Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

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Socal77
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Socal77 »

People, for all practical purposes a factor has to be properly identified and timed. So it should be obvious that seeking alpha from factors is a losers game, especially with the behavioral component muddying the waters.

With some pragmatic and unbiased research, education, and life experience, I have learned that unknown edges (the real factors) are kept that way as long as possible in effort to seek that personal rent. Will you share your rent with me?

How about the recent residential estate factor? You're just trying to identify capital flows with myriad complexly connected variables, not only behavioral, but institutional. Does anyone actually feel the complexity?

In my opinion, the only person, maybe two that I can identify who have legitimately uncovered market factors that were real, exploitable - and most impressively they knew they were correct ahead of time, is James Simons and Edward Thorp.

You are not going to compete with those guys, and if you can, you will not be responding to my critique of seeking alpha via factors because you want to remain as anonymous as humanly possible.
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drumboy256
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by drumboy256 »

I think factor investing if fine if you like throwing money at a problem you don't have.

A few examples this board has specifically taught me:
- People who advocate SCV are so battle hardened, they don't feel numb throwing new money at SCV funds because they literally don't care if they make or lose money, they have "conviction" that their bet is correct.

- People who advocate and/or do actually buy SCV are as bad as the ones who throw money at greater than 20% International because diversification "ain't a free lunch..." preached in most corners of the forums.

- Factor investing is overly complex of which a rudimentary understanding of risk / value and volume (of fund trading) isn't alone enough to encompass the thought power needed to make an "educated" bet on which factor a person should "bet" on.

- Lastly, factor investing when diluted down to the market cap weight and Morning Star grid system shows that whatever system is needed as a Rosetta stone to "interpret" quote "correct" factor investing, I've got some snake oil and a bridge to sell you as well.

Why do I bring up these points, I've lived them over the last few years thanks to all of the insights from some of the smartest and not so smart folks on this board. I think the statements of "beating the market" are assuming a greater than 8% buy investing in "non-leveraged" funds are delusional. As others have said, beating the market isn't a bad thing but I don't count on it being a regular occurrence in my life.

As KlangFool always say, we don't know nothing... and just because a broken clock is right twice a day doesn't make it useful.
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Nathan Drake
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

Socal77 wrote: Thu Dec 02, 2021 9:53 pm People, for all practical purposes a factor has to be properly identified and timed. So it should be obvious that seeking alpha from factors is a losers game, especially with the behavioral component muddying the waters.
Nope.

Factors are robust. Different metrics for Value all work.

Timing is not needed at all - in fact, timing doesn't work. You must stay invested in factors like you do the market.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

drumboy256 wrote: Thu Dec 02, 2021 10:04 pm I think factor investing if fine if you like throwing money at a problem you don't have.
I like throwing money at a problem I do have - US TSM being CAPE10 of 40 with a very likely scenario of extremely poor returns. Luckily not every segment of the investable market landscape is overvalued and exposed to potentially 10+ years of terrible returns.

So that's why I diversify across regions and separate risk factors - diversification. Long-term poor performance in any one class is a problem every investor has, but is often blind to if they only have experienced the good times.
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Socal77
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Socal77 »

Nathan Drake wrote: Thu Dec 02, 2021 10:14 pm
Socal77 wrote: Thu Dec 02, 2021 9:53 pm People, for all practical purposes a factor has to be properly identified and timed. So it should be obvious that seeking alpha from factors is a losers game, especially with the behavioral component muddying the waters.
Nope.

Factors are robust. Different metrics for Value all work.

Timing is not needed at all - in fact, timing doesn't work. You must stay invested in factors like you do the market.
:-)
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9-5 Suited
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by 9-5 Suited »

Socal77 wrote: Thu Dec 02, 2021 10:17 pm
Nathan Drake wrote: Thu Dec 02, 2021 10:14 pm
Socal77 wrote: Thu Dec 02, 2021 9:53 pm People, for all practical purposes a factor has to be properly identified and timed. So it should be obvious that seeking alpha from factors is a losers game, especially with the behavioral component muddying the waters.
Nope.

Factors are robust. Different metrics for Value all work.

Timing is not needed at all - in fact, timing doesn't work. You must stay invested in factors like you do the market.
:-)
I like the way Eugene Fama answers questions about value factor investing strategies, and he's certainly in an interesting position to comment.

An interviewer asked him if he thought all investors should invest in small value companies and he laughed and essentially espoused a general recommendation for the average investor to take a total market approach. But he added as his rationale that it's really a fairly simple premise - factors and facgtor premia are just a recogniztion that some firms have greater cost of capital and therefore have both more risk and more expected return. Those same firms (according to his logic) would have to pay higher interest rates on debt just like they need to offer better expected returns to equity investors because of the possibility of calamity.

So it has really not much to do with timing or picking precisely the right value metric since they're all measuring some degree of something similar. It's just a matter of whether, in your particular investment timeframe, you get the calamity or the big payout. Very similar (though also different in a few ways) to stock vs. bond allocation choices.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Northern Flicker »

Taylor Larimore wrote: Thu Dec 02, 2021 7:03 pm
Northern Flicker wrote: Thu Dec 02, 2021 6:04 pm Factors are not market segments. When you own the market, you have full exposure to the market factor and zero exposure to other factors. That is a perfectly viable choice, but it is not getting exposure to all factors.
Northern Flicker:

Inasmuch as the U.S. total stock market contains nearly ALL U.S. stocks (growth, value, large, small, momentum, etc.), how do you explain your statement about "not getting exposure to all factors"?

It seems to me that the only way to get exposure to all factors is to invest in the total stock market. These experts agree...
Taylor,

None of your quotes (that I left out of the quoted text) address the makeup of factor-tilted portfolios.

Factor exposures are relative to the total market portfolio as the neutral portfolio. The market portfolio is by definition of factors exposed only to the market factor. Like it or not, that is how factors are defined.

Positive exposure to the value factor, for instance, means having more exposure to value stocks than what you get with a total market portfolio. The same is true of other factors.

Whether or not factor exposures are a good idea is a different discussion from how to construct factor-tilted portfolios. Factors try to explain the return that lives in alpha in the Capital Asset Pricing Model. When you hold a total market portfolio, you diversify away all exposure to alpha, and hence to all factors other than the market portfolio. Doing so, that is, holding the market portfolio, has many benefits, so this is a reasonable approach that is appropriate for many investors.

If an investor instead wishes to try to beat the market, for better or for worse, factors provide a systematic way to try to do that, rather than resorting to fundamental stock picking or market timing. An investor can be successful without trying to do this, instead just being content with market returns. Factor exposures take the risk of lower returns than the market but hope for higher returns than the market.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

Northern Flicker wrote: Thu Dec 02, 2021 11:00 pmIf an investor instead wishes to try to beat the market, for better or for worse, factors provide a systematic way to try to do that, rather than resorting to fundamental stock picking or market timing. An investor can be successful without trying to do this, instead just being content with market returns. Factor exposures take the risk of lower returns than the market but hope for higher returns than the market.
More than just hope, based on empirical evidence and market theory, increasing factor exposure is the most systematic method that is about 80% likely to beat the market over rolling 10-yr periods. This of course means there's about a 20% a factor-slanted portfolio won't beat the market, meaning it could under-perform the market.
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lnp
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by lnp »

Socal77 wrote: Thu Dec 02, 2021 5:31 pm IMHO, factors do not exist.

They get arbitraged away just like anything else and you will not be able to time them properly over a lifetime of investing.
But why hasn't the market beta factor then been arbitraged away? (the market itself)
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Laurizas »

larsnyborgpedersen wrote: Fri Dec 03, 2021 5:06 am
Socal77 wrote: Thu Dec 02, 2021 5:31 pm IMHO, factors do not exist.

They get arbitraged away just like anything else and you will not be able to time them properly over a lifetime of investing.
But why hasn't the market beta factor then been arbitraged away? (the market itself)
How this should be done? Is it even possible?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

If anything gets arbitraged away it would receive a huge in-rush of cash, raising valuation multiples to bring them in line with the expected return of the asset being compared against

But that’s the opposite of what has happened with SCV. Despite strong earnings, the valuation multiple has decreased for SCV vs TSM. If anything, the market is pricing in much higher expected returns for SCV and much lower returns for TSM as the Market factor is currently being “arbitraged away” as the market prices it as LESS RISKY
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by burritoLover »

Nathan Drake wrote: Fri Dec 03, 2021 9:29 am If anything gets arbitraged away it would receive a huge in-rush of cash, raising valuation multiples to bring them in line with the expected return of the asset being compared against

But that’s the opposite of what has happened with SCV. Despite strong earnings, the valuation multiple has decreased for SCV vs TSM. If anything, the market is pricing in much higher expected returns for SCV and much lower returns for TSM as the Market factor is currently being “arbitraged away” as the market prices it as LESS RISKY
TSM valuations are being pushed up by a handful of huge tech companies though - it could just be a massive bubble in that area and the spread between growth and value now may not be indicative of any future persistence of the SCV premium.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

burritoLover wrote: Fri Dec 03, 2021 10:22 am
Nathan Drake wrote: Fri Dec 03, 2021 9:29 am If anything gets arbitraged away it would receive a huge in-rush of cash, raising valuation multiples to bring them in line with the expected return of the asset being compared against

But that’s the opposite of what has happened with SCV. Despite strong earnings, the valuation multiple has decreased for SCV vs TSM. If anything, the market is pricing in much higher expected returns for SCV and much lower returns for TSM as the Market factor is currently being “arbitraged away” as the market prices it as LESS RISKY
TSM valuations are being pushed up by a handful of huge tech companies though - it could just be a massive bubble in that area and the spread between growth and value now may not be indicative of any future persistence of the SCV premium.
If the spreads are the result of a growth bubble that pops that does not impact SCV valuations then the premium should persist as spreads narrow due to underperformance of growth

The 00-09 scenario
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burritoLover
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by burritoLover »

Nathan Drake wrote: Fri Dec 03, 2021 10:29 am
burritoLover wrote: Fri Dec 03, 2021 10:22 am
Nathan Drake wrote: Fri Dec 03, 2021 9:29 am If anything gets arbitraged away it would receive a huge in-rush of cash, raising valuation multiples to bring them in line with the expected return of the asset being compared against

But that’s the opposite of what has happened with SCV. Despite strong earnings, the valuation multiple has decreased for SCV vs TSM. If anything, the market is pricing in much higher expected returns for SCV and much lower returns for TSM as the Market factor is currently being “arbitraged away” as the market prices it as LESS RISKY
TSM valuations are being pushed up by a handful of huge tech companies though - it could just be a massive bubble in that area and the spread between growth and value now may not be indicative of any future persistence of the SCV premium.
If the spreads are the result of a growth bubble that pops that does not impact SCV valuations then the premium should persist as spreads narrow due to underperformance of growth

The 00-09 scenario
But weren't SCV valuations lower than the historical average during the dot com boom? We can't assume the same scenario going forward after a crash at least with new money.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

burritoLover wrote: Fri Dec 03, 2021 10:42 am
Nathan Drake wrote: Fri Dec 03, 2021 10:29 am
burritoLover wrote: Fri Dec 03, 2021 10:22 am
Nathan Drake wrote: Fri Dec 03, 2021 9:29 am If anything gets arbitraged away it would receive a huge in-rush of cash, raising valuation multiples to bring them in line with the expected return of the asset being compared against

But that’s the opposite of what has happened with SCV. Despite strong earnings, the valuation multiple has decreased for SCV vs TSM. If anything, the market is pricing in much higher expected returns for SCV and much lower returns for TSM as the Market factor is currently being “arbitraged away” as the market prices it as LESS RISKY
TSM valuations are being pushed up by a handful of huge tech companies though - it could just be a massive bubble in that area and the spread between growth and value now may not be indicative of any future persistence of the SCV premium.
If the spreads are the result of a growth bubble that pops that does not impact SCV valuations then the premium should persist as spreads narrow due to underperformance of growth

The 00-09 scenario
But weren't SCV valuations lower than the historical average during the dot com boom? We can't assume the same scenario going forward after a crash at least with new money.
Not sure but it doesn’t really matter. For the premium to disappear in the face of growth valuations contracting, you would need significant fundamental underperformance of earnings of SCV companies vs Growth companies

It’s a possibility to be sure, but I find it unlikely
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Northern Flicker »

garlandwhizzer wrote: Thu Dec 02, 2021 8:41 pm
Northern Flicker wrote:

Factors are not market segments. When you own the market, you have full exposure to the market factor and zero exposure to other factors.
I believe this is a matter of semantics. The above statement is true if we accept the factor definition as defined by factor models. There is a different way of looking at it if you substitute the world style for the word factor...
I'm not trying to be nitpicky here. It is not just a semantic difference. This actually is very important for the fundamental underpinnings of investing in a total market index fund. It is where the benefits of holding the market portfolio flow from.

Factors are not just a description of types or styles of stocks. They are risk factors for which an investor expects to be compensated. Ever since the articulation of the Capital Asset Pricing Model (CAPM) equity risk has been modeled as market risk and other risks expressed as offsets from market return.

The statement that the market portfolio is exposed to the market factor and has zero exposure to other factors is just a way of saying that the market portfolio diversifies away all equity risk factors other than the market risk factor. This is and should be a welcome property to an investor in a market index fund.

If you look at SPIVA data carefully, you will see that active managers overall actually do a reasonable job of constructing portfolios where risk is rewarded so that about half of the active portfolios beat the market in a given year. The problem is that once costs are deducted, the outcomes skew strongly toward failure. The compensation for taking extra risk compensates for the risk but does not additionally compensate for the cost of active management. Some of the risk premium flows to the manager, and the investor is undercompensated for the risk taken.

By holding a market portfolio through a market index fund, the investor gives up any return premium from an active tilt and saves the cost of active management. But the market index fund strategy is a stool that also needs a 3rd leg to be viable, and that is that it diversifies away all equity risk other than market risk. The index fund investor not only sheds the cost of active management and any premium from active management, but also sheds the added risk of active management.

So the statement that the market portfolio has market exposure but zero exposure to other factors is a precisely defined statement that is not open to varying semantic interpretations. It is in fact a critical property that makes holding a market index fund an attractive proposition-- diversifying away all equity risk other than market risk.

Successful investing with factor tilts ultimately actually is about cost, though few factor proponents present it or analyze it that way. It is active management implemented cheaply enough hopefully to work. If you can take other compensated equity risks beyond market risk at low enough cost, then hopefully enough of the premium flows to the investor to reward for the risk taken. Thus, it is equally important for factor investors to pay close attention to costs.
Last edited by Northern Flicker on Fri Dec 03, 2021 6:50 pm, edited 1 time in total.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by UpperNwGuy »

Northern Flicker wrote: Fri Dec 03, 2021 6:32 pm The statement that the market portfolio is exposed to the market factor and has zero exposure to other factors is just a way of saying that the market portfolio diversifies away all equity risk factors other than the market risk factor. This is and should be a welcome property to an investor in a market index fund.
Thank you for clearly expressing what has been bothering me in my discussions with the factor people on this forum.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by reln »

larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Is it because it only has better risk adjusted returns under the flawed CAPM model and actually would have similar risk adjusted returns under a five factor model?
Or why?
Not every one believes in factor investing. And there are several factor models. And there are many versions of each factor.

Additionally, the factor premiums that were discovered in the Fama and French papers are at this point known to have been significantly overstated. If the analysis were reformulated with small changes in definitions, the premiums almost always decrease on average by about 40% per year.
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"The Telltale Chart"

Post by Taylor Larimore »

Bogleheads:

In June, 2002, I and a few other Bogleheads attended a Morningstar Investment Forum in Chicago. Jack Bogle was the principal speaker. Although "Factors" was an unknown term in 2002, his speech, "The Telltale Chart," covers many of the subjects in this long thread. I hope you enjoy it:

The Telltale Chart

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "The returns of market sectors, of managed investment portfolios, and even of the market itself mysteriously return, overtime, to norms of one kind or another.“
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Triple digit golfer »

Factor investing goes against my goal, which is simply to earn the returns of the global equity markets.

It's a beautiful thing because I am in control of whether or not I do it.

What goes on inside those markets, which companies, countries, sectors, styles and sizes move up and down, which companies move from one little silly Brady Bunch 9 style box to another or what my numbers are on that grid, I couldn't care less.

Anything other than global market cap is a guarantee that I will underperform or overperform the market. It's not a bet I'm interested in.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

Triple digit golfer wrote: Fri Dec 03, 2021 9:45 pm Factor investing goes against my goal, which is simply to earn the returns of the global equity markets.

It's a beautiful thing because I am in control of whether or not I do it.

What goes on inside those markets, which companies, countries, sectors, styles and sizes move up and down, which companies move from one little silly Brady Bunch 9 style box to another or what my numbers are on that grid, I couldn't care less.

Anything other than global market cap is a guarantee that I will underperform or overperform the market. It's not a bet I'm interested in.
You can apply the same logic/approach with factors.

It’s just an extra tweak to an AA….but it’s just set it and forget it
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Triple digit golfer »

Nathan Drake wrote: Fri Dec 03, 2021 10:09 pm
Triple digit golfer wrote: Fri Dec 03, 2021 9:45 pm Factor investing goes against my goal, which is simply to earn the returns of the global equity markets.

It's a beautiful thing because I am in control of whether or not I do it.

What goes on inside those markets, which companies, countries, sectors, styles and sizes move up and down, which companies move from one little silly Brady Bunch 9 style box to another or what my numbers are on that grid, I couldn't care less.

Anything other than global market cap is a guarantee that I will underperform or overperform the market. It's not a bet I'm interested in.
You can apply the same logic/approach with factors.

It’s just an extra tweak to an AA….but it’s just set it and forget it
Definitely. Your benchmark can be whatever you want it to be.

The thing I hate about any fund that isn't a total market fund or close to it (say an S&P 500 index) is that it's all arbitrary.

Who decides what is "small" or "value?" These things are all relative. If large caps and small caps both skyrocket, do mid caps then become small caps, and then the smaller large caps are now mid caps? It all seems so silly and arbitrary to me.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

Triple digit golfer wrote: Fri Dec 03, 2021 9:45 pmAnything other than global market cap is a guarantee that I will underperform or overperform the market. It's not a bet I'm interested in.
I get that that, and there's certainly a convincing argument for the simplicity of just investing a single, globally diverse auto re-balancing fund like VT or VASGX. But if, historically, a factor slanted portfolio has an 80% chance of out-performing the market over rolling 10-yr periods, I don't mind a little more complexity to improve expected returns.

That said, when I get to retirement age I'll seriously consider moving everything into a simple, auto re-balancing fund like VSMGX or VSCGX. Factors won't make much difference to overall returns and volatility with a 50% equities/50% bonds portfolio.
Last edited by Apathizer on Fri Dec 03, 2021 10:38 pm, edited 1 time in total.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Triple digit golfer »

Apathizer wrote: Fri Dec 03, 2021 10:28 pm
Triple digit golfer wrote: Fri Dec 03, 2021 9:45 pmAnything other than global market cap is a guarantee that I will underperform or overperform the market. It's not a bet I'm interested in.
I get that that, and there's certainly a convincing argument for the simplicity of just investing in globally diverse index funds. But if, historically, a factor slanted portfolio has an 80% chance of out-performing the market over rolling 10-yr periods, I don't mind a little more complexity to improve expected returns.

That said, when I get to retirement age I'll seriously consider moving everything into a simple, auto re-balancing fund like VSMGX or VSCGX. Factors won't make much difference to overall returns and volatility with a 50% equities/50% bonds portfolio.
I understand that and certainly respect that viewpoint.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

Triple digit golfer wrote: Fri Dec 03, 2021 10:13 pm
Nathan Drake wrote: Fri Dec 03, 2021 10:09 pm
Triple digit golfer wrote: Fri Dec 03, 2021 9:45 pm Factor investing goes against my goal, which is simply to earn the returns of the global equity markets.

It's a beautiful thing because I am in control of whether or not I do it.

What goes on inside those markets, which companies, countries, sectors, styles and sizes move up and down, which companies move from one little silly Brady Bunch 9 style box to another or what my numbers are on that grid, I couldn't care less.

Anything other than global market cap is a guarantee that I will underperform or overperform the market. It's not a bet I'm interested in.
You can apply the same logic/approach with factors.

It’s just an extra tweak to an AA….but it’s just set it and forget it
Definitely. Your benchmark can be whatever you want it to be.

The thing I hate about any fund that isn't a total market fund or close to it (say an S&P 500 index) is that it's all arbitrary.

Who decides what is "small" or "value?" These things are all relative. If large caps and small caps both skyrocket, do mid caps then become small caps, and then the smaller large caps are now mid caps? It all seems so silly and arbitrary to me.
The way I look at it is more through the lens of diversification. I honestly don't care that much about the premiums involved, though if they do manifest (like I believe they should), then that's icing on top of the cake so to speak. So you can say that defining "small" or "value" is arbitrary (and to some degree, it is), there are certain time-tested metrics to assign to each and the factor research suggests that any of them work because "Value" is robust.

By being 100% in TSM funds, you get exposure to the market factor, which is highly concentrated in the top companies. So your risk exposure is mostly a function of the success of those fairly large firms that are already quite successful. Smaller companies with value characteristics are priced cheaply due to increased risk or behavioral reasons, but the way returns are generated for these sorts of companies over the course of a few years can diverge significantly from the market factor (either good or bad, but that's again part of diversification).

All of this is to say - there is nothing wrong with TSM investing. Over very long periods of time, you'd be surprised just how similar many different asset classes actually perform. We like to fight about Value vs. Growth or US vs. Intl, but if you are looking over the very long-term record you will see success with any of these assets alone. Meb Faber makes this argument when he compares different styles of fund managers for 30+ year periods.

However, any one of those asset classes alone can go through a very prolonged dry spell which may be painful to endure. And I suppose my personal asset allocation is designed around the idea that I want to capture as many regional risks as well as company-specific types of risks that are done in a methodical, rational way for long-term success. You can also play around with various portfolios on Portfolio Visualizer using DFA funds for factor investing to get an idea of how these types of investments in tandem with TSM funds peform over 20 year periods. This gave me quite a bit of confidence to adjust my own allocation after reading up on the factor research.

Factor-based funds IMHO are basically just an extension of index fund investing, filtering against overvaluation to put the odds in your favor for a more reliable outcome, with extremely low expense ratios. It's "slightly active", but done so in a way that's largely passively managed through well designed construction and to the benefit of fund owners through low expenses.
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Re: "The Telltale Chart"

Post by Northern Flicker »

Taylor Larimore wrote: Fri Dec 03, 2021 7:34 pm Bogleheads:

In June, 2002, I and a few other Bogleheads attended a Morningstar Investment Forum in Chicago. Jack Bogle was the principal speaker. Although "Factors" was an unknown term in 2002, his speech, "The Telltale Chart," covers many of the subjects in this long thread. I hope you enjoy it:

The Telltale Chart

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "The returns of market sectors, of managed investment portfolios, and even of the market itself mysteriously return, overtime, to norms of one kind or another.“
The concept of equity risk factors has been known since at least 1992 when the seminal work on the subject was published by Fama & French.

The main issue I have with factor investing is that the academic research on it does not quantify the cost of harvesting factor premiums. There also are questions about sample bias in the samples used.

But index fund investors who invest just in the S&P500 are closeted factor investors. The S&P500 has negative loadings on the size factor and positive loadings on the quality factor as compensation.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

Nathan Drake wrote: Fri Dec 03, 2021 10:52 pmFactor-based funds IMHO are basically just an extension of index fund investing, filtering against overvaluation to put the odds in your favor for a more reliable outcome, with extremely low expense ratios. It's "slightly active", but done so in a way that's largely passively managed through well designed construction and to the benefit of fund owners through low expenses.
:sharebeer :D
I think that's the most succinct, accurate description of factor investing I've read. I don't think even Ben Felix could say it better.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Triple digit golfer »

Nathan Drake wrote: Fri Dec 03, 2021 10:52 pm
Triple digit golfer wrote: Fri Dec 03, 2021 10:13 pm
Nathan Drake wrote: Fri Dec 03, 2021 10:09 pm
Triple digit golfer wrote: Fri Dec 03, 2021 9:45 pm Factor investing goes against my goal, which is simply to earn the returns of the global equity markets.

It's a beautiful thing because I am in control of whether or not I do it.

What goes on inside those markets, which companies, countries, sectors, styles and sizes move up and down, which companies move from one little silly Brady Bunch 9 style box to another or what my numbers are on that grid, I couldn't care less.

Anything other than global market cap is a guarantee that I will underperform or overperform the market. It's not a bet I'm interested in.
You can apply the same logic/approach with factors.

It’s just an extra tweak to an AA….but it’s just set it and forget it
Definitely. Your benchmark can be whatever you want it to be.

The thing I hate about any fund that isn't a total market fund or close to it (say an S&P 500 index) is that it's all arbitrary.

Who decides what is "small" or "value?" These things are all relative. If large caps and small caps both skyrocket, do mid caps then become small caps, and then the smaller large caps are now mid caps? It all seems so silly and arbitrary to me.
The way I look at it is more through the lens of diversification. I honestly don't care that much about the premiums involved, though if they do manifest (like I believe they should), then that's icing on top of the cake so to speak. So you can say that defining "small" or "value" is arbitrary (and to some degree, it is), there are certain time-tested metrics to assign to each and the factor research suggests that any of them work because "Value" is robust.

By being 100% in TSM funds, you get exposure to the market factor, which is highly concentrated in the top companies. So your risk exposure is mostly a function of the success of those fairly large firms that are already quite successful. Smaller companies with value characteristics are priced cheaply due to increased risk or behavioral reasons, but the way returns are generated for these sorts of companies over the course of a few years can diverge significantly from the market factor (either good or bad, but that's again part of diversification).

All of this is to say - there is nothing wrong with TSM investing. Over very long periods of time, you'd be surprised just how similar many different asset classes actually perform. We like to fight about Value vs. Growth or US vs. Intl, but if you are looking over the very long-term record you will see success with any of these assets alone. Meb Faber makes this argument when he compares different styles of fund managers for 30+ year periods.

However, any one of those asset classes alone can go through a very prolonged dry spell which may be painful to endure. And I suppose my personal asset allocation is designed around the idea that I want to capture as many regional risks as well as company-specific types of risks that are done in a methodical, rational way for long-term success. You can also play around with various portfolios on Portfolio Visualizer using DFA funds for factor investing to get an idea of how these types of investments in tandem with TSM funds peform over 20 year periods. This gave me quite a bit of confidence to adjust my own allocation after reading up on the factor research.

Factor-based funds IMHO are basically just an extension of index fund investing, filtering against overvaluation to put the odds in your favor for a more reliable outcome, with extremely low expense ratios. It's "slightly active", but done so in a way that's largely passively managed through well designed construction and to the benefit of fund owners through low expenses.
Good stuff and food for thought. Thank you. :sharebeer
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by lnp »

Laurizas wrote: Fri Dec 03, 2021 9:23 am
larsnyborgpedersen wrote: Fri Dec 03, 2021 5:06 am
Socal77 wrote: Thu Dec 02, 2021 5:31 pm IMHO, factors do not exist.

They get arbitraged away just like anything else and you will not be able to time them properly over a lifetime of investing.
But why hasn't the market beta factor then been arbitraged away? (the market itself)
How this should be done? Is it even possible?
If the other factors can be arbitraged, then why can't the market beta factor?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by grabiner »

larsnyborgpedersen wrote: Fri Dec 03, 2021 5:06 am
Socal77 wrote: Thu Dec 02, 2021 5:31 pm IMHO, factors do not exist.

They get arbitraged away just like anything else and you will not be able to time them properly over a lifetime of investing.
But why hasn't the market beta factor then been arbitraged away? (the market itself)
Because there is nothing to arbitrage away. Market beta is a reward for taking risk, and investors view it this way. Less risk-tolerant investors hold bonds or cash rather than stocks, deliberately accepting less beta and lower expected return because it is more valuable to them. Logically, this should also apply to lower-beta stock; a portfolio of 100% stock with a beta of 0.8 should have the same risk and return as a portfolio of 80% total stock market (beta 1 by definition) and 20% cash.

The same is true for any other factor which is a risk premium. If value stocks have higher expected return than growth stocks, but more risk and that risk is correlated with X, then investors who have no X risk elsewhere can increase return with little risk increase by overweighting value, while investors who are very sensitive to X risk may overweight growth.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Francis42 »

firebirdparts wrote: Tue Nov 30, 2021 6:52 am I think everybody did, and that's why we don't see factor outperformance anymore. That's a simple idea, and somebody will say it's not strictly true, and that's fine. But it is largely true.
This is inaccurate.

If outperformance due to factor-loading was attributable to inefficiencies, you would be correct.

If outperformance due to factor loading is compensation for increased risk, the premium would be unaffected by subsequent investor behavior. Similar to market beta.

I believe it is compensation for increased risk.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Booogle »

Nathan Drake wrote: Fri Dec 03, 2021 10:52 pm You can also play around with various portfolios on Portfolio Visualizer using DFA funds for factor investing to get an idea of how these types of investments in tandem with TSM funds peform over 20 year periods. This gave me quite a bit of confidence to adjust my own allocation after reading up on the factor research.
It is true that from 2000-2007, DFSVX outperformed a lot while large caps completely crashed.

So you are banking your entire portfolio on this TEMPORARY outperformance reoccurring again?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

Booogle wrote: Sat Dec 04, 2021 9:50 am
Nathan Drake wrote: Fri Dec 03, 2021 10:52 pm You can also play around with various portfolios on Portfolio Visualizer using DFA funds for factor investing to get an idea of how these types of investments in tandem with TSM funds peform over 20 year periods. This gave me quite a bit of confidence to adjust my own allocation after reading up on the factor research.
It is true that from 2000-2007, DFSVX outperformed a lot while large caps completely crashed.

So you are banking your entire portfolio on this TEMPORARY outperformance reoccurring again?
No, I tilt 50% TSM and 50% SCV, see my signature for portfolio asset allocation.

And it's not temporary - that's just the cycle of what the value premium does. It can be uncorrelated to the TSM.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Booogle »

Nathan Drake wrote: Sat Dec 04, 2021 1:49 pm And it's not temporary - that's just the cycle of what the value premium does. It can be uncorrelated to the TSM.

What do you mean?

According to your own charts, the outperformance of SCV is only temporary.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

Booogle wrote: Sat Dec 04, 2021 9:50 amIt is true that from 2000-2007, DFSVX outperformed a lot while large caps completely crashed.
So you are banking your entire portfolio on this TEMPORARY outperformance reoccurring again?
You seem to keep erroneously insistent factor out-performance is temporary when in fact it's been historically persistent. Periods of factor under-performance are temporary as has been the case for the last decade for the US market. But factors beat ex-US markets during the same time period.

That's the point of both global diversification and factor diversification. Sure, long-term factor under-performance might happen in some markets, but it's unlikely to simultaneously happen all markets.
Last edited by Apathizer on Sat Dec 04, 2021 2:14 pm, edited 1 time in total.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

Booogle wrote: Sat Dec 04, 2021 1:58 pm
Nathan Drake wrote: Sat Dec 04, 2021 1:49 pm And it's not temporary - that's just the cycle of what the value premium does. It can be uncorrelated to the TSM.

What do you mean?

According to your own charts, the outperformance of SCV is only temporary.
Image
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Marseille07 »

Nathan Drake wrote: Sat Dec 04, 2021 2:06 pm
Booogle wrote: Sat Dec 04, 2021 1:58 pm
Nathan Drake wrote: Sat Dec 04, 2021 1:49 pm And it's not temporary - that's just the cycle of what the value premium does. It can be uncorrelated to the TSM.

What do you mean?

According to your own charts, the outperformance of SCV is only temporary.
Image
You can pencil in anything like this after the fact, provided long-term CAGR of SCV was higher than US TSM until today.

Will it continue? Nobody knows.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

Marseille07 wrote: Sat Dec 04, 2021 2:10 pm
Nathan Drake wrote: Sat Dec 04, 2021 2:06 pm
Booogle wrote: Sat Dec 04, 2021 1:58 pm
Nathan Drake wrote: Sat Dec 04, 2021 1:49 pm And it's not temporary - that's just the cycle of what the value premium does. It can be uncorrelated to the TSM.

What do you mean?

According to your own charts, the outperformance of SCV is only temporary.
Image
You can pencil in anything like this after the fact, provided long-term CAGR of SCV was higher than US TSM until today.

Will it continue? Nobody knows.
Will the market factor continue? Nobody knows.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

Marseille07 wrote: Sat Dec 04, 2021 2:10 pmYou can pencil in anything like this after the fact, provided long-term CAGR of SCV was higher than US TSM until today.

Will it continue? Nobody knows.
For the last 100 years of global stock returns factors have out-performed the market during rolling 10-yr periods about 80% of the time. So while it true we don't know it's likely factors will out-perform based on history and our best understanding of how market-pricing works.
Last edited by Apathizer on Sat Dec 04, 2021 2:19 pm, edited 1 time in total.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Northern Flicker »

grabiner wrote: Sat Dec 04, 2021 8:08 am
larsnyborgpedersen wrote: Fri Dec 03, 2021 5:06 am
Socal77 wrote: Thu Dec 02, 2021 5:31 pm IMHO, factors do not exist.

They get arbitraged away just like anything else and you will not be able to time them properly over a lifetime of investing.
But why hasn't the market beta factor then been arbitraged away? (the market itself)
Because there is nothing to arbitrage away. Market beta is a reward for taking risk, and investors view it this way. Less risk-tolerant investors hold bonds or cash rather than stocks, deliberately accepting less beta and lower expected return because it is more valuable to them. Logically, this should also apply to lower-beta stock; a portfolio of 100% stock with a beta of 0.8 should have the same risk and return as a portfolio of 80% total stock market (beta 1 by definition) and 20% cash.

The same is true for any other factor which is a risk premium...
This is correct from the perspective of fully arbitraging away a source of risk and return. However, when a source of risk becomes better understood, investors also learn how better to manage it, and the premium will shrink as the risk also comes down.

After CAPM it became well understood that idiosyncratic equity return could be diversified away-- all of alpha could be diversified away. Investors could hold equity portfolios with less risk as a result of the understanding. With less risk, they are willing to pay more for the projected future cash flows of the stocks they hold, reducing the risk premium that is discounted in. The result is that equity returns are a bit lower than in times well in the past, but properly constructed equity portfolios also are a little less risky. A major benefit of a market index fund is that it avoids portfolio construction errors that take uncompensated risk.

I believe investors are willing to hold higher equity allocations relative to bonds today than in the past because risk is better understood. Fifty years ago, a typical retail investor would have said "Never invest more than you can afford to lose in stocks". The idea of someone having a significant majority of their net worth in stocks as is common today would have felt far too risky to an average individual 50 years ago, and it probably was without the ability to diversify an equity portfolio properly at the asset level of a retail investor.

Similar effects are likely for other equity risk factors. Low cost small-cap value funds make it cheaper and easier to harvest any value or size premiums. The quantitative framework of having factors defined for the premiums makes it possible to design low cost funds to harvest the premiums. In the past, investors had higher cost to implement the strategies, SCV stocks were less liquid, and implementing the strategy had the risk of harvesting less of the premium due to security selection effects.

An investor should be willing to pay more for SCV stocks when there is a more systematic, low cost method of harvesting the premiums. There is less risk of missing the premium (while still taking the risk) than by trying to harvest the premium by active trading.

The head of factor strategies at Vanguard, Antonio Picca, was interviewed recently on The Rational Podcast. If I understood correctly, I believe he mentioned at one point that he considers that the return of a strategy moving forward will generally be less than what is observed in backtests. I think he was alluding to these types of effects.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Booogle »

Nathan Drake wrote: Sat Dec 04, 2021 2:06 pm
Booogle wrote: Sat Dec 04, 2021 1:58 pm
Nathan Drake wrote: Sat Dec 04, 2021 1:49 pm And it's not temporary - that's just the cycle of what the value premium does. It can be uncorrelated to the TSM.

What do you mean?

According to your own charts, the outperformance of SCV is only temporary.
Image

According to your own chart everything evens out at the end.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Nathan Drake »

Booogle wrote: Sat Dec 04, 2021 2:42 pm
Nathan Drake wrote: Sat Dec 04, 2021 2:06 pm
Booogle wrote: Sat Dec 04, 2021 1:58 pm
Nathan Drake wrote: Sat Dec 04, 2021 1:49 pm And it's not temporary - that's just the cycle of what the value premium does. It can be uncorrelated to the TSM.

What do you mean?

According to your own charts, the outperformance of SCV is only temporary.
Image

According to your own chart everything evens out at the end.
You're not reading the chart correctly
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Beensabu »

Booogle wrote: Sat Dec 04, 2021 2:42 pm According to your own chart everything evens out at the end.
Maybe take a look at the label on the y-axis.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

Northern Flicker wrote: Sat Dec 04, 2021 2:18 pmThe head of factor strategies at Vanguard, Antonio Picca, was interviewed recently on The Rational Podcast. If I understood correctly, I believe he mentioned at one point that he considers that the return of a strategy moving forward will generally be less than what is observed in backtests. I think he was alluding to these types of effects.
I just watched it and that's the impression I got as well. As a strategy becomes more widely employed it's at least somewhat integrated into the market. I guess it's another good argument for index investing.

They also asked him about auto re-balancing products with a factor slant, which really interests me. For simplicity I'd love to have such a single-fund. Something like VSMGX, but with an equity factor slant. Picca said he thinks Vanguard will eventually create such products, but didn't give a time-frame.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Northern Flicker »

VPGDX has a factor slant in its US portfolio. It also has an int'l equity tilt and exposure to alternative investments, so a bit different from adding equity factor exposure to VSMGX.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

Northern Flicker wrote: Sat Dec 04, 2021 6:06 pm VPGDX has a factor slant in its US portfolio. It also has an int'l equity tilt and exposure to alternative investments, so a bit different from adding equity factor exposure to VSMGX.
Yeah, I'm unimpressed with the few factor products Vanguard offers. Their small cap value fund/etf pales in comparison to DFA and Avantis, which seems essentially the same. As sort of a gray area between indexing and active management, factor investing isn't something Vanguard has figured out, at least not yet.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by luckyducky99 »

Apathizer wrote: Sat Dec 04, 2021 7:09 pm
Northern Flicker wrote: Sat Dec 04, 2021 6:06 pm VPGDX has a factor slant in its US portfolio. It also has an int'l equity tilt and exposure to alternative investments, so a bit different from adding equity factor exposure to VSMGX.
Yeah, I'm unimpressed with the few factor products Vanguard offers. Their small cap value fund/etf pales in comparison to DFA and Avantis, which seems essentially the same. As sort of a gray area between indexing and active management, factor investing isn't something Vanguard has figured out, at least not yet.
There’s been some love on this board for VFMF. Mostly by people who aren’t active here anymore, but searching the archives will find some of those discussions. The seemed pretty thoughtful as I recall.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

luckyducky99 wrote: Sat Dec 04, 2021 7:34 pmThere’s been some love on this board for VFMF. Mostly by people who aren’t active here anymore, but searching the archives will find some of those discussions. The seemed pretty thoughtful as I recall.
Interestingly VFMF and Avantis have about as much history (2 years). That's not much of a track record, but in that time Avantis looks better. AVUS has out-performed VFMF with much less volatility, while AVUV is only slightly more volatile and has significantly out-performed VFMF.

Again, Vanguard excels at low-cost well-constructed index funds, but factor investing, not so much.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by luckyducky99 »

Apathizer wrote: Sat Dec 04, 2021 8:41 pm
luckyducky99 wrote: Sat Dec 04, 2021 7:34 pmThere’s been some love on this board for VFMF. Mostly by people who aren’t active here anymore, but searching the archives will find some of those discussions. The seemed pretty thoughtful as I recall.
Interestingly VFMF and Avantis have about as much history (2 years). That's not much of a track record, but in that time Avantis looks better. AVUS has out-performed VFMF with much less volatility, while AVUV is only slightly more volatile and has significantly out-performed VFMF.

Again, Vanguard excels at low-cost well-constructed index funds, but factor investing, not so much.
Fair enough. I plead guilty to not paying enough attention to comment further.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Northern Flicker »

The fund VSIAX/VBR is called small-cap value, but it is not designed for strong loadings on either size or value. It has a low enough ER that you can get higher loadings by holding more of it conpared to a fund like AVUV, without a significant increase in portfolio ER.

VIOV is an ETF that tracks the S&P 600 Small-Cap Value Index-- much like IJS or SLYV.

This is the suite of products from the factor group headed up by Antonio Picca:

https://investor.vanguard.com/etf/factor-funds

These seem to be marketed through advisor channels but are available to be purchased directly.
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