The Bottom Line on Factor Investing

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muffins14
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Re: The Bottom Line on Factor Investing

Post by muffins14 »

Elysium wrote: Wed Apr 29, 2020 9:05 am
if you had a sector neutral (matches total market) fund that loaded on the size or value factor, how would you expect it to perform?

Would you not expect lower correlation to the total market in a way that could improve your overall portfolio performance when including it in some proportion?
IndexCore
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Re: The Bottom Line on Factor Investing

Post by IndexCore »

Elysium wrote: Wed Apr 29, 2020 7:10 am Factor investing may be biggest scam where Wall street re-packaged Sector funds, offered a new story, and sold down to gullible investors.
Using the phrase "biggest scam" to describe the main topic of this thread looks to me like trolling.

Just to troll back, you're saying a hedge fund charging 2% of assets and 20% of profits is a smaller scam than investing in SPDR S&P 600 Small Cap Value ETF (SLYV) which has a 0.15% expense ratio?

https://www.bogleheads.org/wiki/Cost_matters_hypothesis
Elysium
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Re: The Bottom Line on Factor Investing

Post by Elysium »

IndexCore wrote: Wed Apr 29, 2020 10:05 am you're saying a hedge fund charging 2% of assets and 20% of profits is a smaller scam than investing in SPDR S&P 600 Small Cap Value ETF (SLYV) which has a 0.15% expense ratio?
If you are honest, you will know even tiny expense ratios can make a difference when sold in large volumes. Not just that, the number of products available and sold adds to the bottomline, it is designed to capture that money that may flow elsewhere. They are also designed to make securities more widely traded, by ETFs purchasing and selling more number of shares, that creates transactions costs. trading fees, bid/ask spreads for the market makers, traders, brokerages, financial advisors. The Eco system created by more index products / ETFs are much more than the differences in expense ratio. Someone has to be either a novice or disingenuous not to be aware of all this.
acegolfer
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

muffins14 wrote: Wed Apr 29, 2020 9:51 am if you had a sector neutral (matches total market) fund that loaded on the size or value factor, how would you expect it to perform?

Would you not expect lower correlation to the total market in a way that could improve your overall portfolio performance when including it in some proportion?
Not OP. Such portfolio will have

1. E(r) = rf + b*(MKT-rf) + s*SMB + h*HML. This could be higher or lower than MKT depending on the size of b, s, h.
2. considerable idiosyncratic volatility = Var(e)
3. could have low correlation (again depends on the size of b, s, h)
4. regardless, it will not have higher risk-adjusted return than MKT.
Blue456
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Re: The Bottom Line on Factor Investing

Post by Blue456 »

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.)

The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio.
Massdriver
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Re: The Bottom Line on Factor Investing

Post by Massdriver »

I tilt small value. My moment was on these forums around 8 years ago reading through all the debates people had here on TSM vs tilting to small value, and I concluded based on the evidence that SCV has a reasonable chance of outperforming. After reading through those threads and many of the great links provided, I concluded there was sufficient evidence to put around 15-25% of my equity allocation into cheaper small value funds, and small cap int funds, while maintaining 75%+ in TSM. I figured if it outperforms, I will get a modest boost to my long-term returns. If it doesn't, I'm out a bit, but probably not by much unless I sell during a severe downturn when small caps fall harder.

My second moment has been this latest bear market. The downturn allowed me to tax loss harvest one of small cap value funds and reallocate it to a different index. I also bought SCV funds that were 35%+ off YTD. I believe these rebalancing and TLH bonuses will end up paying off in the future even if there isn't a small cap value premium.


With that said, as I've grown older, I've come to appreciate and gravitate towards simplicity and more towards the VT and chill crowd. I have a joint account I'll be starting late this year, and my allocation in that account will likely being very simple going forward. I'll continue to maintain my tilts in my individual account, but I am likely going 100% VT for my equity allocation in my new joint account with my soon to be wife.

I also recommend VT to people new to investing, or VTI-VXUS if they insist on U.S. overweight.
BigJohn
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Re: The Bottom Line on Factor Investing

Post by BigJohn »

Blue456 wrote: Wed Apr 29, 2020 1:07 pm The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio.
Not quite the same in my mind. Overweighting small is a diversification from TSM only if it has some return generation mechanism different and independent from the rest of the market. This might be true or it might just be data mining. Or it might have been true 30+ years ago but market changes (eg knowledge and availability of low cost factor funds) may have reduced or eliminated what used to exist.

On the other hand, international is a different set of investments by simple inspection. It doesn’t require the leap of faith that diversification via factors requires.
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vineviz
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Re: The Bottom Line on Factor Investing

Post by vineviz »

BigJohn wrote: Wed Apr 29, 2020 4:52 pm
Blue456 wrote: Wed Apr 29, 2020 1:07 pm The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio.
Not quite the same in my mind. Overweighting small is a diversification from TSM only if it has some return generation mechanism different and independent from the rest of the market. This might be true or it might just be data mining. Or it might have been true 30+ years ago but market changes (eg knowledge and availability of low cost factor funds) may have reduced or eliminated what used to exist.

On the other hand, international is a different set of investments by simple inspection. It doesn’t require the leap of faith that diversification via factors requires.
If the dramatic underperformance of SCV for the past 18 months doesn’t represent a “different and independent” return stream from large cap stocks, it’s hard to imagine what would.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
klaus14
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Re: The Bottom Line on Factor Investing

Post by klaus14 »

vineviz wrote: Wed Apr 29, 2020 5:05 pm
BigJohn wrote: Wed Apr 29, 2020 4:52 pm
Blue456 wrote: Wed Apr 29, 2020 1:07 pm The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio.
Not quite the same in my mind. Overweighting small is a diversification from TSM only if it has some return generation mechanism different and independent from the rest of the market. This might be true or it might just be data mining. Or it might have been true 30+ years ago but market changes (eg knowledge and availability of low cost factor funds) may have reduced or eliminated what used to exist.

On the other hand, international is a different set of investments by simple inspection. It doesn’t require the leap of faith that diversification via factors requires.
If the dramatic underperformance of SCV for the past 18 months doesn’t represent a “different and independent” return stream from large cap stocks, it’s hard to imagine what would.
do you also make the same argument for junk bonds or energy stocks ?
So, there is something else that makes SCV special, what is it?
35% US, 20 ExUS Dev, 10% EM, 10% EM Bonds, 10% Gold, 10% EDV, 5% I/EE Bonds. 50% value tilt in stocks.
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raven15
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Re: The Bottom Line on Factor Investing

Post by raven15 »

There were two "aha" moments for me. One was when I was learning how to backtest in Portfolio Visualizer and after playing around I realized that by making regular new investments I would get better than market performance by investing in volatile small cap value stocks than by investing in a total market fund, even if they had the exact same annualized return over the period. Further, I realized that this was a unique advantage for me because just starting off I had very little money at risk, whereas presumably nearly every other invested dollar is owned by a person or institution with a lot more money at play and who would just receive the extra volatility on their copious existing money with little expectation of being compensated for it.

The second was reading Bernstein "The Ages of the Investor" which showed the same thing: making regular contributions into small cap value would have 0.6% greater returns than a whole market fund, even if the funds had the same CAGR, because of the phenomenon.

So for now I am banking on better mechanical returns because of my inherent advantage as a relatively new investor, and of course hoping for better returns of small cap value stocks as an equity sub-class. Better risk adjusted returns would also be great, but that seems like too much to hope for.

So far this year it's been playing out about like I hoped it would.
It's Time. Adding Interest.
klaus14
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Re: The Bottom Line on Factor Investing

Post by klaus14 »

raven15 wrote: Wed Apr 29, 2020 5:23 pm There were two "aha" moments for me. One was when I was learning how to backtest in Portfolio Visualizer and after playing around I realized that by making regular new investments I would get better than market performance by investing in volatile small cap value stocks than by investing in a total market fund, even if they had the exact same annualized return over the period. Further, I realized that this was a unique advantage for me because just starting off I had very little money at risk, whereas presumably nearly every other invested dollar is owned by a person or institution with a lot more money at play and who would just receive the extra volatility on their copious existing money with little expectation of being compensated for it.

The second was reading Bernstein "The Ages of the Investor" which showed the same thing: making regular contributions into small cap value would have 0.6% greater returns than a whole market fund, even if the funds had the same CAGR, because of the phenomenon.

So for now I am banking on better mechanical returns because of my inherent advantage as a relatively new investor, and of course hoping for better returns of small cap value stocks as an equity sub-class. Better risk adjusted returns would also be great, but that seems like too much to hope for.

So far this year it's been playing out about like I hoped it would.
is this because rebalancing between TSM and SCV?
Otherwise, i don't get how this would happen, volatility also implies sometimes you buy expensive.
35% US, 20 ExUS Dev, 10% EM, 10% EM Bonds, 10% Gold, 10% EDV, 5% I/EE Bonds. 50% value tilt in stocks.
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raven15
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Re: The Bottom Line on Factor Investing

Post by raven15 »

klaus14 wrote: Wed Apr 29, 2020 5:27 pm
raven15 wrote: Wed Apr 29, 2020 5:23 pm There were two "aha" moments for me. One was when I was learning how to backtest in Portfolio Visualizer and after playing around I realized that by making regular new investments I would get better than market performance by investing in volatile small cap value stocks than by investing in a total market fund, even if they had the exact same annualized return over the period. Further, I realized that this was a unique advantage for me because just starting off I had very little money at risk, whereas presumably nearly every other invested dollar is owned by a person or institution with a lot more money at play and who would just receive the extra volatility on their copious existing money with little expectation of being compensated for it.

The second was reading Bernstein "The Ages of the Investor" which showed the same thing: making regular contributions into small cap value would have 0.6% greater returns than a whole market fund, even if the funds had the same CAGR, because of the phenomenon.

So for now I am banking on better mechanical returns because of my inherent advantage as a relatively new investor, and of course hoping for better returns of small cap value stocks as an equity sub-class. Better risk adjusted returns would also be great, but that seems like too much to hope for.

So far this year it's been playing out about like I hoped it would.
is this because rebalancing between TSM and SCV?
Otherwise, i don't get how this would happen, volatility also implies sometimes you buy expensive.
Nope. The same dollar buys proportionally more shares when things are cheap than when they are expensive, so SCV in isolation does it.

Take TSM Fund A and SCV Fund B.
Year 1: Fund A costs $20/share and Fund B also costs $20 per share. You buy $100 of each. You have 5 of A and 5 of B for this year
Year 2: Fund A costs $25/share and Fund B costs $33.33 per share. You buy $100 of each. You now have 4 of A and 3 of B for this year.
Year 3: Fund A costs $10/share and Fund B costs $5 per share. You buy $100 of each. You now have 10 of A and 20 of B for this year.
Year 4: Both return to their starting value of $20 per share.

You own 19 shares of TSM Fund A which are worth $380. You own 28 shares of SCV Fund B, which are worth $560. However, a person who was not adding money suffered incredible volatility for no gain and decides to hop off the roller coaster. A person selling regularly would have been destroyed by owning B. Advantage: new investor.

Real life is almost never this extreme, but this illustrates the point.
It's Time. Adding Interest.
MotoTrojan
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

raven15 wrote: Wed Apr 29, 2020 5:45 pm
klaus14 wrote: Wed Apr 29, 2020 5:27 pm
raven15 wrote: Wed Apr 29, 2020 5:23 pm There were two "aha" moments for me. One was when I was learning how to backtest in Portfolio Visualizer and after playing around I realized that by making regular new investments I would get better than market performance by investing in volatile small cap value stocks than by investing in a total market fund, even if they had the exact same annualized return over the period. Further, I realized that this was a unique advantage for me because just starting off I had very little money at risk, whereas presumably nearly every other invested dollar is owned by a person or institution with a lot more money at play and who would just receive the extra volatility on their copious existing money with little expectation of being compensated for it.

The second was reading Bernstein "The Ages of the Investor" which showed the same thing: making regular contributions into small cap value would have 0.6% greater returns than a whole market fund, even if the funds had the same CAGR, because of the phenomenon.

So for now I am banking on better mechanical returns because of my inherent advantage as a relatively new investor, and of course hoping for better returns of small cap value stocks as an equity sub-class. Better risk adjusted returns would also be great, but that seems like too much to hope for.

So far this year it's been playing out about like I hoped it would.
is this because rebalancing between TSM and SCV?
Otherwise, i don't get how this would happen, volatility also implies sometimes you buy expensive.
Nope. The same dollar buys proportionally more shares when things are cheap than when they are expensive, so SCV in isolation does it.

Take TSM Fund A and SCV Fund B.
Year 1: Fund A costs $20/share and Fund B also costs $20 per share. You buy $100 of each. You have 5 of A and 5 of B for this year
Year 2: Fund A costs $25/share and Fund B costs $33.33 per share. You buy $100 of each. You now have 4 of A and 3 of B for this year.
Year 3: Fund A costs $10/share and Fund B costs $5 per share. You buy $100 of each. You now have 10 of A and 20 of B for this year.
Year 4: Both return to their starting value of $20 per share.

You own 19 shares of TSM Fund A which are worth $380. You own 28 shares of SCV Fund B, which are worth $560. However, a person who was not adding money suffered incredible volatility for no gain and decides to hop off the roller coaster. A person selling regularly would have been destroyed by owning B. Advantage: new investor.

Real life is almost never this extreme, but this illustrates the point.
The only way you really capitalize here is by buying SCV when it has grown less than TSM, and TSM when it has grown less. What you are actually doing is in fact rebalancing, just by using contributions to buy the underweight asset.

As klaus14 stated, if you are only buying SCV then the volatility is just as equally likely to result in your buy being on a relative high value day as it is on a low one.
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raven15
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Re: The Bottom Line on Factor Investing

Post by raven15 »

MotoTrojan wrote: Wed Apr 29, 2020 5:48 pm
raven15 wrote: Wed Apr 29, 2020 5:45 pm
klaus14 wrote: Wed Apr 29, 2020 5:27 pm
raven15 wrote: Wed Apr 29, 2020 5:23 pm There were two "aha" moments for me. One was when I was learning how to backtest in Portfolio Visualizer and after playing around I realized that by making regular new investments I would get better than market performance by investing in volatile small cap value stocks than by investing in a total market fund, even if they had the exact same annualized return over the period. Further, I realized that this was a unique advantage for me because just starting off I had very little money at risk, whereas presumably nearly every other invested dollar is owned by a person or institution with a lot more money at play and who would just receive the extra volatility on their copious existing money with little expectation of being compensated for it.

The second was reading Bernstein "The Ages of the Investor" which showed the same thing: making regular contributions into small cap value would have 0.6% greater returns than a whole market fund, even if the funds had the same CAGR, because of the phenomenon.

So for now I am banking on better mechanical returns because of my inherent advantage as a relatively new investor, and of course hoping for better returns of small cap value stocks as an equity sub-class. Better risk adjusted returns would also be great, but that seems like too much to hope for.

So far this year it's been playing out about like I hoped it would.
is this because rebalancing between TSM and SCV?
Otherwise, i don't get how this would happen, volatility also implies sometimes you buy expensive.
Nope. The same dollar buys proportionally more shares when things are cheap than when they are expensive, so SCV in isolation does it.

Take TSM Fund A and SCV Fund B.
Year 1: Fund A costs $20/share and Fund B also costs $20 per share. You buy $100 of each. You have 5 of A and 5 of B for this year
Year 2: Fund A costs $25/share and Fund B costs $33.33 per share. You buy $100 of each. You now have 4 of A and 3 of B for this year.
Year 3: Fund A costs $10/share and Fund B costs $5 per share. You buy $100 of each. You now have 10 of A and 20 of B for this year.
Year 4: Both return to their starting value of $20 per share.

You own 19 shares of TSM Fund A which are worth $380. You own 28 shares of SCV Fund B, which are worth $560. However, a person who was not adding money suffered incredible volatility for no gain and decides to hop off the roller coaster. A person selling regularly would have been destroyed by owning B. Advantage: new investor.

Real life is almost never this extreme, but this illustrates the point.
The only way you really capitalize here is by buying SCV when it has grown less than TSM, and TSM when it has grown less. What you are actually doing is in fact rebalancing, just by using contributions to buy the underweight asset.

As klaus14 stated, if you are only buying SCV then the volatility is just as equally likely to result in your buy being on a relative high value day as it is on a low one.
In this example, buying SCV in isolation was better than buying TSM in isolation. There is no rebalancing. :confused
It's Time. Adding Interest.
klaus14
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Re: The Bottom Line on Factor Investing

Post by klaus14 »

raven15 wrote: Wed Apr 29, 2020 5:56 pm
MotoTrojan wrote: Wed Apr 29, 2020 5:48 pm
raven15 wrote: Wed Apr 29, 2020 5:45 pm
klaus14 wrote: Wed Apr 29, 2020 5:27 pm
raven15 wrote: Wed Apr 29, 2020 5:23 pm There were two "aha" moments for me. One was when I was learning how to backtest in Portfolio Visualizer and after playing around I realized that by making regular new investments I would get better than market performance by investing in volatile small cap value stocks than by investing in a total market fund, even if they had the exact same annualized return over the period. Further, I realized that this was a unique advantage for me because just starting off I had very little money at risk, whereas presumably nearly every other invested dollar is owned by a person or institution with a lot more money at play and who would just receive the extra volatility on their copious existing money with little expectation of being compensated for it.

The second was reading Bernstein "The Ages of the Investor" which showed the same thing: making regular contributions into small cap value would have 0.6% greater returns than a whole market fund, even if the funds had the same CAGR, because of the phenomenon.

So for now I am banking on better mechanical returns because of my inherent advantage as a relatively new investor, and of course hoping for better returns of small cap value stocks as an equity sub-class. Better risk adjusted returns would also be great, but that seems like too much to hope for.

So far this year it's been playing out about like I hoped it would.
is this because rebalancing between TSM and SCV?
Otherwise, i don't get how this would happen, volatility also implies sometimes you buy expensive.
Nope. The same dollar buys proportionally more shares when things are cheap than when they are expensive, so SCV in isolation does it.

Take TSM Fund A and SCV Fund B.
Year 1: Fund A costs $20/share and Fund B also costs $20 per share. You buy $100 of each. You have 5 of A and 5 of B for this year
Year 2: Fund A costs $25/share and Fund B costs $33.33 per share. You buy $100 of each. You now have 4 of A and 3 of B for this year.
Year 3: Fund A costs $10/share and Fund B costs $5 per share. You buy $100 of each. You now have 10 of A and 20 of B for this year.
Year 4: Both return to their starting value of $20 per share.

You own 19 shares of TSM Fund A which are worth $380. You own 28 shares of SCV Fund B, which are worth $560. However, a person who was not adding money suffered incredible volatility for no gain and decides to hop off the roller coaster. A person selling regularly would have been destroyed by owning B. Advantage: new investor.

Real life is almost never this extreme, but this illustrates the point.
The only way you really capitalize here is by buying SCV when it has grown less than TSM, and TSM when it has grown less. What you are actually doing is in fact rebalancing, just by using contributions to buy the underweight asset.

As klaus14 stated, if you are only buying SCV then the volatility is just as equally likely to result in your buy being on a relative high value day as it is on a low one.
In this example, buying SCV in isolation was better than buying TSM in isolation. There is no rebalancing. :confused
it's rebalancing with new money. You buy each asset to its target with new money. You would get the same bonus if you didn't have new money but sold and bought.
Rebalancing bonus relies on mean-reversion. (both assets will revert to the mean in the long term)

However, there is also momentum effect. For example, in the recent years if you kept buying SCV as it got cheaper, you lost even more money.

They say momentum is short term and mean-reversion is long term. But we simply don't know. SCV may never revert back. Then rebalancing bonus becomes rebalancing penalty.

This is why i simply stopped adding to SCV (instead of closing the position or keep adding).
35% US, 20 ExUS Dev, 10% EM, 10% EM Bonds, 10% Gold, 10% EDV, 5% I/EE Bonds. 50% value tilt in stocks.
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raven15
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Re: The Bottom Line on Factor Investing

Post by raven15 »

klaus14 wrote: Wed Apr 29, 2020 6:06 pm
raven15 wrote: Wed Apr 29, 2020 5:56 pm
MotoTrojan wrote: Wed Apr 29, 2020 5:48 pm
raven15 wrote: Wed Apr 29, 2020 5:45 pm
klaus14 wrote: Wed Apr 29, 2020 5:27 pm

is this because rebalancing between TSM and SCV?
Otherwise, i don't get how this would happen, volatility also implies sometimes you buy expensive.
Nope. The same dollar buys proportionally more shares when things are cheap than when they are expensive, so SCV in isolation does it.

Take TSM Fund A and SCV Fund B.
Year 1: Fund A costs $20/share and Fund B also costs $20 per share. You buy $100 of each. You have 5 of A and 5 of B for this year
Year 2: Fund A costs $25/share and Fund B costs $33.33 per share. You buy $100 of each. You now have 4 of A and 3 of B for this year.
Year 3: Fund A costs $10/share and Fund B costs $5 per share. You buy $100 of each. You now have 10 of A and 20 of B for this year.
Year 4: Both return to their starting value of $20 per share.

You own 19 shares of TSM Fund A which are worth $380. You own 28 shares of SCV Fund B, which are worth $560. However, a person who was not adding money suffered incredible volatility for no gain and decides to hop off the roller coaster. A person selling regularly would have been destroyed by owning B. Advantage: new investor.

Real life is almost never this extreme, but this illustrates the point.
The only way you really capitalize here is by buying SCV when it has grown less than TSM, and TSM when it has grown less. What you are actually doing is in fact rebalancing, just by using contributions to buy the underweight asset.

As klaus14 stated, if you are only buying SCV then the volatility is just as equally likely to result in your buy being on a relative high value day as it is on a low one.
In this example, buying SCV in isolation was better than buying TSM in isolation. There is no rebalancing. :confused
it's rebalancing with new money. You buy each asset to its target with new money. You would get the same bonus if you didn't have new money but sold and bought.
Rebalancing bonus relies on mean-reversion. (both assets will revert to the mean in the long term)

However, there is also momentum effect. For example, in the recent years if you kept buying SCV as it got cheaper, you lost even more money.

They say momentum is short term and mean-reversion is long term. But we simply don't know. SCV may never revert back. Then rebalancing bonus becomes rebalancing penalty.

This is why i simply stopped adding to SCV (instead of closing the position or keep adding).
There is no "target" in the example. There is no rebalancing. You buy $100 every year regardless of price, and you don't do anything else. It does not rely on momentum, it is strictly mechanical. It does assume that returns will be similar: if SCV does substantially worse then of course it will not work.
It's Time. Adding Interest.
klaus14
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Re: The Bottom Line on Factor Investing

Post by klaus14 »

raven15 wrote: Wed Apr 29, 2020 6:13 pm
klaus14 wrote: Wed Apr 29, 2020 6:06 pm
raven15 wrote: Wed Apr 29, 2020 5:56 pm
MotoTrojan wrote: Wed Apr 29, 2020 5:48 pm
raven15 wrote: Wed Apr 29, 2020 5:45 pm
Nope. The same dollar buys proportionally more shares when things are cheap than when they are expensive, so SCV in isolation does it.

Take TSM Fund A and SCV Fund B.
Year 1: Fund A costs $20/share and Fund B also costs $20 per share. You buy $100 of each. You have 5 of A and 5 of B for this year
Year 2: Fund A costs $25/share and Fund B costs $33.33 per share. You buy $100 of each. You now have 4 of A and 3 of B for this year.
Year 3: Fund A costs $10/share and Fund B costs $5 per share. You buy $100 of each. You now have 10 of A and 20 of B for this year.
Year 4: Both return to their starting value of $20 per share.

You own 19 shares of TSM Fund A which are worth $380. You own 28 shares of SCV Fund B, which are worth $560. However, a person who was not adding money suffered incredible volatility for no gain and decides to hop off the roller coaster. A person selling regularly would have been destroyed by owning B. Advantage: new investor.

Real life is almost never this extreme, but this illustrates the point.
The only way you really capitalize here is by buying SCV when it has grown less than TSM, and TSM when it has grown less. What you are actually doing is in fact rebalancing, just by using contributions to buy the underweight asset.

As klaus14 stated, if you are only buying SCV then the volatility is just as equally likely to result in your buy being on a relative high value day as it is on a low one.
In this example, buying SCV in isolation was better than buying TSM in isolation. There is no rebalancing. :confused
it's rebalancing with new money. You buy each asset to its target with new money. You would get the same bonus if you didn't have new money but sold and bought.
Rebalancing bonus relies on mean-reversion. (both assets will revert to the mean in the long term)

However, there is also momentum effect. For example, in the recent years if you kept buying SCV as it got cheaper, you lost even more money.

They say momentum is short term and mean-reversion is long term. But we simply don't know. SCV may never revert back. Then rebalancing bonus becomes rebalancing penalty.

This is why i simply stopped adding to SCV (instead of closing the position or keep adding).
There is no "target" in the example. There is no rebalancing. You buy $100 every year regardless of price, and you don't do anything else. It does not rely on momentum, it is strictly mechanical. It does assume that returns will be similar: if SCV does substantially worse then of course it will not work.
Then it wouldn't work half of the time even with perfect mean reversion. Example:
Year 1: Fund A costs $20/share and Fund B also costs $20 per share. You buy $100 of each. You have 5 of A and 5 of B for this year
Year 2: Fund A costs $25/share and Fund B costs $33.33 per share. You buy $100 of each. You now have 4 of A and 3 of B for this year.
Year 3: Both return to their starting value of $20 per share.
You own 9 shares of TSM Fund A which are worth $180. You own 8 shares of SCV Fund B, which are worth $160.

You see, it's path dependent.
35% US, 20 ExUS Dev, 10% EM, 10% EM Bonds, 10% Gold, 10% EDV, 5% I/EE Bonds. 50% value tilt in stocks.
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raven15
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Re: The Bottom Line on Factor Investing

Post by raven15 »

klaus14 wrote: Wed Apr 29, 2020 6:06 pm it's rebalancing with new money. You buy each asset to its target with new money. You would get the same bonus if you didn't have new money but sold and bought.
Rebalancing bonus relies on mean-reversion. (both assets will revert to the mean in the long term)
Lets separate them out to make it more clear. we'll make the high price higher this time.

Every year, Investor A buys $100 of Fund A as follows:
Year 1: Fund A costs $20/share, resulting in 5 shares bought
Year 2: Fund A costs $33.33/share, resulting in 3 shares bought
Year 3: Fund A costs $10/share, resulting in 10 shares bought
Year 4: Fund A costs $20/share, resulting in 5 shares bought
Result: After 4 years, Investor A has 23 shares worth $460. bought

Every year, Investor B buys $100 of Fund B as follows:
Year 1: Fund B costs $20/share, resulting in 5 shares bought
Year 2: Fund B costs $50/share, resulting in 2 shares bought
Year 3: Fund B costs $5/share, resulting in 20 shares bought
Year 4: Fund B costs $20/share, resulting in 5 shares bought
Result: After 4 years, Investor B has 32 shares worth $640.

Both assets had no dividends, no momentum, no price increase, no rebalancing. $100 was invested per year for four years and that is all. Yet Investor B ended with more money.
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raven15
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Re: The Bottom Line on Factor Investing

Post by raven15 »

klaus14 wrote: Wed Apr 29, 2020 6:17 pm You see, it's path dependent.
Yes, it is path dependent. You need to assume volatility cuts both ways and invest for a full cycle. Usually SCV has greater losses in downturns so that is good. And it doesn't guarantee an outcome, but it is another thing improving my odds in the event that factor investing should turn out to be bunk with lower returns during my time frame.
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Re: The Bottom Line on Factor Investing

Post by klaus14 »

raven15 wrote: Wed Apr 29, 2020 6:28 pm
klaus14 wrote: Wed Apr 29, 2020 6:17 pm You see, it's path dependent.
Yes, it is path dependent. You need to assume volatility cuts both ways and invest for a full cycle. Usually SCV has greater losses in downturns so that is good. And it doesn't guarantee an outcome, but it is another thing improving my odds in the event that factor investing should turn out to be bunk with lower returns during my time frame.
Not really. Unless you are rebalancing. You cannot expect positive results from this. Because sometimes you'll buy cheap, sometimes you'll buy expensive and average case they cancel each other.

And that was more than full cycle. It had up and down. Cycle usually ends higher than where it started. Your example was less realistic than mine.

I am not saying your method would underperform. I am just saying it doesn't generate any additional return due to volatility difference.
Last edited by klaus14 on Wed Apr 29, 2020 6:37 pm, edited 1 time in total.
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raven15
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Re: The Bottom Line on Factor Investing

Post by raven15 »

klaus14 wrote: Wed Apr 29, 2020 6:30 pm
raven15 wrote: Wed Apr 29, 2020 6:28 pm
klaus14 wrote: Wed Apr 29, 2020 6:17 pm You see, it's path dependent.
Yes, it is path dependent. You need to assume volatility cuts both ways and invest for a full cycle. Usually SCV has greater losses in downturns so that is good. And it doesn't guarantee an outcome, but it is another thing improving my odds in the event that factor investing should turn out to be bunk with lower returns during my time frame.
Not really. Unless you are rebalancing. You cannot expect positive results from this. Because sometimes you'll buy cheap, sometimes you'll buy expensive and average case they cancel each other.

And that was more than full cycle. Cycle usually ends higher than where it started. Your example was less realistic than mine.
No this is a real thing. It is the inverse of sequence of returns risk which new retirees need to deal with. Positive results are not guaranteed, but they are more likely than negative results.
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Taylor Larimore
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Re: The Bottom Line on Factor Investing

Post by Taylor Larimore »

Blue456 wrote: "The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio."
Blue456:

Sorry, but U.S. small-cap stocks are not "just like international." U.S. small-cap stocks are already in the Total U.S. Stock Market Index. International's are not.

A total stock market index fund holds nearly all U.S. stocks. It is as diversified as you can get in U.S. stocks. Adding more small-cap stocks actually reduces diversification and adds concentration (and risk). Anyone who added small-cap stocks to their total stock market index fund will understand. :(

Best wishes
Taylor
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

raven15 wrote: Wed Apr 29, 2020 6:36 pm
klaus14 wrote: Wed Apr 29, 2020 6:30 pm
raven15 wrote: Wed Apr 29, 2020 6:28 pm
klaus14 wrote: Wed Apr 29, 2020 6:17 pm You see, it's path dependent.
Yes, it is path dependent. You need to assume volatility cuts both ways and invest for a full cycle. Usually SCV has greater losses in downturns so that is good. And it doesn't guarantee an outcome, but it is another thing improving my odds in the event that factor investing should turn out to be bunk with lower returns during my time frame.
Not really. Unless you are rebalancing. You cannot expect positive results from this. Because sometimes you'll buy cheap, sometimes you'll buy expensive and average case they cancel each other.

And that was more than full cycle. Cycle usually ends higher than where it started. Your example was less realistic than mine.
No this is a real thing. It is the inverse of sequence of returns risk which new retirees need to deal with. Positive results are not guaranteed, but they are more likely than negative results.
Positive results are not guaranteed indeed, they are close to 50/50 actually :). You are making some serious mental gymnastics to say that this boosts returns, but over the long-term it should not unless you are contributing to the underweight holding of a pair of (volatile) uncorrelated holdings.
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Re: The Bottom Line on Factor Investing

Post by vineviz »

Taylor Larimore wrote: Wed Apr 29, 2020 7:01 pm It is as diversified as you can get in U.S. stocks. Adding more small-cap stocks actually reduces diversification and adds concentration (and risk).
You know very well that none of these things is actually true.

You can be more diversified than "Total Stock Market".

Adding more small cap stocks improves diversification and reduces concentration.
"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 raven15 »

MotoTrojan wrote: Wed Apr 29, 2020 7:09 pm
raven15 wrote: Wed Apr 29, 2020 6:36 pm
klaus14 wrote: Wed Apr 29, 2020 6:30 pm
raven15 wrote: Wed Apr 29, 2020 6:28 pm
klaus14 wrote: Wed Apr 29, 2020 6:17 pm You see, it's path dependent.
Yes, it is path dependent. You need to assume volatility cuts both ways and invest for a full cycle. Usually SCV has greater losses in downturns so that is good. And it doesn't guarantee an outcome, but it is another thing improving my odds in the event that factor investing should turn out to be bunk with lower returns during my time frame.
Not really. Unless you are rebalancing. You cannot expect positive results from this. Because sometimes you'll buy cheap, sometimes you'll buy expensive and average case they cancel each other.

And that was more than full cycle. Cycle usually ends higher than where it started. Your example was less realistic than mine.
No this is a real thing. It is the inverse of sequence of returns risk which new retirees need to deal with. Positive results are not guaranteed, but they are more likely than negative results.
Positive results are not guaranteed indeed, they are close to 50/50 actually :). You are making some serious mental gymnastics to say that this boosts returns, but over the long-term it should not unless you are contributing to the underweight holding of a pair of (volatile) uncorrelated holdings.
Wrong. If both funds have the same underlying CAGR over a given time frame, then regular purchases of the more volatile fund will* cause an end result of more money. About 0.5% historically. So if SCV has annualized returns of at least 0.5% less than TSM over my period, then I will at least break even in comparison. However, most invested money is owned by people with a lot of wealth who cannot tolerate a lower CAGR especially for a more volatile asset, so I concede that SCV will not have higher risk adjusted returns and maybe not even higher absolute returns; however, I see no reason for it to have lower absolute returns. Of course if factor proponents are right then SCV should have higher returns. We would probably agree that 100% SCV would be a terrible risk for a retiree. Well (mechanically if not always mentally) the inverse of the retiree is true for a newish investor making regular contributions.

*Edit: Ok that is not true, you could get a bad sequence of very high prices and end on a down note. As I said, it is inverse of sequence of returns for a retiree. But just as miscellaneous volatility is bad for a retiree, it is good for an accumulator.
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

raven15 wrote: Wed Apr 29, 2020 7:24 pm
MotoTrojan wrote: Wed Apr 29, 2020 7:09 pm
raven15 wrote: Wed Apr 29, 2020 6:36 pm
klaus14 wrote: Wed Apr 29, 2020 6:30 pm
raven15 wrote: Wed Apr 29, 2020 6:28 pm
Yes, it is path dependent. You need to assume volatility cuts both ways and invest for a full cycle. Usually SCV has greater losses in downturns so that is good. And it doesn't guarantee an outcome, but it is another thing improving my odds in the event that factor investing should turn out to be bunk with lower returns during my time frame.
Not really. Unless you are rebalancing. You cannot expect positive results from this. Because sometimes you'll buy cheap, sometimes you'll buy expensive and average case they cancel each other.

And that was more than full cycle. Cycle usually ends higher than where it started. Your example was less realistic than mine.
No this is a real thing. It is the inverse of sequence of returns risk which new retirees need to deal with. Positive results are not guaranteed, but they are more likely than negative results.
Positive results are not guaranteed indeed, they are close to 50/50 actually :). You are making some serious mental gymnastics to say that this boosts returns, but over the long-term it should not unless you are contributing to the underweight holding of a pair of (volatile) uncorrelated holdings.
Wrong. If both funds have the same underlying CAGR over a given time frame, then regular purchases of the more volatile fund will* cause an end result of more money. About 0.5% historically. So if SCV has annualized returns of at least 0.5% less than TSM over my period, then I will at least break even in comparison. However, most invested money is owned by people with a lot of wealth who cannot tolerate a lower CAGR especially for a more volatile asset, so I concede that SCV will not have higher risk adjusted returns and maybe not even higher absolute returns; however, I see no reason for it to have lower absolute returns. Of course if factor proponents are right then SCV should have higher returns. We would probably agree that 100% SCV would be a terrible risk for a retiree. Well (mechanically if not always mentally) the inverse of the retiree is true for a newish investor making regular contributions.

*Edit: Ok that is not true, you could get a bad sequence of very high prices and end on a down note. As I said, it is inverse of sequence of returns for a retiree. But just as miscellaneous volatility is bad for a retiree, it is good for an accumulator.
Let’s agree to disagree. I don’t believe there’s a direct inverse scenario to sequence of returns risk in withdrawal phase.
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Re: The Bottom Line on Factor Investing

Post by raven15 »

MotoTrojan wrote: Wed Apr 29, 2020 7:55 pm Let’s agree to disagree.
Agreed. However, please be advised that if we agree volatility is bad for a retiree, then we secretly agree to agree.

And if you see page 19 of Ages of the Investor you'll see other people agree with me :o
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Re: The Bottom Line on Factor Investing

Post by acegolfer »

vineviz wrote: Wed Apr 29, 2020 7:16 pm
Taylor Larimore wrote: Wed Apr 29, 2020 7:01 pm It is as diversified as you can get in U.S. stocks. Adding more small-cap stocks actually reduces diversification and adds concentration (and risk).
You know very well that none of these things is actually true.

You can be more diversified than "Total Stock Market".

Adding more small cap stocks improves diversification and reduces concentration.
Depends on what diversification means. For some people, CRSP VW (=MKT) is the most diversified. Other ppl argue CRSP EW is more diversified because less concentration on big.

The benefit of diversification is to lower stdev and become more efficient. One thing I think everybody can agree is MKT portfolio is efficient but EW is not.
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Re: The Bottom Line on Factor Investing

Post by KEotSK66 »

the inverse is an inflated nav

you get your draw without selling many shares
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Re: The Bottom Line on Factor Investing

Post by raven15 »

Since math and reason have failed, appeal to authority is my most logical recourse. In page 19 of "Ages of the Investor: A Critical Look at Lifecycle Investing" https://www.bogleheads.org/wiki/William_Bernstein wrote:

"[for 30 year rolling periods investing $100 'real' per month] Finally, Figure 9 eliminates all of the small-value advantage by equalizing the returns of the small value and S&P500 indexes, again, by subtracting a constant amount from each monthly return. Amazingly, even with a zero small-value advantage, the small-value strategy beats the S&P500 strategy 71% of the time. The reason, once again, is the contradictory nature of both Nalebuff/Ayers and small-value strategies: higher volatility than a conventional S&P500 strategy, and, thus, more opportunity to buy at much lower prices. The excess returns of both strategies, of course, come with a double cost. There is much greater volatility and, thus, far greater emotional demands on the investor - in plain English, stomach churning uncertainty.

Nevertheless, discipline has its rewards. Figure 10 shows that the long-term small-value return must be 0.64% below the return of the S&P500 before the success rate of the small-value strategy relative to the S&P500 strategy falls below 50%."


Add in reading Chapter 4 of Rational Expectations, and comparing starting with and adding $10,000 per year with a goal of $1,000,000 at https://portfoliocharts.com/portfolio/portfolio-growth/ and its clear what side my bread is buttered on :mrgreen:

For an accumulator, small value has three chances:
1. It might have higher returns, per the usual factor proponent arguments
2. It might provide a higher rebalancing bonus, which we all know and hope to love
3. Uniquely for an accumulator, the additional volatility is a benefit all by itself
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

raven15 wrote: Wed Apr 29, 2020 8:38 pm Since math and reason have failed, appeal to authority is my most logical recourse. In page 19 of "Ages of the Investor: A Critical Look at Lifecycle Investing" https://www.bogleheads.org/wiki/William_Bernstein wrote:

"[for 30 year rolling periods investing $100 'real' per month] Finally, Figure 9 eliminates all of the small-value advantage by equalizing the returns of the small value and S&P500 indexes, again, by subtracting a constant amount from each monthly return. Amazingly, even with a zero small-value advantage, the small-value strategy beats the S&P500 strategy 71% of the time. The reason, once again, is the contradictory nature of both Nalebuff/Ayers and small-value strategies: higher volatility than a conventional S&P500 strategy, and, thus, more opportunity to buy at much lower prices. The excess returns of both strategies, of course, come with a double cost. There is much greater volatility and, thus, far greater emotional demands on the investor - in plain English, stomach churning uncertainty.

Nevertheless, discipline has its rewards. Figure 10 shows that the long-term small-value return must be 0.64% below the return of the S&P500 before the success rate of the small-value strategy relative to the S&P500 strategy falls below 50%."


Add in reading Chapter 4 of Rational Expectations, and comparing starting with and adding $10,000 per year with a goal of $1,000,000 at https://portfoliocharts.com/portfolio/portfolio-growth/ and its clear what side my bread is buttered on :mrgreen:

For an accumulator, small value has three chances:
1. It might have higher returns, per the usual factor proponent arguments
2. It might provide a higher rebalancing bonus, which we all know and hope to love
3. Uniquely for an accumulator, the additional volatility is a benefit all by itself
I haven’t seen any math at all, just a backtest that ignores historical sequence of returns. How does volatility itself increase returns on average if it means you’re equally likely to buy towards a local peak as a trough? What’s the logic?
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Re: The Bottom Line on Factor Investing

Post by Random Walker »

Whether in accumulation or decumulation, I think volatility detracts from returns. I appreciate the potential of rebalancing with new money going into the worst performing investment during accumulation, but I don’t know that that overrides the drag caused by volatility. With volatility, there is simply less money invested to make the comeback after a down period.

Dave
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Re: The Bottom Line on Factor Investing

Post by rascott »

BigJohn wrote: Wed Apr 29, 2020 4:52 pm
Blue456 wrote: Wed Apr 29, 2020 1:07 pm The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio.
Not quite the same in my mind. Overweighting small is a diversification from TSM only if it has some return generation mechanism different and independent from the rest of the market. This might be true or it might just be data mining. Or it might have been true 30+ years ago but market changes (eg knowledge and availability of low cost factor funds) may have reduced or eliminated what used to exist.

On the other hand, international is a different set of investments by simple inspection. It doesn’t require the leap of faith that diversification via factors requires.

Nonsense..... just look at the last 20 years. Or 2 years.

Small caps move much, much differently than large. There are many fundamental reasons for this, if you care to get into it.
Last edited by rascott on Thu Apr 30, 2020 12:14 am, edited 2 times in total.
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Re: The Bottom Line on Factor Investing

Post by rascott »

Taylor Larimore wrote: Wed Apr 29, 2020 7:01 pm
Blue456 wrote: "The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio."
Blue456:

Sorry, but U.S. small-cap stocks are not "just like international." U.S. small-cap stocks are already in the Total U.S. Stock Market Index. International's are not.

A total stock market index fund holds nearly all U.S. stocks. It is as diversified as you can get in U.S. stocks. Adding more small-cap stocks actually reduces diversification and adds concentration (and risk). Anyone who added small-cap stocks to their total stock market index fund will understand. :(

Best wishes
Taylor
Jack Bogle's Words of Wisdom: "In the ideal portfolio (the all-market index fund) all specific security risk is diversified away."

Sorry.... but this isn't an accurate description of diversification in investing.
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Re: The Bottom Line on Factor Investing

Post by raven15 »

MotoTrojan wrote: Wed Apr 29, 2020 9:21 pm
raven15 wrote: Wed Apr 29, 2020 8:38 pm Since math and reason have failed, appeal to authority is my most logical recourse. In page 19 of "Ages of the Investor: A Critical Look at Lifecycle Investing" https://www.bogleheads.org/wiki/William_Bernstein wrote:

"[for 30 year rolling periods investing $100 'real' per month] Finally, Figure 9 eliminates all of the small-value advantage by equalizing the returns of the small value and S&P500 indexes, again, by subtracting a constant amount from each monthly return. Amazingly, even with a zero small-value advantage, the small-value strategy beats the S&P500 strategy 71% of the time. The reason, once again, is the contradictory nature of both Nalebuff/Ayers and small-value strategies: higher volatility than a conventional S&P500 strategy, and, thus, more opportunity to buy at much lower prices. The excess returns of both strategies, of course, come with a double cost. There is much greater volatility and, thus, far greater emotional demands on the investor - in plain English, stomach churning uncertainty.

Nevertheless, discipline has its rewards. Figure 10 shows that the long-term small-value return must be 0.64% below the return of the S&P500 before the success rate of the small-value strategy relative to the S&P500 strategy falls below 50%."


Add in reading Chapter 4 of Rational Expectations, and comparing starting with and adding $10,000 per year with a goal of $1,000,000 at https://portfoliocharts.com/portfolio/portfolio-growth/ and its clear what side my bread is buttered on :mrgreen:

For an accumulator, small value has three chances:
1. It might have higher returns, per the usual factor proponent arguments
2. It might provide a higher rebalancing bonus, which we all know and hope to love
3. Uniquely for an accumulator, the additional volatility is a benefit all by itself
I haven’t seen any math at all, just a backtest that ignores historical sequence of returns. How does volatility itself increase returns on average if it means you’re equally likely to buy towards a local peak as a trough? What’s the logic?
It ignores excess S&P500 returns, so historical sequence of returns is all that is left in it. It is because you buy disproportionately more shares at low prices, and disproportionately less at high prices. In most cases you end up with more shares from the more volatile asset/fund, which of course is not useful if you end on a down note, but the other 70% of the time it is. Run a few situations through Excel if you want.
Last edited by raven15 on Thu Apr 30, 2020 12:55 am, edited 1 time in total.
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Re: The Bottom Line on Factor Investing

Post by raven15 »

Random Walker wrote: Wed Apr 29, 2020 11:59 pm Whether in accumulation or decumulation, I think volatility detracts from returns. I appreciate the potential of rebalancing with new money going into the worst performing investment during accumulation, but I don’t know that that overrides the drag caused by volatility. With volatility, there is simply less money invested to make the comeback after a down period.

Dave
So first, I'm one of those people who disagrees with you on volatility drag, saying I only care about CAGR in the first place, so volatility drag has already been baked in to my assumptions. But OT.

Second, with regular investing of new money, there is more money invested during a drawdown to make a comeback. That's why it works. Assuming of course that the two options do have similar long run CAGR. You can read the books I mentioned, or go look for it in backtesting, or make up your own sequences in Excel to see how it works.
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Re: The Bottom Line on Factor Investing

Post by klaus14 »

raven15 wrote: Thu Apr 30, 2020 12:46 am
MotoTrojan wrote: Wed Apr 29, 2020 9:21 pm
raven15 wrote: Wed Apr 29, 2020 8:38 pm Since math and reason have failed, appeal to authority is my most logical recourse. In page 19 of "Ages of the Investor: A Critical Look at Lifecycle Investing" https://www.bogleheads.org/wiki/William_Bernstein wrote:

"[for 30 year rolling periods investing $100 'real' per month] Finally, Figure 9 eliminates all of the small-value advantage by equalizing the returns of the small value and S&P500 indexes, again, by subtracting a constant amount from each monthly return. Amazingly, even with a zero small-value advantage, the small-value strategy beats the S&P500 strategy 71% of the time. The reason, once again, is the contradictory nature of both Nalebuff/Ayers and small-value strategies: higher volatility than a conventional S&P500 strategy, and, thus, more opportunity to buy at much lower prices. The excess returns of both strategies, of course, come with a double cost. There is much greater volatility and, thus, far greater emotional demands on the investor - in plain English, stomach churning uncertainty.

Nevertheless, discipline has its rewards. Figure 10 shows that the long-term small-value return must be 0.64% below the return of the S&P500 before the success rate of the small-value strategy relative to the S&P500 strategy falls below 50%."


Add in reading Chapter 4 of Rational Expectations, and comparing starting with and adding $10,000 per year with a goal of $1,000,000 at https://portfoliocharts.com/portfolio/portfolio-growth/ and its clear what side my bread is buttered on :mrgreen:

For an accumulator, small value has three chances:
1. It might have higher returns, per the usual factor proponent arguments
2. It might provide a higher rebalancing bonus, which we all know and hope to love
3. Uniquely for an accumulator, the additional volatility is a benefit all by itself
I haven’t seen any math at all, just a backtest that ignores historical sequence of returns. How does volatility itself increase returns on average if it means you’re equally likely to buy towards a local peak as a trough? What’s the logic?
It ignores excess S&P500 returns, so historical sequence of returns is all that is left in it. It is because you buy disproportionately more shares at low prices, and disproportionately less at high prices. In most cases you end up with more shares from the more volatile asset/fund, which of course is not useful if you end on a down note, but the other 70% of the time it is. Run a few situations through Excel if you want.
it's path dependent. it worked in historical sequence. but it may not work in future sequence.
if it first goes down and you buy cheap, and then it goes back up, then it works.
but if it first goes up and then down, then you do worse with this method.
you cannot know which of these will happen.
35% US, 20 ExUS Dev, 10% EM, 10% EM Bonds, 10% Gold, 10% EDV, 5% I/EE Bonds. 50% value tilt in stocks.
MotoTrojan
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Re: The Bottom Line on Factor Investing

Post by MotoTrojan »

raven15 wrote: Thu Apr 30, 2020 12:46 am
MotoTrojan wrote: Wed Apr 29, 2020 9:21 pm
raven15 wrote: Wed Apr 29, 2020 8:38 pm Since math and reason have failed, appeal to authority is my most logical recourse. In page 19 of "Ages of the Investor: A Critical Look at Lifecycle Investing" https://www.bogleheads.org/wiki/William_Bernstein wrote:

"[for 30 year rolling periods investing $100 'real' per month] Finally, Figure 9 eliminates all of the small-value advantage by equalizing the returns of the small value and S&P500 indexes, again, by subtracting a constant amount from each monthly return. Amazingly, even with a zero small-value advantage, the small-value strategy beats the S&P500 strategy 71% of the time. The reason, once again, is the contradictory nature of both Nalebuff/Ayers and small-value strategies: higher volatility than a conventional S&P500 strategy, and, thus, more opportunity to buy at much lower prices. The excess returns of both strategies, of course, come with a double cost. There is much greater volatility and, thus, far greater emotional demands on the investor - in plain English, stomach churning uncertainty.

Nevertheless, discipline has its rewards. Figure 10 shows that the long-term small-value return must be 0.64% below the return of the S&P500 before the success rate of the small-value strategy relative to the S&P500 strategy falls below 50%."


Add in reading Chapter 4 of Rational Expectations, and comparing starting with and adding $10,000 per year with a goal of $1,000,000 at https://portfoliocharts.com/portfolio/portfolio-growth/ and its clear what side my bread is buttered on :mrgreen:

For an accumulator, small value has three chances:
1. It might have higher returns, per the usual factor proponent arguments
2. It might provide a higher rebalancing bonus, which we all know and hope to love
3. Uniquely for an accumulator, the additional volatility is a benefit all by itself
I haven’t seen any math at all, just a backtest that ignores historical sequence of returns. How does volatility itself increase returns on average if it means you’re equally likely to buy towards a local peak as a trough? What’s the logic?
It ignores excess S&P500 returns, so historical sequence of returns is all that is left in it. It is because you buy disproportionately more shares at low prices, and disproportionately less at high prices. In most cases you end up with more shares from the more volatile asset/fund, which of course is not useful if you end on a down note, but the other 70% of the time it is. Run a few situations through Excel if you want.
Unless the volatility is deeper on the downside as compared to the normalized trend then it doesn’t matter if your DCA buys more shares when under trend and less when over, your average value is equal.
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Re: The Bottom Line on Factor Investing

Post by Random Walker »

vineviz wrote: Wed Apr 29, 2020 5:05 pm
BigJohn wrote: Wed Apr 29, 2020 4:52 pm
Blue456 wrote: Wed Apr 29, 2020 1:07 pm The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio.
Not quite the same in my mind. Overweighting small is a diversification from TSM only if it has some return generation mechanism different and independent from the rest of the market. This might be true or it might just be data mining. Or it might have been true 30+ years ago but market changes (eg knowledge and availability of low cost factor funds) may have reduced or eliminated what used to exist.

On the other hand, international is a different set of investments by simple inspection. It doesn’t require the leap of faith that diversification via factors requires.
If the dramatic underperformance of SCV for the past 18 months doesn’t represent a “different and independent” return stream from large cap stocks, it’s hard to imagine what would.
The above vineviz point is worth emphasizing. The poor recent performance of SCV relative to TSM and LG SUPPORTS the argument that size and value are unique and independent sources of risk.

Dave
skeptic42
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Re: The Bottom Line on Factor Investing

Post by skeptic42 »

Random Walker wrote: Thu Apr 30, 2020 9:25 am
vineviz wrote: Wed Apr 29, 2020 5:05 pm
BigJohn wrote: Wed Apr 29, 2020 4:52 pm
Blue456 wrote: Wed Apr 29, 2020 1:07 pm The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio.
Not quite the same in my mind. Overweighting small is a diversification from TSM only if it has some return generation mechanism different and independent from the rest of the market. This might be true or it might just be data mining. Or it might have been true 30+ years ago but market changes (eg knowledge and availability of low cost factor funds) may have reduced or eliminated what used to exist.

On the other hand, international is a different set of investments by simple inspection. It doesn’t require the leap of faith that diversification via factors requires.
If the dramatic underperformance of SCV for the past 18 months doesn’t represent a “different and independent” return stream from large cap stocks, it’s hard to imagine what would.
The above vineviz point is worth emphasizing. The poor recent performance of SCV relative to TSM and LG SUPPORTS the argument that size and value are unique and independent sources of risk.

Dave
I think there is a lot of agreement that there are more risk factors than just a single market factor. The disagreement is with the notion that these factors deserve a persistent premium which is more than a data-mining artifact from backtests.
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Re: The Bottom Line on Factor Investing

Post by vineviz »

skeptic42 wrote: Thu Apr 30, 2020 9:53 am
I think there is a lot of agreement that there are more risk factors than just a single market factor. The disagreement is with the notion that these factors deserve a persistent premium which is more than a data-mining artifact from backtests.
It would be illogical for anyone to believe that there are systematic sources of risk for which investors do not expect to be compensated.

Anyone who thought that size and/or value represented risk factors with no expected return premium would find it irrational to expose themselves to such uncompensated risks and would refuse to own portfolios with exposure to those risk factors. They would prefer large cap growth stocks over total stock market funds. Which would increase the expected returns of small cap value stocks, until . . . .
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Re: The Bottom Line on Factor Investing

Post by Random Walker »

skeptic42 wrote: Thu Apr 30, 2020 9:53 am
Random Walker wrote: Thu Apr 30, 2020 9:25 am
vineviz wrote: Wed Apr 29, 2020 5:05 pm
BigJohn wrote: Wed Apr 29, 2020 4:52 pm
Blue456 wrote: Wed Apr 29, 2020 1:07 pm The aha moment was realizing that small caps, just like international is a way of diversifying my portfolio.
Not quite the same in my mind. Overweighting small is a diversification from TSM only if it has some return generation mechanism different and independent from the rest of the market. This might be true or it might just be data mining. Or it might have been true 30+ years ago but market changes (eg knowledge and availability of low cost factor funds) may have reduced or eliminated what used to exist.

On the other hand, international is a different set of investments by simple inspection. It doesn’t require the leap of faith that diversification via factors requires.
If the dramatic underperformance of SCV for the past 18 months doesn’t represent a “different and independent” return stream from large cap stocks, it’s hard to imagine what would.
The above vineviz point is worth emphasizing. The poor recent performance of SCV relative to TSM and LG SUPPORTS the argument that size and value are unique and independent sources of risk.

Dave
I think there is a lot of agreement that there are more risk factors than just a single market factor. The disagreement is with the notion that these factors deserve a persistent premium which is more than a data-mining artifact from backtests.
Wouldn’t the recent relatively bad performance represent greater risk? And shouldn’t greater risk be associated with increased expected return?

Dave
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Re: The Bottom Line on Factor Investing

Post by raven15 »

MotoTrojan wrote: Thu Apr 30, 2020 8:07 am Unless the volatility is deeper on the downside as compared to the normalized trend then it doesn’t matter if your DCA buys more shares when under trend and less when over, your average value is equal.
Seriously, try it in Excel. Admittedly the effect in my illustration is tiny. I'm sure Bernstein's historic difference was helped along by the SCV tendency to crash and burn before recovering, as we have seen this year. Or else to simply go nowhere for long periods of time.

Code: Select all

Baseline	*1.3, /1.3	
Price	Shares	Price	Shares
100.0	10.0	76.9	13.0
100.0	10.0	130.0	7.7
100.0	10.0	76.9	13.0
100.0	10.0	130.0	7.7
100.0	10.0	76.9	13.0
100.0	10.0	130.0	7.7
100.0	10.0	76.9	13.0
100.0	10.0	130.0	7.7
100.0	10.0	76.9	13.0
100.0	10.0	130.0	7.7
Final Number of Shares Bought			
	100.0		103.5
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Re: The Bottom Line on Factor Investing

Post by raven15 »

klaus14 wrote: Thu Apr 30, 2020 1:14 am it's path dependent. it worked in historical sequence. but it may not work in future sequence.
if it first goes down and you buy cheap, and then it goes back up, then it works.
but if it first goes up and then down, then you do worse with this method.
you cannot know which of these will happen.
It is path dependent, but regular volatility contributes to the effect. 71% of historic periods seems like a reasonable odds to me. It is an additional margin of safety that contributors have (70% of the time), in addition to the other ones commonly kicked around on here. I said it a lot already but: that implies a retiree would have been harmed by the effect about 70% of the time, relative to the S&P500, and hence should not be 100% invested in SCV. For most invested dollars it is not a free lunch, actually an expensive lunch. I note that Bernstein is also a fan of the LMP.
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Re: The Bottom Line on Factor Investing

Post by skeptic42 »

Random Walker wrote: Thu Apr 30, 2020 10:29 am
skeptic42 wrote: Thu Apr 30, 2020 9:53 am
Random Walker wrote: Thu Apr 30, 2020 9:25 am
vineviz wrote: Wed Apr 29, 2020 5:05 pm
BigJohn wrote: Wed Apr 29, 2020 4:52 pm
Not quite the same in my mind. Overweighting small is a diversification from TSM only if it has some return generation mechanism different and independent from the rest of the market. This might be true or it might just be data mining. Or it might have been true 30+ years ago but market changes (eg knowledge and availability of low cost factor funds) may have reduced or eliminated what used to exist.

On the other hand, international is a different set of investments by simple inspection. It doesn’t require the leap of faith that diversification via factors requires.
If the dramatic underperformance of SCV for the past 18 months doesn’t represent a “different and independent” return stream from large cap stocks, it’s hard to imagine what would.
The above vineviz point is worth emphasizing. The poor recent performance of SCV relative to TSM and LG SUPPORTS the argument that size and value are unique and independent sources of risk.

Dave
I think there is a lot of agreement that there are more risk factors than just a single market factor. The disagreement is with the notion that these factors deserve a persistent premium which is more than a data-mining artifact from backtests.
Wouldn’t the recent relatively bad performance represent greater risk? And shouldn’t greater risk be associated with increased expected return?

Dave
Yes, recent relatively bad performance is a sign of greater risk. And no, it doesn't follow that there is an associated increased expected return. Otherwise, you could make the same argument for an underperforming sector or for underperforming LG prior to the publication of SCV superiority.
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Re: The Bottom Line on Factor Investing

Post by Random Walker »

skeptic42 wrote: Thu Apr 30, 2020 11:04 am
Random Walker wrote: Thu Apr 30, 2020 10:29 am
skeptic42 wrote: Thu Apr 30, 2020 9:53 am
Random Walker wrote: Thu Apr 30, 2020 9:25 am
vineviz wrote: Wed Apr 29, 2020 5:05 pm

If the dramatic underperformance of SCV for the past 18 months doesn’t represent a “different and independent” return stream from large cap stocks, it’s hard to imagine what would.
The above vineviz point is worth emphasizing. The poor recent performance of SCV relative to TSM and LG SUPPORTS the argument that size and value are unique and independent sources of risk.

Dave
I think there is a lot of agreement that there are more risk factors than just a single market factor. The disagreement is with the notion that these factors deserve a persistent premium which is more than a data-mining artifact from backtests.
Wouldn’t the recent relatively bad performance represent greater risk? And shouldn’t greater risk be associated with increased expected return?

Dave
Yes, recent relatively bad performance is a sign of greater risk. And no, it doesn't follow that there is an associated increased expected return. Otherwise, you could make the same argument for an underperforming sector or for underperforming LG prior to the publication of SCV superiority.
Well just one data point supporting the argument, I wouldn’t intend for it to stand alone as proof.

Dave
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Re: The Bottom Line on Factor Investing

Post by skeptic42 »

vineviz wrote: Thu Apr 30, 2020 10:07 am
skeptic42 wrote: Thu Apr 30, 2020 9:53 am
I think there is a lot of agreement that there are more risk factors than just a single market factor. The disagreement is with the notion that these factors deserve a persistent premium which is more than a data-mining artifact from backtests.
It would be illogical for anyone to believe that there are systematic sources of risk for which investors do not expect to be compensated.

Anyone who thought that size and/or value represented risk factors with no expected return premium would find it irrational to expose themselves to such uncompensated risks and would refuse to own portfolios with exposure to those risk factors. They would prefer large cap growth stocks over total stock market funds. Which would increase the expected returns of small cap value stocks, until . . . .
Yes, that would be illogical. Maybe, I shouldn't call these factors "risk factors", because I am not convinced by all the different risk narratives. So from my point of view there are many factors which drive the performance of stocks, but I don't know whether these are risk or behavior based and I don't know which factors other than the market factor will drive the performance in the future.
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Re: The Bottom Line on Factor Investing

Post by redbarn »

raven15 wrote: Wed Apr 29, 2020 5:45 pm
klaus14 wrote: Wed Apr 29, 2020 5:27 pm
raven15 wrote: Wed Apr 29, 2020 5:23 pm There were two "aha" moments for me. One was when I was learning how to backtest in Portfolio Visualizer and after playing around I realized that by making regular new investments I would get better than market performance by investing in volatile small cap value stocks than by investing in a total market fund, even if they had the exact same annualized return over the period. Further, I realized that this was a unique advantage for me because just starting off I had very little money at risk, whereas presumably nearly every other invested dollar is owned by a person or institution with a lot more money at play and who would just receive the extra volatility on their copious existing money with little expectation of being compensated for it.

The second was reading Bernstein "The Ages of the Investor" which showed the same thing: making regular contributions into small cap value would have 0.6% greater returns than a whole market fund, even if the funds had the same CAGR, because of the phenomenon.

So for now I am banking on better mechanical returns because of my inherent advantage as a relatively new investor, and of course hoping for better returns of small cap value stocks as an equity sub-class. Better risk adjusted returns would also be great, but that seems like too much to hope for.

So far this year it's been playing out about like I hoped it would.
is this because rebalancing between TSM and SCV?
Otherwise, i don't get how this would happen, volatility also implies sometimes you buy expensive.
Nope. The same dollar buys proportionally more shares when things are cheap than when they are expensive, so SCV in isolation does it.

Take TSM Fund A and SCV Fund B.
Year 1: Fund A costs $20/share and Fund B also costs $20 per share. You buy $100 of each. You have 5 of A and 5 of B for this year
Year 2: Fund A costs $25/share and Fund B costs $33.33 per share. You buy $100 of each. You now have 4 of A and 3 of B for this year.
Year 3: Fund A costs $10/share and Fund B costs $5 per share. You buy $100 of each. You now have 10 of A and 20 of B for this year.
Year 4: Both return to their starting value of $20 per share.

You own 19 shares of TSM Fund A which are worth $380. You own 28 shares of SCV Fund B, which are worth $560. However, a person who was not adding money suffered incredible volatility for no gain and decides to hop off the roller coaster. A person selling regularly would have been destroyed by owning B. Advantage: new investor.

Real life is almost never this extreme, but this illustrates the point.
This is a very interesting point but slightly misleading to see it is a "virtue" of investing in a higher volatility asset class. In some sense, the comparison is constructed artificially to turn a downside into a virtue.

Given the same year-to-year annual return (e.g. 5% a year), if you buy and hold a $100 in a more volatile vs. less volatile asset, your annualized returns over the whole period will be higher for the less volatility asset. This is the sense in which volatility reduces returns. This is still true even if you contribute over time. This is a downside of a more volatile asset, which has to outperform on a year-to-year basis to do as well over the long-run.

What you are doing in your comparison, is assuming that a one time buy and hold investor in the volatile asset ends up with the exact same return as a one time buy and hold investor in the safer asset at the end of the period. By doing this, you are equalizing the final return in this comparison, but in order to overcome the volatility drag, you are effectively assuming higher year-to-year returns for the more volatile asset. Someone who contributes repeatedly will experience less of a volatility drag than someone who buys and holds once, and since the example is constructed to equalize the final returns between the two assets for someone who buys and holds once, it somewhat trivially follows that the repeated contributor will do better with the more volatile asset.

What I do think is a useful lesson from this is that when backtesting a more volatile vs. less volatile asset class for someone who is making repeated contributions, it does not make sense to look at a one time buy and hold scenario. This will bias us against the more volatile asset, which attained its one time buy and hold return in the long-run despite the higher volatility, which means it had relatively higher year to year returns.
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Re: The Bottom Line on Factor Investing

Post by rkhusky »

It is easier for me to think of risk/reward in terms of bonds. If there are two companies A and B, with A considered to be on more solid financial footing than B, one would normally require B to pay a higher rate in order to loan them money. This is because the risk of B defaulting on the debt is larger than the risk of A defaulting. If investors were able to look into the future, then the return of a basket of A-type companies would be the same as a basket of B-type companies, because if one knew the number of B-type companies that would default, one could adjust the interest rates to exactly compensate. However, this is not possible, and so investors require a higher expected return for B-type companies to take on this unknown risk. That is, even if investors were to correctly guess the number of defaults, they would still require an excess of return for investing in B-type companies versus A-type companies. Since the market is not prescient, sometimes there are significantly more defaults than expected and investing in high risk bonds pays less than low risk bonds. But, over an extended period of time, the return for B-type companies should be higher than for A-type companies, if the market, on average, correctly predicts the number of defaults, and the under- and over-forecasts average out.

Nothing in the above says that one should tilt towards or away from higher risk bonds. It is a personal decision on the perceived risk/reward tradeoff. The market eventually reaches an equilibrium, which provides the average additional return expected for taking on an additional amount of risk.

How does this carry over to stocks, where there is no contractual mechanism for extracting profit? One can still examine companies to see how solid they are financially. One can also look at their prospects for future earnings. If there are two companies A and B, with A considered to be on more solid financial footing than B, one might require B to have higher future prospective earnings than A in order to pay the same price for B's shares in comparison to A's. If their prospective earnings are the same, then one would require B's price to be lower, because there is more uncertainty in B attaining those earnings. Again, if investors could see into the future, they would know what the future earnings would be, and could then accurately price A-type companies versus B-type companies, such that the returns were equal. But, since this is not possible, investors require that B-type companies provide higher prospective earnings and/or have higher book value and/or provide higher dividends in order to offer the same price as for A-type companies. For taking on the added risk, investors still expect to make more investing in B-type companies, even if their guesses for future earnings turn out to be accurate. Since the market is not prescient, future earnings of more risky companies sometimes come in significantly lower than expected, and investing in B-type companies provides lower returns than for A-type companies. But, over an extended period of time, the return for B-type companies should be higher than for A-type companies, if the market, on average, correctly predicts future earnings, and the under- and over-forecasts average out.

Nothing in the above says that one should tilt towards or away from higher risk stocks. It is a personal decision on the perceived risk/reward tradeoff. The market eventually reaches an equilibrium, which provides the average additional return expected for taking on an additional amount of risk.
Last edited by rkhusky on Thu Apr 30, 2020 11:54 am, edited 1 time in total.
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Re: The Bottom Line on Factor Investing

Post by Taylor Larimore »

Dave wrote: shouldn’t greater risk be associated with increased expected return?
Dave:

Many years ago when we were invested with Merrill Lynch, our "Advisor" recommended the Merrill Lynch Phenix Fund which we purchased. His primary selling point was that this fund invested in risky companies that were expected to become winners. He was wrong and the Phenix Fund folded along with most of our investment.

I also remember when the risky Vanguard Gold Fund had the BEST 10-year performance of all Vanguard Funds. During the next 10 years it had the WORST performance of all Vanguard funds. It subsequently changed its name to the "Gold and Precious Metals Fund."

It is very dangerous to assume that greater risk will result in increased expected return. There is no better example than the current dismal performance of risky Small Cap Value Funds.

Best wishes.
Taylor
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