Value, and Slice and Dice - How Much?

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Park
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Joined: Sat Nov 06, 2010 4:56 pm

Value, and Slice and Dice - How Much?

Post by Park » Sun Nov 12, 2017 3:31 pm

I'm reading "The New Wealth Management", written by Harold Evensky, Stephen M. Horan and Thomas R. Robinson. It comes from the CFA Institute, and was published in 2011.

The following is from the chapter describing the practice philosophy of Harold Evensky's financial planning company.

"We believe in the conclusions of the Fama-French research that, over time, value portfolios will provide superior returns. However, we also believe that a sole allocation to value will result in interim divergence from the broad markets that our behavioral clients would find unacceptable"

One interpretation is that a 100% value stock portfolio is an acceptable option, as long as you can withstand the tracking error. It assumes that you can access the value premium in a cost and tax efficient manner. Also, value investing tends to result in decreased sector diversification. This can causes problems, such as financial stocks in 2008. Finally, your portfolio will be more volatile.

"We believe that reasonable expectations for real equity market returns over the next decade are in the range of 3 percent to 6 percent. In such a low return environment, for retail investors, the expense and tax drag on net-net real portfolio returns overwhelms the enhanced return benefits associated with traditional multi-asset class, multistyle portfolio design."

The statement about expectations is still relevant in 2017. It's a cautionary note regarding slice and dice portfolios. To some extent, it isn't consistent with the earlier quote, as a slice and dice portfolio is commonly used to access the value premium.
Last edited by Park on Sun Nov 12, 2017 3:54 pm, edited 1 time in total.

Random Walker
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Re: Value, and Slice and Dice - How Much?

Post by Random Walker » Mon Nov 13, 2017 10:40 am

Tracking error is totally behavioral. An investor needs to either acknowledge it in himself or more productively, educate himself to build the mental fortitude to not be subject to it. One can increase the SV tilt, decrease the overall exposure to equity market risk, increase bond allocation, keep expected return constant, and thus decrease the SD and maximal drawdown of the portfolio. Larry is soon coming out with a new edition of Reducing The Risk Of Black Swans which I’m sure will elucidate this concept greatly.

Dave

dbr
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Re: Value, and Slice and Dice - How Much?

Post by dbr » Mon Nov 13, 2017 10:43 am

Random Walker wrote:
Mon Nov 13, 2017 10:40 am
Tracking error is totally behavioral. An investor needs to either acknowledge it in himself or more productively, educate himself to build the mental fortitude to not be subject to it. One can increase the SV tilt, decrease the overall exposure to equity market risk, increase bond allocation, keep expected return constant, and thus decrease the SD and maximal drawdown of the portfolio. Larry is soon coming out with a new edition of Reducing The Risk Of Black Swans which I’m sure will elucidate this concept greatly.

Dave
In other words the "error" is in the possible behavior of the investor. Different assets having different behavior in the market is not an error.

onthecusp
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Re: Value, and Slice and Dice - How Much?

Post by onthecusp » Mon Nov 13, 2017 12:20 pm

The error would be in buying say Small-Value, comparing the performance with Total Stock Market, and calling any difference tracking error. Tracking error, as a term, should be reserved for how well a fund/ETF that claims to track an index does so.

It is a day to day, month to month, year to year, or decade to decade performance difference.

betablocker
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Re: Value, and Slice and Dice - How Much?

Post by betablocker » Mon Nov 13, 2017 12:32 pm

The question is do the increased returns make up for the increased expenses? Depends on what you buy. iShares small value (IJS) is .25%. Vanguard Total stock market ETF .04%. Can value make up the 21 basis points. Historically evidence says yes by a long shot. DFA's small value is .52% plus the advisor fee. you still make up the difference and then some. But if you buy a 2% fee momentum/value fund, maybe not.

garlandwhizzer
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Re: Value, and Slice and Dice - How Much?

Post by garlandwhizzer » Mon Nov 13, 2017 9:58 pm

Better "expected returns" with factors. The important word here IMO is not "returns' but "expected." Is it written in stone somewhere that factor out-return expectations are certain to met in the future over a given time frame such that they more than cover the increased costs of accessing the factors? That isn't entirely clear to me going forward. Past backtesting history suggests that with sufficient patience you'll be rewarded by factor investing. There is a wide gulf, however, between the returns of cost-free academic studies and the funds that have attempted to harvest those premiums, particularly in the recent past.

Everyone knows about factors now and 90% of market action is professionally driven. Factor based investing funds and etfs are proliferating massively now and many billions of dollars pour into it every year. In some ways the "expected" future may differ significantly from the optimistic backtesting past. Will the factor well eventually run dry from overuse? I don't know, but I've been around long enough to know that a lot of very experienced, very knowledgeable, and very intelligent market mavens have been befuddled by the market when their "expected returns" failed to materialize in the future. My personal expectation is that some factor approaches/funds/etfs will work, some will not net of costs. Sort of like active management, it is difficult to determine up front who the future winners or losers will be. It may not be as easy as it looks to outperform.

Garland Whizzer

Random Walker
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Re: Value, and Slice and Dice - How Much?

Post by Random Walker » Mon Nov 13, 2017 10:48 pm

Here is why I have more faith than garlandwhizzer. The market prices risk, it doesn’t equilibrate returns. Prices of small and value should be lower because they are more risky. Lower prices implies higher expected future returns. It makes sense to me that the expected return on a company is it’s cost of capital. If I were lending money to a company, my interest rate would certainly be affected by the size of the company, it’s growth, its level of distress.
The above only looks at risk stories for the premia. I also think there are behavioral components to value/growth which aren’t going away.

Dave

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