the US TSM is a tilt to US, etc. But I don't think I have seen anyone identify a "country" factor in the same sense as small and value, etc. The relevant portfolio that would be neutral on that factor would be a world capitalization.
FYI, from asset pricing theory perspective, a country factor is of no use. It won't be a "common factor" to explain cross sectional returns. Yes, you can add a UK factor to explain UK stocks. But it won't be a common factor to explain US stocks.
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Post by grayfox »

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Re: The Bottom Line on Factor Investing

Post by CULater »

Image
The iShares Large Cap Growth ETF (JKE) has absolutely crushed the iShares Large Cap Value ETF (JKF) since inception and this relative performance is representative of the major indexes. In fact, growth has out-performed value over every recent time horizon. For the year to date, JKE is down 1% but JKF is down almost 19%.
Ironically, could the Bogleheads be to blame?
First, the massive shift towards passive investing and index funds reduces the significance of value. Stocks that have increased in price more quickly than peers are an ever-larger component of the indexes (because most indexes are market cap weighted), which means that index investors are effectively growth investors.
https://seekingalpha.com/article/434003 ... ent=link-1
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Re: The Bottom Line on Factor Investing

Post by Uncorrelated »

grayfox wrote: Mon Apr 27, 2020 8:17 am My A-Ha moment with factors was as soon as I learned about them on the Bogleheads forum.

Up until that time I had only read two books on investing way back in about 1980. A Random Walk Down Wall Street by Burton G. Malkiel and The Only Investment Guide You Will Ever Need by Andrew Tobias. From those books, I learned that professors at Universities had researched stock returns and concluded that the market was efficient and nobody could make excess returns by picking stocks or market timing. The only possible way to beat the market was using inside information, which is illegal. It's called the Efficient Markets Hypothesis. So just invest in broad market index. End of story.

So that's what I did. I invested in 100% in S&P 500 and never read another investing book...until I found the Bogleheads sometime in the 2000's.

That's when I heard about these so-called "factors". I looked into it and learned that a couple of finance professors were now claiming that, after proving that the market was efficient and no one could beat the market by stock picking or market timing, they, in fact, could beat the market by stock picking.

So the theory was no one can beat the market because the market is efficient. Suddenly the theory is no one can beat the market, except us. And we just happen to run a fund. Just gives us your money and you can beat the market, too. Right.

:arrow: Factors were discovered so that they have something to sell you. That's why researchers keep finding more factors. They all want to start a fund based on their new factor to get AUM. That's why there are now 400 factors. They all want their piece of the action.

Another aA-Ha: Who was the main guy on the BH board pushing factors? A guy selling factor funds. What a coincidence.
The existence of factors is not a contradiction to the efficient market hypothesis. People tilt towards equities (as opposed to holding stocks & bonds in market-weighted quantities) for the same underlying reasons that factor tilters use to tilt towards factors.
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Re: The Bottom Line on Factor Investing

Post by megabad »

Never really had an “aha” moment of support. Just needed a TLH option and since SCV was a fad, I swung slightly toward that tilt on a particular sale. I still hold a pretty good chuck there but it is tiny compared to overall portfolio size. “Aha” moment that went against most factor investing for me was the “unicorn” trend. There are some spectacular examples of unexpected volatility in valuation which lead me to generally support just riding the market cap wave. If I had billions and direct access to [legal] insider information on private equity, my opinion might change (or it might not). “Fortunately”... I will almost certainly never have this problem. If I do, see you on shark tank.
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

grayfox wrote: Mon Apr 27, 2020 8:17 am That's when I heard about these so-called "factors". I looked into it and learned that a couple of finance professors were now claiming that, after proving that the market was efficient and no one could beat the market by stock picking or market timing, they, in fact, could beat the market by stock picking.
I doubt those professors literally said "they could beat the market by stock picking". Perhaps ppl took it out of context and misinterpreted it.
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