Who should not invest in the market portfolio

[exodusing]

[Apathizer's and exodusing's threads on the Ben Felix video have been merged. -moderator Kendall.]

Ben Felix has a very well done video on who should not invest in the market portfolio at https://www.youtube.com/watch?v=4hSFzVoZkiA

He also posted a rational reminders video with more detail at https://www.youtube.com/watch?v=mGCwuS8bjGA

Basically, the average investor should hold the market. You should consider deviating if you are meaningfully different. Determining if you are meaningfully different and how to deviate are the hard parts, but in the absence of good reasons to deviate, the market portfolio is a fine place to be.

A long thread on the general subject is at viewtopic.php?t=207804

[Apathizer]

[Apathizer's and exodusing's threads on the Ben Felix video have been merged. -moderator Kendall.]

Felix has new episode with a somewhat different take on index investing. While index are a fine default option for most investors, there are reasons to consider diverging from this paradigm, though of course not everyone should.
https://www.youtube.com/watch?v=4hSFzVoZkiA

[WS1]

Cautiously optimistic

[secondopinion]

Felix has new episode with a somewhat different take on index investing. While index are a fine default option for most investors, there are reasons to consider diverging from this paradigm, though of course not everyone should.
https://www.youtube.com/watch?v=4hSFzVoZkiA

The sum of all divergence will end up with market-weight. The question then is who should do the opposite of the recommendation?

[Apathizer]

Cautiously optimistic

Er, care to elaborate? An ambiguous two word adverb-adjective statement isn't really saying anything.

[Apathizer]

Felix has new episode with a somewhat different take on index investing. While index are a fine default option for most investors, there are reasons to consider diverging from this paradigm, though of course not everyone should.
https://www.youtube.com/watch?v=4hSFzVoZkiA

The sum of all divergence will end up with market-weight. The question then is who should do the opposite of the recommendation?

Did you actually watch it? It's not the opposite. it's much more nuanced than that. Factor tilts are market based; they're just aren't market cap weight. It's a fairly minor variation of MCW indexing.

[secondopinion]

Felix has new episode with a somewhat different take on index investing. While index are a fine default option for most investors, there are reasons to consider diverging from this paradigm, though of course not everyone should.
https://www.youtube.com/watch?v=4hSFzVoZkiA

The sum of all divergence will end up with market-weight. The question then is who should do the opposite of the recommendation?

Did you actually watch it? It's not the opposite. it's much more nuanced than that. Factor tilts are market based; they're just aren't market cap weight. It's a fairly minor variation of MCW indexing.

I did not. Now that I watched it, it seems interesting.

[Lastrun]

Felix has new episode with a somewhat different take on index investing. While index are a fine default option for most investors, there are reasons to consider diverging from this paradigm, though of course not everyone should.
https://www.youtube.com/watch?v=4hSFzVoZkiA

The sum of all divergence will end up with market-weight. The question then is who should do the opposite of the recommendation?

Right, I always think of Cochrane's line on an RR podcast (#169):

And a good question I suggested for when the investment advisor says, "Well, you really ought to be buying value stocks." You should ask, "Okay, who are you advising to buy growth stocks and short value stocks?"

[secondopinion]

Felix has new episode with a somewhat different take on index investing. While index are a fine default option for most investors, there are reasons to consider diverging from this paradigm, though of course not everyone should.
https://www.youtube.com/watch?v=4hSFzVoZkiA

The sum of all divergence will end up with market-weight. The question then is who should do the opposite of the recommendation?

Right, I always think of Cochrane's line on an RR podcast (#169):

And a good question I suggested for when the investment advisor says, "Well, you really ought to be buying value stocks." You should ask, "Okay, who are you advising to buy growth stocks and short value stocks?"

Right. Someone has to have a rational reason for tilting towards growth stocks for tilting towards value to make sense.

[Apathizer]

Felix has new episode with a somewhat different take on index investing. While index are a fine default option for most investors, there are reasons to consider diverging from this paradigm, though of course not everyone should.
https://www.youtube.com/watch?v=4hSFzVoZkiA

The sum of all divergence will end up with market-weight. The question then is who should do the opposite of the recommendation?

Right, I always think of Cochrane's line on an RR podcast (#169):

And a good question I suggested for when the investment advisor says, "Well, you really ought to be buying value stocks." You should ask, "Okay, who are you advising to buy growth stocks and short value stocks?"

Yes, the sum of all divergence in aggregate, which also means individual stocks are likely to eventually mean revert. That means value stocks are likely to eventually have higher appreciation since they have a lower price relative to financial fundamentals than growth.

As for what to tilt towards, while he doesn't address that specific question, he touches on it. Highly risk averse investors might want to consider allocating more to growth stocks, while investors with a higher risk tolerance might consider allocating more to value/small value. Investors who prefer simplicity and want to monitor their investments as little as possible are probably best served with simple MCW indexes.

[WS1]

Cautiously optimistic

Er, care to elaborate? An ambiguous two word adverb-adjective statement isn't really saying anything.

That this thread will be a good discussion rather than a food fight full of unhelpful things like “why do you think you’re better than average” or “sorry bud, this isn’t lake wobegon”

I’ve listened to almost every Rational Reminder, and I’m really enjoying the slow unpacking of who should own what.

[arcticpineapplecorp.]

this video is simply stating if you're the average investor, own the total market (CAPM).

if you're not the average investor, do I-CAPM instead (factor investing).

how to determine if you're the average investor?

who should not invest in total stock market index funds

Investors who are more able or more willing to take on the risks that the average investor wants to avoid should tilt their portfolios away from the multifactor hedged portfolios and towards the portfolios more exposed to priced risks like value stocks.

But the total market portoflio is suboptimal for everyone who is different from average

But if you have more or less sensitivity to the risk that the average investor is worried about, your portfolio should be different from the market portfolio, at least in theory. If you are not exposed to any common risks outside your portfolio, that is, you don't depend on labor income own a business or otherwise have sensitivity to risk outside of your portfolio. A retiree might be a good example. Or if you're willing to load up on more risk than the average investor, you might want your portfolio to look different from the average investor's portfolio.

[Apathizer]

this video is simply stating if you're the average investor, own the total market (CAPM).

if you're not the average investor, do I-CAPM instead (factor investing).

how to determine if you're the average investor?

who should not invest in total stock market index funds

Investors who are more able or more willing to take on the risks that the average investor wants to avoid should tilt their portfolios away from the multifactor hedged portfolios and towards the portfolios more exposed to priced risks like value stocks.

But it is suboptimal for everyone who is different from average

But if you have more or less sensitivity to the risk that the average investor is worried about, your portfolio should be different from the market portfolio, at least in theory. If you are not exposed to any common risks outside your portfolio, that is, you don't depend on labor income own a business or otherwise have sensitivity to risk outside of your portfolio. A retiree might be a good example. Or if you're willing to load up on more risk than the average investor, you might want your portfolio to look different from the average investor's portfolio.

Exactly. Thank you. Unfortunately it seems likely this thread could digress into another MCW v factors discussion when that's not the point.

[nedsaid]

My take on the issue. The Total Market Index Funds are good investments for everyone.

There has been criticism of Total Bond Market Index but McQ had a thread that defended both using Investment Grade and Intermediate Term bonds for your bond allocation and also Total Bond Market Index. He did say that Intermediate Treasuries are a slightly better investment but that Total Bond Index is good enough.

One criticism of Total Stock Market Index is that when there is a Growth stock bubble that it tends to make Total Stock Market Index overvalued relative to fundamentals as well. We saw this is in early 2000 and we saw it again, though not as drastic, about 20 years later. You don't have to ditch Total Stock Market, just use a Value Index fund to tilt away from Total Stock Market.

Total International Stock Index I suppose is subject to criticism but certainly hasn't been subject to Growth stock bubbles as the US Market has been. I think Total International Stock is a perfectly good product.

Total International Bond Market Index is relatively new, seeing that it is currency hedged to the US Dollar, I expect it to perform in very similar fashion to a US Bond Index fund.

A portfolio built on the foundation of the four "Total Index" funds is perfectly fine. If you have concerns about whatever perceived flaws are in these indexes, easy enough to tilt away from them a bit. I still believe these "Total" index funds should be the foundation for everyone's portfolio.

One could use Avantis or DFA ETFs to invest in "improved" versions of the so-called Total Indexes, one could do that for US Stocks, International Stocks, and US Bonds. The fees are a bit higher, Avantis or DFA may or may not outperform the indexes, but that would be a rational approach as well if you believe in factor investing. No guarantees obviously but you have a shot at outperformance.

[Taylor Larimore]

Bogleheads:

Whenever I am tempted to move away from my market portfolio, I remember what experts say:

What Experts Say About Total Market Index Funds

Best wishes.
Taylor

Jack Bogle's Words of Wisdom: “Don't look for the needle in the haystack. Just buy the haystack!”

[burritoLover]

Virtually everyone here is already tilted away from the market average portfolio - which is something like 55% global stocks at market weight and 45% global bonds at market weight. Even if you want to consider only the US market, you probably still aren't holding exactly the US market weight in stocks/bonds - you either have more bonds or less bonds based on your willingness/need/ability to take risk. So, many of you already understand this concept despite not realizing you are doing it yourself.

[Kendall]

An unnecessary comment was deleted. Please remember forum rules on civility when posting:

Attacks on individuals, insults, name calling, trolling, baiting or other attempts to sow dissension are not acceptable.

[000]

Is there an easy way to invest in something like the ex-factor portfolio? Like ex-VFMF for example?

[muffins14]

Is there an easy way to invest in something like the ex-factor portfolio? Like ex-VFMF for example?

If you wanted to be anti-factor, one reasonable way would be to hold cash, or short the market.

Another easy way might be to try to be Mega-cap growth. Maybe Mega Cap growth plus short VOO, so you were 0 on market beta and then tilted to large and growth

[Apathizer]

Is there an easy way to invest in something like the ex-factor portfolio? Like ex-VFMF for example?

If you wanted to be anti-factor, one reasonable way would be to hold cash, or short the market.

Another easy way might be to try to be Mega-cap growth. Maybe Mega Cap growth plus short VOO, so you were 0 on market beta and then tilted to large and growth

Yes, if by ex-factor you mean no factors at all, then that would be cash savings since ex-factor would mean no risk at all. For equities as muffins says that would mean only the largest, safest companies, so large growth exclusively.

[km91]

Is there an easy way to invest in something like the ex-factor portfolio? Like ex-VFMF for example?

VTI or any other total market index should be sufficient. Portfolio Visualizer confirms that VTI has a loading close to 1 on the market factor (Rm-Rf) and minimal exposure to the other factors

Code: Select all

Ticker	Rm-Rf	SMB	HML	RMW	CMA
VFMF	0.94	0.36	0.28	0.08	0.09
VTI	0.98	0.00	0.02	0.04	-0.01

[abc132]

One of the mistakes of factor investing was calling the market a factor and things that deviate from the market factors.

There is lots of research that it is not easy to actionably time the market, and that for professionals active investing in the market tends to be a negative after costs.

Why would we not expect all of these things for factors if they have the same characteristics as the market?

Factors must be substantially different than the market for them to have the properties that investors commonly express:
1) We know what combinations of them to hold
2) We can time when it is a good time to own them
3) Active management can gain an additional premium after fees on average.

A significant portion of factor investors seem to have forgotten all lessons for the market factor. For factors to be something real factors can not be come just another excuse to actively trade things. They must hold up to the same standards with the same lessons as the market factor.

Anyone that agrees with these things is a good candidate for factor investing. You have reasonable expectations in-line with what we know about the market factor.

[Charles Joseph]

Bogleheads:

Whenever I am tempted to move away from my market portfolio, I remember what experts say:

What Experts Say About Total Market Index Funds

Best wishes.
Taylor

Jack Bogle's Words of Wisdom: “Don't look for the needle in the haystack. Just buy the haystack!”

Thank you Taylor. My fidgety, jittery and restless mind needs frequent reminds to sit tight and stay the course the the total market.

[Apathizer]

One of the mistakes of factor investing was calling the market a factor and things that deviate from the market factors.

There is lots of research that it is not easy to actionably time the market, and that for professionals active investing in the market tends to be a negative after costs.

Why would we not expect all of these things for factors if they have the same characteristics as the market?

Factors must be substantially different than the market for them to have the properties that investors commonly express:
1) We know what combinations of them to hold
2) We can time when it is a good time to own them
3) Active management can gain an additional premium after fees on average.

A significant portion of factor investors seem to have forgotten all lessons for the market factor. For factors to be something real factors can not be come just another excuse to actively trade things. They must hold up to the same standards with the same lessons as the market factor.

Anyone that agrees with these things is a good candidate for factor investing. You have reasonable expectations in-line with what we know about the market factor.

As Felix says, while there isn't perfect information, there's still quite a bit of decent information showing which stocks are likely to have higher returns. Tilting towards these stocks might make sense for investors willing to take these additional risks, but those doubtful of factors (like you apparently) should probably just hold MCW indexes.

[abc132]

I have a wind turbine that reliably produces electricity from the wind.

Someone comes up with a scheme to buy and sell wind energy based on the volatility of wind.

They call the average wind speed a factor and their back-tested advantage a factor.

One of these must exist and one may be completely imaginary or poorly implemented to our disadvantage.

Deviations from the norm are not the same as the norm. They should not all be treated equally or all called "factors".

[nisiprius]

The thing that doesn't get addressed enough is sensitivity. People debate a lot over what the exact optimum is. For example, John C. Bogle thought that market cap weight was the optimum and that "fundamental indexing" was a departure from the optimum. International fans think that VT is the optimum and that 80% US, 20% international is a departure from the optimum. The obvious question is "just how sure are we that a particular direction is going to be an improvement, over the next thirty years, versus just being an even-money bet?" The less obvious one is: "even if we take everything at face value, how much difference is it going to make? How much is really at stake?

Earlier today I think I showed that it would have made virtually no difference if, since 2007, you had split your international allocation 80/20, 75/25, or 70/30 between developed and emerging markets, for example.

[Apathizer]

I have a wind turbine that reliably produces electricity from the wind.

Someone comes up with a scheme to buy and sell wind energy based on the volatility of wind.

They call the average wind speed a factor and their back-tested advantage a factor.

One of these must exist and one may be completely imaginary or poorly implemented to our disadvantage.

Deviations from the norm are not the same as the norm. They should not all be treated equally or all called "factors".

Bad analogy. The information available shows over decade long periods small value has about an 95% chance of outperforming or equaling market returns and a 5% chance of underperforming the market. So tilting towards these stocks is likely to improve performance, with only a fairly negligible chance of underperformance.

[nisiprius]

...The information available shows over decade long periods small value has about an 95% chance of outperforming or equaling market returns and a 5% chance of underperforming the market...

But does it? Your statement says nothing about risk.

It's not clear how we should regard data prior to the publication of the Fama and French 1993 paper on risk factors. There was no way to invest in the factor systematically. Furthermore, even today, it is not possible to buy an index fund that tracks the Fama and French research portfolios. 1993-to-present is a respectable time period--three decades long.

However, we can look back to 1993 using real dollars in real funds. The DFA Small Cap Value Portfolio, DFSVX, came out the same year as the Fama-French paper, and is an explicit attempt to capture the small-cap value factor.

Here we compare its whole history (blue) to a total market index fund (red) and an S&P 500 index fund (yellow).

Source



Did the small-cap value fund outperform the other funds. Yes, it did.

But what about risk? Was it riskier? Yes, it was.

The short-term volatility as measured by standard deviation was considerably higher, 20.27% compared about 15%. The risk as measured by maximum drawdown was considerably higher, -61.18% compared to about -51%.

The Sharpe and Sortino ratios are an attempt to measure whether the extra return was worth the risk. And by both measures, if we adjust for risk, the S&P 500 and total market funds did better than the small-cap value fund. Not much better--if you want to say "about the same," fine.

But it is misleading to talk only about return, without saying anything about risk.

What these results mean is that for any hypothetical portfolio using a total market fund, if we are willing to take more risk, it should be slightly better to do so simply by increasing our stock allocation than by adding a small-cap value tilt.

[Apathizer]

...The information available shows over decade long periods small value has about an 95% chance of outperforming or equaling market returns and a 5% chance of underperforming the market...

But does it? Your statement says nothing about risk.

It's not clear how we should regard data prior to the publication of the Fama and French 1993 paper on risk factors. There was no way to invest in the factor systematically. Furthermore, even today, it is not possible to buy an index fund that tracks the Fama and French research portfolios. 1993-to-present is a respectable time period--three decades long.

However, we can look back to 1993 using real dollars in real funds. The DFA Small Cap Value Portfolio, DFSVX, came out the same year as the Fama-French paper, and is an explicit attempt to capture the small-cap value factor.

Here we compare its whole history (blue) to a total market index fund (red) and an S&P 500 index fund (yellow).

Source



Did the small-cap value fund outperform the other funds. Yes, it did.

But what about risk? Was it riskier? Yes, it was.

The short-term volatility as measured by standard deviation was considerably higher, 20.27% compared about 15%. The risk as measured by maximum drawdown was considerably higher, -61.18% compared to about -51%.

The Sharpe and Sortino ratios are an attempt to measure whether the extra return was worth the risk. And by both measures, if we adjust for risk, the S&P 500 and total market funds did better than the small-cap value fund. Not much better--if you want to say "about the same," fine.

But it is misleading to talk only about return, without saying anything about risk.

What these results mean is that for any hypothetical portfolio using a total market fund, if we are willing to take more risk, it should be slightly better to do so simply by increasing our stock allocation than by adding a small-cap value tilt.

Not necessarily since risks are imperfectly correlated. For instance, 2000-2009 small value and bonds both significantly outperformed the MCW total market. I don't expect this history to exactly repeat itself, but it illustrates how factors can provide beneficial diversification even in portfolios that include bonds.

[secondopinion]

...The information available shows over decade long periods small value has about an 95% chance of outperforming or equaling market returns and a 5% chance of underperforming the market...

But does it? Your statement says nothing about risk.

It's not clear how we should regard data prior to the publication of the Fama and French 1993 paper on risk factors. There was no way to invest in the factor systematically. Furthermore, even today, it is not possible to buy an index fund that tracks the Fama and French research portfolios. 1993-to-present is a respectable time period--three decades long.

However, we can look back to 1993 using real dollars in real funds. The DFA Small Cap Value Portfolio, DFSVX, came out the same year as the Fama-French paper, and is an explicit attempt to capture the small-cap value factor.

Here we compare its whole history (blue) to a total market index fund (red) and an S&P 500 index fund (yellow).

Source



Did the small-cap value fund outperform the other funds. Yes, it did.

But what about risk? Was it riskier? Yes, it was.

The short-term volatility as measured by standard deviation was considerably higher, 20.27% compared about 15%. The risk as measured by maximum drawdown was considerably higher, -61.18% compared to about -51%.

The Sharpe and Sortino ratios are an attempt to measure whether the extra return was worth the risk. And by both measures, if we adjust for risk, the S&P 500 and total market funds did better than the small-cap value fund. Not much better--if you want to say "about the same," fine.

But it is misleading to talk only about return, without saying anything about risk.

What these results mean is that for any hypothetical portfolio using a total market fund, if we are willing to take more risk, it should be slightly better to do so simply by increasing our stock allocation than by adding a small-cap value tilt.

If one considers risk as a singular nebulous concept that everyone would universally agree, then sure. But not everyone agrees on what risk is; this is because risk is a personally assessed matter. If it did not, then we would hold the market portfolio of all assets (not just stocks) and borrow against the “risk-free” asset if we wanted more risk.

We cannot agree on what is truly “risk-free”, so we cannot agree on a risk assessment either.

[km91]

But it is misleading to talk only about return, without saying anything about risk.

It's misleading to talk about risk and only mention volatility. An S&P 500 investor is exposed to other risks beyond volatility. For one, the market cap of their portfolio is relatively concentrated in a small number of stocks. 30% concentration to 10 names is risky even if that risk didn't come to fruition in the historical data. There's also a sector concentration in these stocks, the risk of which also doesn't appear in the back test. Valuations also represent a risk even if most investors don't believe it. Stocks with low valuations are risky, we know the market is applying a higher discount rate to these stocks. But stocks with expensive valuations are also risky, paying too much for an asset offsets the benefit of earning it's return stream. I think there's very strong evidence that the market overestimates the riskiness of low valuations, or at the very least, underestimates the riskiness of expensive valuations

[Charles Joseph]

[Apathizer's and exodusing's threads on the Ben Felix video have been merged. -moderator Kendall.]

Ben Felix has a very well done video on who should not invest in the market portfolio at https://www.youtube.com/watch?v=4hSFzVoZkiA

He also posted a rational reminders video with more detail at https://www.youtube.com/watch?v=mGCwuS8bjGA

Basically, the average investor should hold the market. You should consider deviating if you are meaningfully different. Determining if you are meaningfully different and how to deviate are the hard parts, but in the absence of good reasons to deviate, the market portfolio is a fine place to be.

A long thread on the general subject is at viewtopic.php?t=207804

I listen to Ben Felix's podcast from time to time, but I have to say that I think people who make videos about "who should not invest in the market portfolio" are filling empty space, making useless noise, and have nothing better to do with their time.

Producing these kinds of videos is a complete and total waste of, well, everything.

[exodusing]

Bad analogy. The information available shows over decade long periods small value has about an 95% chance of outperforming or equaling market returns and a 5% chance of underperforming the market. So tilting towards these stocks is likely to improve performance, with only a fairly negligible chance of underperformance.

The available information shows that over specific historical periods small value outperformed or equaled market returns. We don't know what will happen in the future regarding small value relative to the market portfolio.

[secondopinion]

But it is misleading to talk only about return, without saying anything about risk.

It's misleading to talk about risk and only mention volatility. An S&P 500 investor is exposed to other risks beyond volatility. For one, the market cap of their portfolio is relatively concentrated in a small number of stocks. 30% concentration to 10 names is risky even if that risk didn't come to fruition in the historical data. There's also a sector concentration in these stocks, the risk of which also doesn't appear in the back test. Valuations also represent a risk even if most investors don't believe it. Stocks with low valuations are risky, we know the market is applying a higher discount rate to these stocks. But stocks with expensive valuations are also risky, paying too much for an asset offsets the benefit of earning it's return stream. I think there's very strong evidence that the market overestimates the riskiness of low valuations, or at the very least, underestimates the riskiness of expensive valuations

If the earnings were known completely, then the various PE amounts would still be acceptable depending on when the earnings are expected. In practice, extremely low PE is about when will the earnings give out; the opposite end is if the earnings will ever come in before they go broke. Generally speaking, I do not think one side is overestimated in general; I think the only case is when the personal assessment of that risk suggests it is not as bad as the market feels it is (because you can honestly withstand the risk).

[LeoB]

What these results mean is that for any hypothetical portfolio using a total market fund, if we are willing to take more risk, it should be slightly better to do so simply by increasing our stock allocation than by adding a small-cap value tilt.

I was curious about your statement, so I ran this backtest.

https://www.portfoliovisualizer.com/bac ... tion3_2=20

Hypothetically, suppose a person starts with a portfolio of 80% U.S. total stock market (VTSMX) and 20% cash. They want the possibility of higher returns, so they switch to an allocation of 60% VTSMX, 20% small-cap value (DFSVX), and 20% cash. Suppose taxes aren't an issue. In the backtest, this had CAGR of 8.75% and stdev of 12.89%.

If they wanted to get the same CAGR by simply increasing their VTSMX exposure, an allocation of 85.5% VTSMX and 14.5% cash would have matched the CAGR of 8.75% but resulted in a higher stdev of 13.22%. Therefore, it seems like it was slightly better to add a small-cap value tilt rather than simply increasing the stock allocation.

Perhaps I'm mistaken, but this seems to be at odds with your statement. I'm a layperson when it comes to the subject, so could you please explain this discrepancy? Thanks!

[WS1]

If it’s reasonable to discuss whether a tenured professor should have a different stock/bond split than a commercial real estate broker, why is it unreasonable to ask if people with different life circumstances should own different equities?

[secondopinion]

What these results mean is that for any hypothetical portfolio using a total market fund, if we are willing to take more risk, it should be slightly better to do so simply by increasing our stock allocation than by adding a small-cap value tilt.

I was curious about your statement, so I ran this backtest.

https://www.portfoliovisualizer.com/bac ... tion3_2=20

Hypothetically, suppose a person starts with a portfolio of 80% U.S. total stock market (VTSMX) and 20% cash. They want the possibility of higher returns, so they switch to an allocation of 60% VTSMX, 20% small-cap value (DFSVX), and 20% cash. I guess ignore taxes for this hypothetical. In the backtest, this had CAGR of 8.75% and stdev of 12.89%.

If they wanted to match the same CAGR by simply increasing their VTSMX exposure instead, an allocation of 85.5% VTSMX and 14.5% cash would have matched the CAGR of 8.75% but resulted in a higher stdev of 13.22%. Therefore, it seems like it was slightly better to add a small-cap value tilt rather than simply increasing the stock allocation.

Perhaps I'm mistaken, but this seems to be at odds with your statement. I'm a layperson when it comes to the subject, so could you please explain this discrepancy? Thanks!

Skew of the risk. Value stocks are likely to perform better slightly, but occasionally will fall considerably. The volatility level could be also more volatile.

But both should be checked before I stand on it.

[secondopinion]

If it’s reasonable to discuss whether a tenured professor should have a different stock/bond split than a commercial real estate broker, why is it unreasonable to ask if people with different life circumstances should own different equities?

It is not unreasonable. Especially when bonds are given a slant by most.

[secondopinion]

[Apathizer's and exodusing's threads on the Ben Felix video have been merged. -moderator Kendall.]

Ben Felix has a very well done video on who should not invest in the market portfolio at https://www.youtube.com/watch?v=4hSFzVoZkiA

He also posted a rational reminders video with more detail at https://www.youtube.com/watch?v=mGCwuS8bjGA

Basically, the average investor should hold the market. You should consider deviating if you are meaningfully different. Determining if you are meaningfully different and how to deviate are the hard parts, but in the absence of good reasons to deviate, the market portfolio is a fine place to be.

A long thread on the general subject is at viewtopic.php?t=207804

I listen to Ben Felix's podcast from time to time, but I have to say that I think people who make videos about "who should not invest in the market portfolio" are filling empty space, making useless noise, and have nothing better to do with their time.

Producing these kinds of videos is a complete and total waste of, well, everything.

Each to own opinion; but if you believe in what you say you do, then why is your complete portfolio market-weighted? Apparently, something is worth taking a second look.

[Apathizer]

Bad analogy. The information available shows over decade long periods small value has about an 95% chance of outperforming or equaling market returns and a 5% chance of underperforming the market. So tilting towards these stocks is likely to improve performance, with only a fairly negligible chance of underperformance.

The available information shows that over specific historical periods small value outperformed or equaled market returns. We don't know what will happen in the future regarding small value relative to the market portfolio.

No, but we can use information to structure our portfolio to improve the likelihood of higher returns.

In fact that's all we can do. We don't know if MCW portfolios will continue to outperform most random individual stocks, but based on our understanding of markets it seems like they will. Factor tilts are just an extension of this reasoning. We don't know if they will continue to outperform the total market, but based on our understanding of markets it seems likely they will.

[alex_686]

If it’s reasonable to discuss whether a tenured professor should have a different stock/bond split than a commercial real estate broker, why is it unreasonable to ask if people with different life circumstances should own different equities?

The standard answer is that a tenured professor’s human capital is bond like while the broker’s is equity like. The level of complexity here us low and can be handled here.

Your second statement is also correct. People should have a AA that fits their goals and that one can do much better than the generic total stock portfolio. But it is much more complex. I got the training to do it but I don’t have the time to handle the complexity of execution.

[arcticpineapplecorp.]

Bad analogy. The information available shows over decade long periods small value has about an 95% chance of outperforming or equaling market returns and a 5% chance of underperforming the market. So tilting towards these stocks is likely to improve performance, with only a fairly negligible chance of underperformance.

The available information shows that over specific historical periods small value outperformed or equaled market returns. We don't know what will happen in the future regarding small value relative to the market portfolio.

No, but we can use information to structure our portfolio to improve the likelihood of higher returns.

In fact that's all we can do. We don't know if MCW portfolios will continue to outperform most random individual stocks, but based on our understanding of markets it seems like they will. Factor tilts are just an extension of this reasoning. We don't know if they will continue to outperform the total market, but based on our understanding of markets it seems likely they will.

Actually i would think the premiums would shrink overtime as more people chase these factor premiums. We already have seen that with the size premium. If the value premium persists it could simply be a behavioral story, i.e., most people can't hold on to value long enough to capture the premium. Like 19.5 years patience:

[km91]

If the earnings were known completely, then the various PE amounts would still be acceptable depending on when the earnings are expected. In practice, extremely low PE is about when will the earnings give out; the opposite end is if the earnings will ever come in before they go broke. Generally speaking, I do not think one side is overestimated in general; I think the only case is when the personal assessment of that risk suggests it is not as bad as the market feels it is (because you can honestly withstand the risk).

I don't know, you never see funds full of cheap junk, but you often see funds full expensive junk. ARK sells a bunch of them. For some reason people like spending lots of money on companies with no earnings. I think there's good evidence that investors misprice how much a dollar of earnings in the future is actually worth compared to a dollar of earnings today

[secondopinion]

If the earnings were known completely, then the various PE amounts would still be acceptable depending on when the earnings are expected. In practice, extremely low PE is about when will the earnings give out; the opposite end is if the earnings will ever come in before they go broke. Generally speaking, I do not think one side is overestimated in general; I think the only case is when the personal assessment of that risk suggests it is not as bad as the market feels it is (because you can honestly withstand the risk).

I don't know, you never see funds full of cheap junk, but you often see funds full expensive junk. ARK sells a bunch of them. For some reason people like spending lots of money on companies with no earnings. I think there's good evidence that investors misprice how much a dollar of earnings in the future is actually worth compared to a dollar of earnings today

Having bought stock that has negative earnings but used to have positive earnings, it is not the same as a company that never had earnings. Trust me, there is cheap junk as well. Because the cheap junk either recovers or goes broke quickly.

[km91]

Having bought stock that has negative earnings but used to have positive earnings, it is not the same as a company that never had earnings. Trust me, there is cheap junk as well. Because the cheap junk either recovers or goes broke quickly.

I know that cheap junk exists, I'm saying no one is clamoring to buy it the way they do for expensive junk. Investors really like to pay up for no earning companies when there is a growth story attached. For every AMZN and TSLA, there's 10 PTON and ZM that didn't quite live up to the hype. Every single stock in ARKK has the same price chart, it's not a coincidence

[000]

If you wanted to be anti-factor, one reasonable way would be to hold cash, or short the market.

Another easy way might be to try to be Mega-cap growth. Maybe Mega Cap growth plus short VOO, so you were 0 on market beta and then tilted to large and growth

VTI or any other total market index should be sufficient. Portfolio Visualizer confirms that VTI has a loading close to 1 on the market factor (Rm-Rf) and minimal exposure to the other factors

Code: Select all

Ticker	Rm-Rf	SMB	HML	RMW	CMA
VFMF	0.94	0.36	0.28	0.08	0.09
VTI	0.98	0.00	0.02	0.04	-0.01

I mean excluding-non-market-factor-factors. In other words, hold all the stocks in VTI except those in VFMF. Obviously VTI itself cannot fulfill this criteria because it does not have loadings which cancel out VFMF's loadings. VTI + VFMF = VFMF basically, not what is needed here.

The purpose of doing this would be to hold the stocks excluded from factor-tilted portfolios (again, not talking about the market "factor"). For every deviation (VFMF) from the market (VTI) there must be someone else holding (VTI-VFMF). So, how can that be implemented? If it can't be done easily, that may have informational value about market structure and who is holding what.

Mega Cap Growth doesn't work because it has quality, momentum.

[WS1]

If it’s reasonable to discuss whether a tenured professor should have a different stock/bond split than a commercial real estate broker, why is it unreasonable to ask if people with different life circumstances should own different equities?

The standard answer is that a tenured professor’s human capital is bond like while the broker’s is equity like. The level of complexity here us low and can be handled here.

Your second statement is also correct. People should have a AA that fits their goals and that one can do much better than the generic total stock portfolio. But it is much more complex. I got the training to do it but I don’t have the time to handle the complexity of execution.

THIS IS THE CORRECT ANSWER

[km91]

If you wanted to be anti-factor, one reasonable way would be to hold cash, or short the market.

Another easy way might be to try to be Mega-cap growth. Maybe Mega Cap growth plus short VOO, so you were 0 on market beta and then tilted to large and growth

VTI or any other total market index should be sufficient. Portfolio Visualizer confirms that VTI has a loading close to 1 on the market factor (Rm-Rf) and minimal exposure to the other factors

Code: Select all

Ticker	Rm-Rf	SMB	HML	RMW	CMA
VFMF	0.94	0.36	0.28	0.08	0.09
VTI	0.98	0.00	0.02	0.04	-0.01

I mean excluding-non-market-factor-factors. In other words, hold all the stocks in VTI except those in VFMF. Obviously VTI itself cannot fulfill this criteria because it does not have loadings which cancel out VFMF's loadings. VTI + VFMF = VFMF basically, not what is needed here.

The purpose of doing this would be to hold the stocks excluded from factor-tilted portfolios (again, not talking about the market "factor"). For every deviation (VFMF) from the market (VTI) there must be someone else holding (VTI-VFMF). So, how can that be implemented? If it can't be done easily, that may have informational value about market structure and who is holding what.

Mega Cap Growth doesn't work because it has quality, momentum.

So if VTI holds Apple and Facebook, and VFMF holds only Facebook, you want to hold only Apple? If a factor portfolio is one that is tilted towards earnings and cheap valuations, the anti factor portfolio is probably ARKK or the Softbank Vision Fund or Tiger Global or my coworkers who trade CNBC headlines

[nedsaid]

One of the mistakes of factor investing was calling the market a factor and things that deviate from the market factors.

Nedsaid: The Market factor is really Beta, originally defined as the volatility of the S&P 500. High Beta stocks had lower returns than what the Capital Asset Pricing Model predicted and Low Beta stocks had higher returns than expected. There was more to this than more risk for more return and less risk for less return. CAPM could explain about 2/3 of the variability of performance of stock portfolios. Clearly something else was at work here.

Factors are what explain the behavior of the market and the variances in performance of various stock portfolios. The 3 factor model explained about 90% of the variability and the 5 factor model got it up to about 96%. Market Beta itself was a very incomplete explanation for what was going on within the market.

There is lots of research that it is not easy to actionably time the market, and that for professionals active investing in the market tends to be a negative after costs.

Nedsaid: I don't disagree with the above comment.

Why would we not expect all of these things for factors if they have the same characteristics as the market?

Nedsaid: The market and the market factor are the same and different at the same time. In one sense they are actually two different things as explained above. In another sense, a market portfolio will only contain the Market factor. What is also accurate to say is that factor portfolios, let's use a Small Value portfolio as an example, will still have a relatively high correlation to the stock market itself. It is also accurate to say that the Market factor is the main driver of returns for stock market portfolios, probably 70% to 80% or perhaps a bit more of the returns over long periods of time.

Factors must be substantially different than the market for them to have the properties that investors commonly express:

Nedsaid: Factors are what explain the variances in performance of different stock market portfolios. For example, factors explain why a portfolio of utility stocks will act differently and perform differently than a portfolio of high tech stocks. If you want a stock portfolio to perform differently than the market itself, you need a portfolio with different characteristics than the market itself.

1) We know what combinations of them to hold

Nedsaid: This represents an evolution in Factor investing. If you find that certain factors working in combination would improve portfolio performance, wouldn't you make the changes if you were a portfolio manager? DFA's Small Cap Value fund from what I understand sets Momentum to neutral and has a Quality bent to its screening processes but the fund is still a Small Cap Value fund. This is a matter of nuance.

2) We can time when it is a good time to own them

Nedsaid: Very few factor practitioners and academics will make this argument. Doubtless, there are folks who time factors but most here who are Factor investors do not attempt to time factors. This is a bit of a strawman.

3) Active management can gain an additional premium after fees on average.

Nedsaid: You keep equating Factor investing with active management. Grain of truth to this but modern Factor investing is not your Father's active investing. Lower turnover, lower cost, and selecting all of the stocks that pass your factor screening. An active fund will pick the "best" of the stocks that pass the screening criteria where a more passive factor fund will pick all of them. So a Factor fund will tend to have more stocks than the traditional active fund. I would put Factor funds on the continuum between passive and active, not really passive but not really active either, but I think such Factor funds are much closer to passive than to active.

Indeed, I have said that Factor funds are the future of active management. But when I say "active" it is in a different sense than what was once commonly understood. More holdings, less turnover, lower costs than traditional active funds.

A significant portion of factor investors seem to have forgotten all lessons for the market factor. For factors to be something real factors can not be come just another excuse to actively trade things. They must hold up to the same standards with the same lessons as the market factor.

Nedsaid: Hate to break this to you, Vanguard's Total Stock Market Index fund trades things all of the time. They employ a team of something like 48 traders to make it all work as investors purchase and redeem shares. You have to trade to handle fund inflows and outflows.

DFA and Avantis use patient trading techniques to prevent front running by professional traders, if a stock no longer fits the criteria of a particular fund, the stock will be sold over time and not all at once. They aren't trading stocks just to be trading stocks. Again, factor funds will have lower turnover than traditional active funds.

Anyone that agrees with these things is a good candidate for factor investing. You have reasonable expectations in-line with what we know about the market factor.

[Joey Jo Jo Jr]

[/quote]
As for what to tilt towards, while he doesn't address that specific question, he touches on it. Highly risk averse investors might want to consider allocating more to growth stocks, while investors with a higher risk tolerance might consider allocating more to value/small value.
[/quote]

This is the opposite of what I thought I understood, which was that growth included things like Tesla that have high PE ratios based on the expectation/hope of future earnings, and value has more of your cash cows that aren’t going to light the world on fire but aren’t likely to go belly up either.

Can anyone help me understand how I’m misunderstanding these fundamental classifications?