Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

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scottj19707
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Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by scottj19707 » Thu Nov 30, 2017 10:10 pm

Jack and Wes @ Alpha Architect are good guys IHMO.

"Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)": https://alphaarchitect.com/2017/11/30/e ... -investor/

In relation to lots of chatter on factor-based investing, here and elsewhere, right now.

I brought this up a few times in the past wrt Vanguard...

See this:

"New Vanguard Video: 'Using factors in a portfolio'": viewtopic.php?f=10&t=171362&p=2585454#p2585454

"Who is Denis B. Chaves? ... and why did Vanguard's Quantitative Equity Group just hire him?": viewtopic.php?f=10&t=173842&p=2624079#p2624079

"Vanguard’s new global factor investing ETFs" (Monevator.com, 12-10-15): viewtopic.php?f=10&t=179380&p=2716305#p2716305

Here's the opening and closing to Jack's recent AA post...

"Much has been made of Factor Investing, and even Vanguard is launching a suite of actively-managed factor ETFs. But even now, with Vanguard offering factor ETFs, there are many investors that only invest passively into an index fund, such as the SP500 or EAFE index. These investors will cite the numerous studies showing that (on average) active management fails compared to an index fund (there are many studies that highlight this fact).

No arguments with most of those studies and costs clearly matter, but what I would like to highlight in this article is the following:
Even passive index investors are betting on factors.

The idea behind this article is to highlight/review a summary of the literature on factors. Many tend to forget, but the factor with the largest premium is the market factor!(1) Yes, simply investing in the market (i.e. the Sp500) is not really passive — this is a factor-investing bet. Investors in the market-beta asset class are implicitly betting on the equity-premium, which is the outsized returns (in the past) to equities over U.S. Treasury Bills (or cash).(2)"

...

"Conclusion

Vanguard is moving into “factors,” but they have always been a factor investing shop–their main factor is the market factor.
And to be clear, the market factor is a reasonable factor if one has the capacity to bear (and hold onto) risk.

We would also argue (surprisingly, along with Vanguard!) that adding other factors, such as value, momentum, and trend can possibly help a portfolio capture alternative return premiums.(7)

So in the end, everyone, even a passive Sp500 Vanguard investor, is a factor investor. They are betting on generic market risk.

Hopefully, that market factor will continue to work in the future, but like all factors that expect to earn a positive premium over time, one should expect a rocky road at some point in the future!"

Thanks Jack!

I can't resist... I told you so.

Best regards,


s. jay
“To acquire knowledge, one must study; but to acquire wisdom, one must observe.”-Marilyn vos Savant; “If you can’t explain it simply, you don’t understand it well enough.”-Albert Einstein; VTI/VXUS/BND

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by avalpert » Thu Nov 30, 2017 10:20 pm

scottj19707 wrote:
Thu Nov 30, 2017 10:10 pm
"Yes, simply investing in the market (i.e. the Sp500) is not really passive — this is a factor-investing bet."
Boy do I hate it when people equivocate on the word 'passive' to try to imply that it is all the same type of bet in the end.

Otherwise, nothing new here - I'm pretty sure everyone knows that investing in a broad market fund is making a bet that stocks will provide higher returns for the risk - that's why all those life strategy funds exist with different degrees of exposure to equities...

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by lack_ey » Thu Nov 30, 2017 10:27 pm

By this definition, virtually every investor is a factor investor, which makes it not a very useful distinction. It also contradicts the underlying thinking of a lot of these investors, who do not have a factor-model-theoretic view or justification for investing in equities.

Furthermore, a cross-sectional factor defined on within-group relative return is simply not the same thing as a asset class factor (which doesn't in of itself make one or the other more reliable or anything else, but there is a big difference in construction and underlying theory).

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by scottj19707 » Thu Nov 30, 2017 10:31 pm

by avalpert » Thu Nov 30, 2017 7:20 pm

scottj19707 wrote: ↑

Thu Nov 30, 2017 7:10 pm

"Yes, simply investing in the market (i.e. the Sp500) is not really passive — this is a factor-investing bet." Boy do I hate it when people equivocate on the word 'passive' to try to imply that it is all the same type of bet in the end.

Otherwise, nothing new here - I'm pretty sure everyone knows that investing in a broad market fund is making a bet that stocks will provide higher returns for the risk - that's why all those life strategy funds exist with different degrees of exposure to equities...
Thanks for your reply, avalpert...

Re: "Otherwise, nothing new here - I'm pretty sure everyone knows that investing in a broad market fund is making a bet that stocks will provide higher returns for the risk"

My hypothesis: > 98% of investors, including Bogleheads.com participants, do not truly understand the fundamentals of "factor-based investing."

See John Cochrane and Campbell Harvey.

BR,

s. jay
“To acquire knowledge, one must study; but to acquire wisdom, one must observe.”-Marilyn vos Savant; “If you can’t explain it simply, you don’t understand it well enough.”-Albert Einstein; VTI/VXUS/BND

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by scottj19707 » Thu Nov 30, 2017 10:36 pm

Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by lack_ey » Thu Nov 30, 2017 7:27 pm

By this definition, virtually every investor is a factor investor, which makes it not a very useful distinction. It also contradicts the underlying thinking of a lot of these investors, who do not have a factor-model-theoretic view or justification for investing in equities.
Your right, "every investor" is a "factor-based investor." We differ only on portfolio asset allocations. See www.portfoliovisualizer.com.

BR,

s. jay
“To acquire knowledge, one must study; but to acquire wisdom, one must observe.”-Marilyn vos Savant; “If you can’t explain it simply, you don’t understand it well enough.”-Albert Einstein; VTI/VXUS/BND

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by scottj19707 » Thu Nov 30, 2017 10:47 pm

Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by lack_ey » Thu Nov 30, 2017 7:27 pm

Furthermore, a cross-sectional factor defined on within-group relative return is simply not the same thing as a asset class factor (which doesn't in of itself make one or the other more reliable or anything else, but there is a big difference in construction and underlying theory).
Dear lack_ey,

I have no idea what the above means. I'm probably slow, but that doesn't register with me. I'm sort of familiar with this topic... can you please explain further?

Thx,

s. jay
“To acquire knowledge, one must study; but to acquire wisdom, one must observe.”-Marilyn vos Savant; “If you can’t explain it simply, you don’t understand it well enough.”-Albert Einstein; VTI/VXUS/BND

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by scottj19707 » Thu Nov 30, 2017 10:48 pm

Larry, what do you think?
“To acquire knowledge, one must study; but to acquire wisdom, one must observe.”-Marilyn vos Savant; “If you can’t explain it simply, you don’t understand it well enough.”-Albert Einstein; VTI/VXUS/BND

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by lack_ey » Thu Nov 30, 2017 11:08 pm

scottj19707 wrote:
Thu Nov 30, 2017 10:47 pm
Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by lack_ey » Thu Nov 30, 2017 7:27 pm

Furthermore, a cross-sectional factor defined on within-group relative return is simply not the same thing as a asset class factor (which doesn't in of itself make one or the other more reliable or anything else, but there is a big difference in construction and underlying theory).
Dear lack_ey,

I have no idea what the above means. I'm probably slow, but that doesn't register with me. I'm sort of familiar with this topic... can you please explain further?

Thx,

s. jay
I'm contrasting
(1) a factor defined within an asset class from relative performance of different subgroups
with
(2) a factor defined as an asset class return
(minus risk-free rate, usually).

Clearly (1) is a much more contrived formulation and there are a lot of ways to construct and define that (with varying levels of sensibility), whereas (2) leaves a lot less wiggle room. Just because in a factor model they can both appear as factors, it doesn't mean they are theoretically equivalent with the same economic and logical support. Some people are too quick to push a false equivalency.

There are more modeling assumptions and views expressed in the deliberate factor investor's investment philosophy, which is either a good or a bad thing or some combination of the two, depending on your perspective.

In any case, regardless of the origin and underpinnings of any factor, you have to evaluate the evidence and the support.

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by nisiprius » Fri Dec 01, 2017 11:09 am

Everybody is a factor investor because the market factor is a factor? Reminds me of the Samuel Hoffenstein poem (from memory) which begins

"Nothing to do but work, nothing to eat but food,
Nothing to wear but clothes to keep you from going nude."

Nothing to invest in but factors.

Now, since I am already eatng food that has a high loading on the "food" factor, I am considering diversifying into eating paste, clay, and sawdust so that I am not placing all my "edibility" bets on a single factor.
Last edited by nisiprius on Fri Dec 01, 2017 11:15 am, edited 1 time in total.
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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by dbr » Fri Dec 01, 2017 11:11 am

nisiprius wrote:
Fri Dec 01, 2017 11:09 am
Everybody is a factor investor because the market factor is a factor? Reminds me of the Samuel Hoffenstein poem (from memory) which begins

"Nothing to do but work, nothing to eat but food,
Nothing to wear but clothes to keep you from going nude."

Nothing to invest in but factors.
Exactly. That article is just silly.

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by stevewolfe » Fri Dec 01, 2017 11:20 am

Seems a distinction without a difference to me. It would seem that the factor folks are trying to convince the non-factor folks (excuse me, the market investors e.g. the BETA investors e.g. the market factor investors) that they have a better way. Or that by defining new terms for existing concepts that voila, you're already doing it, but in a "simple" or "non-optimized" way. Yawn.

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All Investors are Factor Investors

Post by betablocker » Tue Dec 05, 2017 10:58 am

[Thread merged into here, see below. --admin LadyGeek]

A good blog from Alpha Architect about how all investors including even the hardest core 3 fund portfolio investor is a factor investor: https://alphaarchitect.com/2017/11/30/e ... -investor/

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Re: All Investors are Factor Investors

Post by Random Walker » Tue Dec 05, 2017 1:11 pm

I think a TSM investor needs to appreciate this point of view. He needs to understand he is investing in one single factor, the market factor. This could well be a rational choice: low cost, tax efficient, and the factor that dominates most all of our portfolios. But it should be an informed choice, and the TSM investor should understand that he is not diversified across factors shown to drive returns. This understanding will add to the TSM investor’s fortitude to stick to his plan. Alternatively, it could cause him to consider the trade offs and choose to diversify across factors.
I recall Fama writing that it could be rational to tilt to growth even. The investor just needs to understand the trade offs involved in his decision making process. Costs are certain and the benefits of diversifying across factors only potential. That being said, I’ve placed my bet on paying more for portfolio efficiency.

Dave

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Re: All Investors are Factor Investors

Post by Epsilon Delta » Tue Dec 05, 2017 1:55 pm

I think a TSM investor needs to recognize this point of view and realize that this is hooey.

It's the same argument that "you take a risk every time you cross the street therefore you are a gambler and should bet it all on red".

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Re: All Investors are Factor Investors

Post by rkhusky » Tue Dec 05, 2017 2:04 pm

Wonder why the author chose 7/1/1963 as the starting point for his factor returns?
Owning the market at market weight is the baseline or default. Everything else is a bet on a tilt.
Will the Vanguard funds be of the Long/Short variety?

I you don't invest in bitcoins, you are still betting on bitcoins, i.e. betting against the bitcoin factor.

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Re: All Investors are Factor Investors

Post by PuddlesTheDuck » Tue Dec 05, 2017 2:46 pm

Epsilon Delta wrote:
Tue Dec 05, 2017 1:55 pm
I think a TSM investor needs to recognize this point of view and realize that this is hooey.

It's the same argument that "you take a risk every time you cross the street therefore you are a gambler and should bet it all on red".
TSM is a representation of the equity premium. No one will give you grief over investing in that. From the article you didn't read:
Vanguard is moving into “factors,” but they have always been a factor investing shop–their main factor is the market factor.

And to be clear, the market factor is a reasonable factor if one has the capacity to bear (and hold onto) risk.
If anything, I read that as trying to calm people down on factors. You've already been investing in a factor, are you sure you need 10 more funds?

Yes, there are points in the article that describe how diversifying your risk factors has a good chance of leading to higher returns. But please read before you react.

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Re: All Investors are Factor Investors

Post by Epsilon Delta » Tue Dec 05, 2017 2:56 pm

PuddlesTheDuck wrote:
Tue Dec 05, 2017 2:46 pm
Epsilon Delta wrote:
Tue Dec 05, 2017 1:55 pm
I think a TSM investor needs to recognize this point of view and realize that this is hooey.

It's the same argument that "you take a risk every time you cross the street therefore you are a gambler and should bet it all on red".
TSM is a representation of the equity premium. No one will give you grief over investing in that. From the article you didn't read:
Vanguard is moving into “factors,” but they have always been a factor investing shop–their main factor is the market factor.

And to be clear, the market factor is a reasonable factor if one has the capacity to bear (and hold onto) risk.
If anything, I read that as trying to calm people down on factors. You've already been investing in a factor, are you sure you need 10 more funds?

Yes, there are points in the article that describe how diversifying your risk factors has a good chance of leading to higher returns. But please read before you react.
I read the article before I posted and it remains hooey.

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Re: All Investors are Factor Investors

Post by staythecourse » Tue Dec 05, 2017 2:58 pm

I've been saying this for awhile Any intelligent/ well read investor KNOWS even a TSM investing is investing in a factor, beta/ market factor. I am assuming this is not news from the TSM folks. I am assuming they choose to stop there as they are not interested in learning/ researching/ or better educating themselves to other factors.

There are many reasonable reasons NOT to invest in other factors the biggest being cost (ER, transaction costs, tax inefficiency, and cost to access passive funds in this arena through, i.e. DFA which needs to pay for a FA).

I really do hope folks are not just investing in market cap TSM and TBM because Mr. Bogle says so or Taylor says so. Following any person blindly is never a good idea no matter what.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: All Investors are Factor Investors

Post by Epsilon Delta » Tue Dec 05, 2017 3:04 pm

PuddlesTheDuck wrote:
Tue Dec 05, 2017 2:46 pm
Epsilon Delta wrote:
Tue Dec 05, 2017 1:55 pm
I think a TSM investor needs to recognize this point of view and realize that this is hooey.

It's the same argument that "you take a risk every time you cross the street therefore you are a gambler and should bet it all on red".
TSM is a representation of the equity premium. No one will give you grief over investing in that. From the article you didn't read:
Vanguard is moving into “factors,” but they have always been a factor investing shop–their main factor is the market factor.

And to be clear, the market factor is a reasonable factor if one has the capacity to bear (and hold onto) risk.
If anything, I read that as trying to calm people down on factors. You've already been investing in a factor, are you sure you need 10 more funds?

Yes, there are points in the article that describe how diversifying your risk factors has a good chance of leading to higher returns. But please read before you react.
I read the article before I posted and it remains hooey. It's designed not designed to make people calmly ignore factors, it's designed to sell factors by making people calmly accept them. The financial industry has a long and dishonorable history of doing this.

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Re: All Investors are Factor Investors

Post by betablocker » Tue Dec 05, 2017 3:12 pm

Epsilon Delta wrote:
Tue Dec 05, 2017 1:55 pm
I think a TSM investor needs to recognize this point of view and realize that this is hooey.

It's the same argument that "you take a risk every time you cross the street therefore you are a gambler and should bet it all on red".
Your view does seem to represent the view of many. I'd just say that I agree with the premise. Every time you get up and walk out the door it's all a gamble. You just use the evidence of experience to know that crossing the street in the right way is pretty low risk with high odds of a good outcome. Betting it all on red has low expected outcomes. That's why I'd focus on proven factors that are persistent, robust, and pervasive.

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Re: All Investors are Factor Investors

Post by White Coat Investor » Tue Dec 05, 2017 3:13 pm

staythecourse wrote:
Tue Dec 05, 2017 2:58 pm
I've been saying this for awhile Any intelligent/ well read investor KNOWS even a TSM investing is investing in a factor, beta/ market factor. I am assuming this is not news from the TSM folks. I am assuming they choose to stop there as they are not interested in learning/ researching/ or better educating themselves to other factors.

There are many reasonable reasons NOT to invest in other factors the biggest being cost (ER, transaction costs, tax inefficiency, and cost to access passive funds in this arena through, i.e. DFA which needs to pay for a FA).

I really do hope folks are not just investing in market cap TSM and TBM because Mr. Bogle says so or Taylor says so. Following any person blindly is never a good idea no matter what.

Good luck.
I think you're missing the point, and I say this as someone who does tilt to non-beta factors. The TSM investor is skeptical that the other factors even exist. The alternative hypotheses are that they're just a back-tested anomaly or that even if they were real in the past, there is no guarantee they will be in the future.

Just because a factor believer calls beta "just another factor" doesn't mean it is just another factor or that any other factors even exist.

Finance isn't physics and it is important to consider not just the likelihood that your position is wrong, but also the consequences. An appropriate level of humility often leads to Taylor's favorite phrase- There are many roads to Dublin. I'm not so sure that tilting to factors is so correct that I would tell a total market investor that they are doing it wrong. And I'm not sure that my decision to ignore quality and low volatility and most of the rest of the factor zoo is so right that I would tell a true multi-factor believer that he is doing it wrong either.

Honestly, staying the course with either strategy and funding it adequately is likely to help someone reach their goals. Investing is a single player game. You either win or you don't and the only benchmark is your own goals.
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Re: All Investors are Factor Investors

Post by staythecourse » Tue Dec 05, 2017 3:26 pm

White Coat Investor wrote:
Tue Dec 05, 2017 3:13 pm
staythecourse wrote:
Tue Dec 05, 2017 2:58 pm
I've been saying this for awhile Any intelligent/ well read investor KNOWS even a TSM investing is investing in a factor, beta/ market factor. I am assuming this is not news from the TSM folks. I am assuming they choose to stop there as they are not interested in learning/ researching/ or better educating themselves to other factors.

There are many reasonable reasons NOT to invest in other factors the biggest being cost (ER, transaction costs, tax inefficiency, and cost to access passive funds in this arena through, i.e. DFA which needs to pay for a FA).

I really do hope folks are not just investing in market cap TSM and TBM because Mr. Bogle says so or Taylor says so. Following any person blindly is never a good idea no matter what.

Good luck.
I think you're missing the point, and I say this as someone who does tilt to non-beta factors. The TSM investor is skeptical that the other factors even exist. The alternative hypotheses are that they're just a back-tested anomaly or that even if they were real in the past, there is no guarantee they will be in the future.

Just because a factor believer calls beta "just another factor" doesn't mean it is just another factor or that any other factors even exist.

Finance isn't physics and it is important to consider not just the likelihood that your position is wrong, but also the consequences. An appropriate level of humility often leads to Taylor's favorite phrase- There are many roads to Dublin. I'm not so sure that tilting to factors is so correct that I would tell a total market investor that they are doing it wrong. And I'm not sure that my decision to ignore quality and low volatility and most of the rest of the factor zoo is so right that I would tell a true multi-factor believer that he is doing it wrong either.

Honestly, staying the course with either strategy and funding it adequately is likely to help someone reach their goals. Investing is a single player game. You either win or you don't and the only benchmark is your own goals.
How do the same folks know ERP exist? It isn't on the Ten Commandments. Someone noticed it as a way to explain the excess returns given by stocks over fixed income. That is how that factor started. No different then any of the factors.

Good luck.
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Re: All Investors are Factor Investors

Post by Epsilon Delta » Tue Dec 05, 2017 3:47 pm

staythecourse wrote:
Tue Dec 05, 2017 3:26 pm

How do the same folks know ERP exist? It isn't on the Ten Commandments. Someone noticed it as a way to explain the excess returns given by stocks over fixed income. That is how that factor started. No different then any of the factors.

Good luck.
Beta of the total market* is quite different from the other factors. In aggregate the market is long Beta. This is a risk that must be borne or there is no industrial economy. The other factors are long/short and by definition in aggregate exposure is zero. You get paid for taking risks that must be taken, you do not get paid for taking unnecessary risk.

Also almost all of this is done in the context of mean/variance optimization, which is a completely solved problem. The solution is a linear combination of two "funds", a.k.a. the Markowitz bullet. We can not be sure that the two funds are TSM and MM, indeed they probably aren't. But we can be mathematically certain that somebody doing mean/variance optimization who suggests a free choice among three funds is wrong. So if you want to talk about factors you need to be talking about higher moments or similar.

*I don't mean just TSM, I mean everything, but consider TSM a close enough proxy until a better one comes along.

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Re: All Investors are Factor Investors

Post by betablocker » Tue Dec 05, 2017 3:52 pm

Is there some evidence that market beta is more pervasive and robust than value, momentum, etc? I'd like to see that.

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Re: All Investors are Factor Investors

Post by UpsetRaptor » Tue Dec 05, 2017 4:40 pm

Cliffs from article:
- Some semantics over what the word "factor" means.
- "Market" factor investing (i.e. passive indexing) has risk and you can maybe beat it.
- Everything on site is surrounded by Buy-my-products links and comments.

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by LadyGeek » Tue Dec 05, 2017 4:57 pm

I moved betablocker's thread into here.

I also removed an off-topic post and reply.
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Re: All Investors are Factor Investors

Post by rkhusky » Tue Dec 05, 2017 5:05 pm

staythecourse wrote:
Tue Dec 05, 2017 3:26 pm
How do the same folks know ERP exist? It isn't on the Ten Commandments. Someone noticed it as a way to explain the excess returns given by stocks over fixed income. That is how that factor started. No different then any of the factors.
No. Investors demanded a higher return for taking the greater risk of investing in or taking partial ownership of a company, compared to lending the company money with a well defined contractual instrument. It is difficult for me to see how investors can demand a higher return from a long/short scheme involving part of the market vs another part of the market, compared to investing in the market as a whole. It is much easier to demand a higher return from stock investing versus bond investing. The two are not even comparable. If the risk of not realizing greater returns of stocks versus bonds is R, then the risk of not realizing greater returns of a long/short scheme versus total market investing is at least R^2.

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by saltycaper » Tue Dec 05, 2017 5:20 pm

I find it interesting to hear that some posters do not believe factors exist. Besides the ERP, I find it pretty intuitive that long-term government bonds ought to offer a premium over short-term bills, and that long-term corporate bonds ought to offer a premium over long-term government bonds.
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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by Theoretical » Tue Dec 05, 2017 5:39 pm

Actually, even market beta is long-short, as market returns are reduced by the risk-free rate (t-bills).

lack_ey
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Re: All Investors are Factor Investors

Post by lack_ey » Tue Dec 05, 2017 6:24 pm

betablocker wrote:
Tue Dec 05, 2017 3:52 pm
Is there some evidence that market beta is more pervasive and robust than value, momentum, etc? I'd like to see that.
For one view you can look up the t-stats, average excess return, Sharpe ratios, etc.

Going by the traditional factor definitions and not using some backtested formulation that improves results, market beta has been relatively good as far as factors go, and better when you consider transaction costs / investability (e.g. cross-sectional momentum does even better but of course would incur higher trading costs, and some decent degree of it from relative return in small caps). Then even better if you consider the data mining concerns generally.

There are some country stock markets where we have data on overall stock returns (so we have a market beta return figure) but not enough info on fundamentals to determine quality factor returns or something similar involving a cross-sectional sort.

Theoretical wrote:
Tue Dec 05, 2017 5:39 pm
Actually, even market beta is long-short, as market returns are reduced by the risk-free rate (t-bills).
Yeah, it's long/short in terms of how it is presented in the factor context, being an excess return of an asset class above cash.

But regardless that's different from talking about a factor defined on relative return across subgroups of assets within an asset class, where there are so many different ways you could define the groups.

There are other models and ways of looking at asset class returns that would not specify the market return as an excess return above cash.

Random Walker
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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by Random Walker » Tue Dec 05, 2017 6:33 pm

It is difficult for me to see how investors can demand a higher return from a long/short scheme involving part of the market vs another part of the market, compared to investing in the market as a whole

The long/short “scheme” is the point. By subtracting out the market factor, the long/short is isolating a unique, independent, different risk from market risk. By buying small stocks and selling big stocks, one is cancelling out the market factor and isolating the separate factor of size. Buying stocks and selling stocks yields no net exposure to stocks. Buying small and selling big yields pure exposure to the size factor.

Dave

staythecourse
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Re: All Investors are Factor Investors

Post by staythecourse » Tue Dec 05, 2017 6:39 pm

rkhusky wrote:
Tue Dec 05, 2017 5:05 pm
staythecourse wrote:
Tue Dec 05, 2017 3:26 pm
How do the same folks know ERP exist? It isn't on the Ten Commandments. Someone noticed it as a way to explain the excess returns given by stocks over fixed income. That is how that factor started. No different then any of the factors.
No. Investors demanded a higher return for taking the greater risk of investing in or taking partial ownership of a company, compared to lending the company money with a well defined contractual instrument. It is difficult for me to see how investors can demand a higher return from a long/short scheme involving part of the market vs another part of the market, compared to investing in the market as a whole. It is much easier to demand a higher return from stock investing versus bond investing. The two are not even comparable. If the risk of not realizing greater returns of stocks versus bonds is R, then the risk of not realizing greater returns of a long/short scheme versus total market investing is at least R^2.
Same can be said of those who believe in value or small. They could say it is that investors demand more from companies that have a higher chance of default, such as: small and value. No doubt ANY investor would never put a dollar in my small solo practitioner doctor practice if the expected return was the same as that of amazon. So any reasonable investor would demand higher return.

The point I am making is that ALL these factors have a "common sense" aspect. It is just which ones you believe in. The ONLY reasonable argument for a TSM investor NOT to believe in other factors is based on cost (does the higher cost lose the benefit of adding these factors to one's portfolio) and/ or the data is newer and we have not seen it prevail long enough after being known to see if they will persist unlike ERP.

To argue that some or all of the other factors exist and only that one factor (beta) is just turning a blind eye to what they want to see and nothing else.

Good luck.

p.s. I invest in some of the factors and not others, but don't claim that the others don't exist. Just question how much extra return for the higher cost.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

lack_ey
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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by lack_ey » Tue Dec 05, 2017 6:53 pm

Random Walker wrote:
Tue Dec 05, 2017 6:33 pm
It is difficult for me to see how investors can demand a higher return from a long/short scheme involving part of the market vs another part of the market, compared to investing in the market as a whole

The long/short “scheme” is the point. By subtracting out the market factor, the long/short is isolating a unique, independent, different risk from market risk. By buying small stocks and selling big stocks, one is cancelling out the market factor and isolating the separate factor of size. Buying stocks and selling stocks yields no net exposure to stocks. Buying small and selling big yields pure exposure to the size factor.

Dave
I don't think that really answers the question, which is about why some stocks would have a higher return than others.


First off, when we talk about these factor returns, we're looking at raw returns of theoretical portfolios. If you want to profit from investing based on these, you then furthermore have to consider implementation costs and feasibility. A value factor loading can be attained by overweighting some stocks relative to others and doesn't require an investment in the exact groups of stocks long and short as specified. You don't have to short anything, necessarily.

Anyway, that means that we first just want to know if some stocks can have higher returns than others (rather than if an actual live-trading version going long and short would make money).

I think the answer to that is clearly yes, this generally should make some sense. Stock returns are governed by current and future pricing, as well as growth of the underlying. The reason we expect relatively high returns from stocks as opposed to other assets is that there is risk associated with the stock market, plenty of uncertainty and potentially bad features, etc., so the resulting return might reasonably be higher on average.

It should make sense that certain stocks are riskier than other stocks (this is empirically borne out and obvious), and that subsequently there would be little reason to own the riskier stocks unless there is greater return potential. The discount rate is higher on the less certain, riskier investment.

If the market is reasonably pricing the risk, that should mean that some stocks should be priced to earn more on average than others.

Empirically we see that you can find groups of riskier stocks with an excess return pattern that is not even highly correlated with the stock market as a whole. You don't get a scenario where group A's return mixed with 30% cash behaves similarly to 100% total market stocks.

That suggests that certain features of certain stocks are priced in, and that these risks are distinct from market risk. Hence we have something like a Fama/French three-factor model to describe some additional non-market risks that seem to explain stock portfolio returns.


Of course, there are plenty of non-risk-based explanations people give for certain factor returns, and few risk-based explanations for some of the other factors. We also see empirically in past results that the relationship between risk and return doesn't seem to hold like we think it would based on the above, at least in some notable ways.

cantos
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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by cantos » Tue Dec 05, 2017 7:19 pm

Ho hum. Change the typical definition of a word into what you want it to be, and suddenly everyone's a factor investor. I hereby define factor investing as spending money in any asset. So when you buy a car you are factor investing. :oops:

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by LadyGeek » Tue Dec 05, 2017 7:23 pm

OK, but let's be sure we understand the academic definition first: Factors (finance)
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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by Taylor Larimore » Tue Dec 05, 2017 7:34 pm

Yes, there are points in the article that describe how diversifying your risk factors has a good chance of leading to higher returns.
Unfortunately, the article does not describe how "diversifying your risk factors" has a good chance of leading to lower returns, higher-costs and complexity.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

rkhusky
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Re: All Investors are Factor Investors

Post by rkhusky » Tue Dec 05, 2017 7:36 pm

staythecourse wrote:
Tue Dec 05, 2017 6:39 pm

The ONLY reasonable argument for a TSM investor NOT to believe in other factors is based on cost (does the higher cost lose the benefit of adding these factors to one's portfolio) and/ or the data is newer and we have not seen it prevail long enough after being known to see if they will persist unlike ERP.

To argue that some or all of the other factors exist and only that one factor (beta) is just turning a blind eye to what they want to see and nothing else.
Most people believe in the factors, but many question whether they will provide a higher future return after expenses in their investing lifetimes. Incidentally, the factors in the Fama-French formulation are Small minus Big and High minus Low, not small and value. The FF factors involve long and short positions.

Random Walker
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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by Random Walker » Tue Dec 05, 2017 7:43 pm

Lack_ey
Agree with everything you said. Some stocks would have higher expected return than others because they have exposure to both the market factor and an additional factor like small and value.

Dave

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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by jadd806 » Tue Dec 05, 2017 7:54 pm

Wow, add another line to my resume!

jadd806, Factor Investor.

On second thought, I'd rather just be average. This sound like too much complexity, and I know I'd be kicking myself if these "factors" didn't work out over the next 40 years.

staythecourse
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Re: Everyone, Even a Passive Vanguard Investor, is a Factor Investor (Alpha Architect/Jack Vogel, 11-30-17)

Post by staythecourse » Tue Dec 05, 2017 7:56 pm

Taylor Larimore wrote:
Tue Dec 05, 2017 7:34 pm
Yes, there are points in the article that describe how diversifying your risk factors has a good chance of leading to higher returns.
Unfortunately, the article does not describe how "diversifying your risk factors" has a good chance of leading to lower returns, higher-costs and complexity.

Best wishes.
Taylor
I do agree with that. There is no guarantee as there is not guarantee that 3 fund will not lead to lower returns with higher risk on an ex post basis. That is why ALL these arguments are done ex ante and not ex post. I also agree that the one guarantee (despite Vanguard entering the space) is that factor investing can NOT be done with a LOWER cost then just doing market cap.

Personally, I've always believed factors exists and are true to their world in the academic world. The question is in the REAL world of investing can they give the delta difference over market cap investing over the extra costs to make it worthwhile. It is a risk that every investor has to be educated about and make their own choice for what is best for them and their family.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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