Larry Swedroe: Simple Factor Investing

[Random Walker]

https://www.etf.com/sections/index-inve ... nopaging=1

One of the advantages of Total Stock Market Funds is the simplicity with which one can construct a portfolio. One can construct an equity portfolio comprised of only two funds: Total US Stock Market and Total International Stock Market. In this article though, Larry shows that one can construct a portfolio tilted to size and value without much more complexity at all. Rather than exposure to a single factor, the market factor, these portfolios provide exposure to 3 weakly or uncorrelated factors: market, size, and value.Core funds provide simple access to factors that keep rebalancing and tax costs low. He provides evidence supporting the thesis that a portfolio tilted to size and value may well outperform significantly, and when it underperforms the deficit tends to be much less significant. He also evaluates the efficiency of total market portfolios versus the tilted portfolios with Sharpe ratios.<br/>
<br/>
Dave</r>

[HEDGEFUNDIE]

Great, now how do I implement this without paying a DFA advisor?

[triceratop]

Great, now how do I implement this without paying a DFA advisor?

ETFs tracking the following indices/asset classes exist: iShares S&P 600 Value, EAFE Value, International Small, EM Value.

I always find it unfortunate Larry doesn't often construct portfolios with matching factor exposures using ETFs.

[wolf359]

Options:
1. I can't give you specifics, because I'm currently not doing it, but I've been told that some Dimensional advisors will give you access to the funds for a low, perhaps fixed fee if you self-manage. Alternatively, see whether or not you need some planning work done, and perhaps you can work something out.

2. The article itself said that you could access the factors by simply buying funds that focus on the specific factors. The Dimensional funds he cited just simplify it by combining multiple factor exposure into a few core funds.

3. This is how I'm doing it. I am investing in the 3 Fund portfolio for market factor exposure. I then tilt the portfolio by adding extra funds. Swedroe's book has more details and identifies funds that enable this type of investing. Not all the fund choices require use of investment advisors (although some do.) In addition, Vanguard came out with new factor mutual funds and ETFs after the book came out. They also have some multifactor products.

[vineviz]

Great, now how do I implement this without paying a DFA advisor?

50.00% Vanguard US Multifactor ETF (VFMF)
25.00% Invesco FTSE RAFI Emerging Markets ETF (PXH)
25.00% iShares Edge MSCI Mltfct Intl SmCp ETF (ISCF)

[HEDGEFUNDIE]

Great, now how do I implement this without paying a DFA advisor?

50.00% Vanguard US Multifactor ETF (VFMF)
25.00% Invesco FTSE RAFI Emerging Markets ETF (PXH)
25.00% iShares Edge MSCI Mltfct Intl SmCp ETF (ISCF)

Thanks vineviz. PXH is new to me. Which factors does it target? Description from Invesco site says:

The Index is designed to track the performance of the largest emerging market equities, selected based on the following four fundamental measures of firm size: book value, cash flow, sales and dividends. The equities with the highest fundamental strength are weighted according to their fundamental scores.

Sounds to me like Quality?

[larryswedroe]

Lots of different funds one can use and to find factor loadings just use www.portfoliovisualizer.com and/or can also look at portfolio metrics on M*

[gclancer]

Lots of different funds one can use and to find factor loadings just use www.portfoliovisualizer.com and/or can also look at portfolio metrics on M*

Given the tenor of your article I’m surprised you didn’t address DFA’s global equity mutual fund (DGEIX) that is a fund-of-funds holding the DFA core equity funds. Any reason you didn’t address that fund? Care to share any thoughts (I ask because DGEIX is commonly offered within 401(k)s and thus may be more relevant to the readership here).

[vineviz]

Thanks vineviz. PXH is new to me. Which factors does it target? Description from Invesco site says:

The Index is designed to track the performance of the largest emerging market equities, selected based on the following four fundamental measures of firm size: book value, cash flow, sales and dividends. The equities with the highest fundamental strength are weighted according to their fundamental scores.

The RAFI indexes aren't specifically designed to produce factor loadings, but those four metrics generally produce some combination of size and value loadings.

[vineviz]

Great, now how do I implement this without paying a DFA advisor?

50.00% Vanguard US Multifactor ETF (VFMF)
25.00% Invesco FTSE RAFI Emerging Markets ETF (PXH)
25.00% iShares Edge MSCI Mltfct Intl SmCp ETF (ISCF)

If you really like living dangerously:

30.00% iShares Edge MSCI Intl Value Factor ETF (IVLU)
30.00% ProShares Ultra SmallCap600 (SAA)
20.00% iShares Edge MSCI Multifactor EmMkts ETF (EMGF)
20.00% Vanguard Intmdt-Term Trs ETF (VGIT)

[Random Walker]

2. The article itself said that you could access the factors by simply buying funds that focus on the specific factors. The Dimensional funds he cited just simplify it by combining multiple factor exposure into a few core funds.

3. This is how I'm doing it. I am investing in the 3 Fund portfolio for market factor exposure. I then tilt the portfolio by adding extra funds. Swedroe's book has more details and identifies funds that enable this type of investing. Not all the fund choices require use of investment advisors (although some do.) In addition, Vanguard came out with new factor mutual funds and ETFs after the book came out. They also have some multifactor products.

2.It is better, when possible, to use Core funds than separate asset class or factor funds. A core fund will be more efficient with regard to rebalancing and taxes. Don’t need to buy and sell as individual stocks migrate.

3.I believe this approach is best. Start off with a cheaper core fund, then tilt to taste with modest amounts of the more expensive focused factor fund. Sometimes a more expensive and more tilted fund is a better choice than a less expensive fund with less factor exposure. First of all, the investor will need less of the factor fund to achieve the same factor exposures in the portfolio. Secondly, when a fund has deeper factor exposure, the investor takes on less market factor to achieve the same tilts to the other factors. This is more efficient. The goal is to diversify away from market beta (we all have enough of that) and more evenly diversify across factors.

Dave

[nisiprius]

Weird... I looked at the article yesterday. Today, I can log into etf.com and read his September 5th article, Myth Busting Active Investing, but your link to Simple Factor Investing is giving me a "not authorized to access this page" error.

I get the same result trying to search on the etf.com site. A Google search on swedroe simple factor gives me an etf.com page as the first hit, but, again, I get the same error when I try to follow the link.

My recollection is that he compared two 100%-stock portfolios.

I wanted to extend his comparison by adding a bond fund, to make both portfolios 60/40 portfolios, and I was going to ask for suggestions about what single DFA fund would best serve as a counterpart to the Vanguard Total Bond Market Index Fund.

I am thinking it would be the Intermediate Government Fixed Income Portfolio, DFIGX. Since in fact it has performed similarly to, and has outperformed Total Bond, I would expect this not to change the comparison in any material way. But I don't think it's appropriate to compare 100%-stock portfolios since, as far as I know neither Taylor Larimore nor Larry Swedroe would recommend them, so I think we ought to make the comparison in a 60/40 balanced portfolio including bonds.

Does someone have the exact composition, by ticker symbol and percentage, of his two comparison portfolios?

[nisiprius]

The ultimate in simplicity, of course, is a target date fund. DFA's target date funds have only had inception since since 11/2015, so it's not reasonable to try to compare their performance to e.g. Vanguard's (OK, the 2060 funds have been virtually identical if you want to peek anyway).

However, I think it is interesting how little factor tilt there is in DFA's target date funds (well, the 2060 fund anyway). Dimensional has 29% in small-caps and mid-caps, only 5% more than Vanguard. And it has no value tilt at all. I wonder why not?

[Kevin8696]

Clicked the link in the OP post.

Took me to a site to create an account.

Created account.

Verified account.

Now, where the heck is the article that is the subject of the original post ?

Or do I have to buy something to see it ?

[larryswedroe]

fyi
I just emailed the editor as it has disappeared for some reason

[Kevin8696]

[Elysium]

The ultimate in simplicity, of course, is a target date fund. DFA's target date funds have only had inception since since 11/2015, so it's not reasonable to try to compare their performance to e.g. Vanguard's (OK, the 2060 funds have been virtually identical if you want to peek anyway).

However, I think it is interesting how little factor tilt there is in DFA's target date funds (well, the 2060 fund anyway). Dimensional has 29% in small-caps and mid-caps, only 5% more than Vanguard. And it has no value tilt at all. I wonder why not?

Tracking error risk? because most likely candidates for a TR fund cannot adjust to it.

[fennewaldaj]

Great, now how do I implement this without paying a DFA advisor?

50.00% Vanguard US Multifactor ETF (VFMF)
25.00% Invesco FTSE RAFI Emerging Markets ETF (PXH)
25.00% iShares Edge MSCI Mltfct Intl SmCp ETF (ISCF)

Any particular reason you would choose the invesco fund over schwabs fund (fnde) seems better in more or less all ways.

[vineviz]

Great, now how do I implement this without paying a DFA advisor?

50.00% Vanguard US Multifactor ETF (VFMF)
25.00% Invesco FTSE RAFI Emerging Markets ETF (PXH)
25.00% iShares Edge MSCI Mltfct Intl SmCp ETF (ISCF)

Any particular reason you would choose the invesco fund over schwabs fund (fnde) seems better in more or less all ways.

PXH has slightly more tilt towards value and small size.

I agree that FNDE looks like a fine choice, though.

[fennewaldaj]

Great, now how do I implement this without paying a DFA advisor?

50.00% Vanguard US Multifactor ETF (VFMF)
25.00% Invesco FTSE RAFI Emerging Markets ETF (PXH)
25.00% iShares Edge MSCI Mltfct Intl SmCp ETF (ISCF)

Any particular reason you would choose the invesco fund over schwabs fund (fnde) seems better in more or less all ways.

PXH has slightly more tilt towards value and small size.

I agree that FNDE looks like a fine choice, though.

I had not looked super close at the invesco funds until just now as I have the schwab ones available in my 403b brokeragelink. I know the methodology is a bit different between them but in leads to some pretty major differences between the 2 funds particularly in the weight of the financial and energy sector. I suppose South Korea being in the schwab fund but not the invesco fund is part of that too.

[nisiprius]

The ultimate in simplicity, of course, is a target date fund. DFA's target date funds... I think it is interesting how little factor tilt there is in DFA's target date funds (well, the 2060 fund anyway). Dimensional has 29% in small-caps and mid-caps, only 5% more than Vanguard. And it has no value tilt at all. I wonder why not?

Tracking error risk? because most likely candidates for a TR fund cannot adjust to it.

Right. I should have remembered. Presumably many of these funds will be bought without going through an advisor, and in the past, one of the stated reasons why they were sold only through advisors was that Dimensional wanted to sell only to investors who had been educated on the theory, and signed on to the idea of a long-term commitment with possible long periods underperformance.

Also, of course, there's no reason to expect complete purity of strategy across all of Dimensional's funds, just as Vanguard offers both index and active funds, and just as their managed payout fund has a very different portfolio composition from their other retirement income funds.

[Elysium]

The ultimate in simplicity, of course, is a target date fund. DFA's target date funds... I think it is interesting how little factor tilt there is in DFA's target date funds (well, the 2060 fund anyway). Dimensional has 29% in small-caps and mid-caps, only 5% more than Vanguard. And it has no value tilt at all. I wonder why not?

Tracking error risk? because most likely candidates for a TR fund cannot adjust to it.

Right. I should have remembered. Presumably many of these funds will be bought without going through an advisor, and in the past, one of the stated reasons why they were sold only through advisors was that Dimensional wanted to sell only to investors who had been educated on the theory, and signed on to the idea of a long-term commitment with possible long periods underperformance.

Also, of course, there's no reason to expect complete purity of strategy across all of Dimensional's funds, just as Vanguard offers both index and active funds, and just as their managed payout fund has a very different portfolio composition from their other retirement income funds.

I think they have changed their business strategy a bit over the years, and offering some funds through retirement plans and college savings plans. They have the building blocks for it through their Core funds which are pretty much like Total Stock Index funds. My guess is that, without taking a peek, that these TR funds are invested primarily in the Core funds, so mostly market like.

I guess the thinking over there must be why not gather some money through retirement plans and college plans, it cannot hurt the bottomline operation of the company to have asset flows. They still keep the deep value funds available only through advisor channel. I also heard that they have liquidity and trading issues with the smallest and most valuey funds, so they might have been forced to go with these other strategies.

[nisiprius]

...I think they have changed their business strategy a bit over the years, and offering some funds through retirement plans and college savings plans. They have the building blocks for it through their Core funds which are pretty much like Total Stock Index funds. My guess is that, without taking a peek, that these TR funds are invested primarily in the Core funds, so mostly market like.

I guess the thinking over there must be why not gather some money through retirement plans and college plans, it cannot hurt the bottomline operation of the company to have asset flows. They still keep the deep value funds available only through advisor channel. I also heard that they have liquidity and trading issues with the smallest and most valuey funds, so they might have been forced to go with these other strategies...

IIRC Bob Kirchner (bobcat2) thinks there is something special about them, but unless he sees this and jumps in himself, I can't explain it myself. He puts a lot of stress on Robert Merton's participation in developing the asset mix and glide paths.

[Theoretical]

If I remember correctly, the special sauce is in the way the fixed income allocation is handled as part of the glide path.

[international001]

Isn't this the same concept than Paul Merriman's portfolios?

25% LC, 25% LV, 25% S, 25% SV

[jalbert]

He provides evidence supporting the thesis that a portfolio tilted to size and value may well outperform significantly, and when it underperforms has underperformed in the past the deficit tends has tended to be much less significant.

Corrections to text above.

No doubt many factor proponents will chime in to disagree, but if such an asymmetry were probable/reliable, it is not credible to me that it would fail to be arbitraged away by the market.

[larryswedroe]

Jalbert
No reason to expect arbitrage away because the factors are risk-based and risk cannot be arbed away. Now premiums can shrink due to cash flows, which is true of all factors/assets/investment strategies including market beta. Now if you think they are behavioral based then yes they can be arbed away, at least to some degree, though limits to arbitrage prevent full elimination of mispricing

[Random Walker]

Jalbert,
I meant it the way it was written. First of all, as Larry said above, the factors are risk based. Secondly, the phenomenon is a function of how portfolios work. Because size and market are weakly correlated, value and market uncorrelated, size and value uncorrelated, the underperformance can be muted. Certainly correlations can vary over time and can go to one in bad times. In fact, a big part of the size and value premia are compensation for doing poorly in bad times. But I believe it is the overall lack of correlation between the factors, and the fact that both portfolios are dominated by market beta, that the behavior is quite reliable.

And this effect would be further emphasized if the investor both tilted the equity to SV and decreased the overall equity allocation to keep the overall portfolio expected return same as the TSM portfolio. If I’ve made any misstatements, hopefully Larry will chime in to correct them.

Dave

[packer16]

The correlation is dependent upon the asset class. IMO to say value, size and the market are uncorrelated is a stretch. To say they are weakly correlated I think is more appropriate.

Also, the difference in volatility between Vanguard SCV & the S&P 500 is about 1% per my calcs since 1994 & almost the same volatility as TSM so I have a hard time seeing extra risk especially when you look at the returns since 1994. If this is true then most of it is behavior driven then the reduced recent returns are evidence of arbing reducing the premium significantly. The measure folks use to state the premium is still there is relative values of growth versus value names. The comparison assumes the relative growth of value/growth stays the same over time or at least reverts to some mean. But IMO today you have the stocks with highest weight having much faster relative growth than in the past due to their asset light revenue models which should result in a larger growth/value spread. I am not sure the value factor is broke but you have to account for the possibility that most of it has been arbed away due to more efficient markets as the vol difference is pretty small.

Packer

[jalbert]

Jalbert
No reason to expect arbitrage away because the factors are risk-based and risk cannot be arbed away.

I wasn’t suggesting the risk could be arbitraged away. I was saying something more subtle, that the asymmetry of upside and downside in historical data is a historical outcome, not a future expected result. If the assymmetry were robust and highly probable in the future, it would be arbitraged away. That is different from saying the risk of an individual factor can be arbitraged away.

[larryswedroe]

Jalbert don't agree. It has to do with what Dave suggested. How the assets mix. In good times correlation of safe bonds to stocks about 0, but in bad times correlation turns highly negative pulling in that left tail a lot IF you use the allocations to factors to also lower BETA. Have to do both.
I don't see this changing in any way. this has been well known for many decades and in fact is part of whole idea behind risk parity and all weather and "permanent" portfolios. That shifting correlation.

[jalbert]

If a risk associated with an asset can be diversified away reliably, it will be arbitraged away by market participants bidding up the price of an asset until the risk is fairly priced. This is not specific to factors nor do I think it should be a controversial point.

Diversifying away security-specific risk is a good example. Market participants know how to do that reliably so they are willing to pay more for a stock than if it were priced with security-specific risk discounted in, bidding up the price until the free lunch that otherwise would arise is gone.

Applying the above to the notion of diversification across factors, the more reliably factor risks can be diversified away, the less the factor premia will be.

I think the way to justify diversification across factors is to turn the above argument on its head by applying it to market risk. Market beta is a factor. To the extent that diversification across factors diversifies market risk, the market risk premium will be arbitraged away. If diversification across factors does diversify some market risk, then failing to use such a diversification would mean that market risk is not fully compensated.

I find that to be a much more compelling argument than saying diversification across factors gives you a good likelihood of realizing the upside of factor premia while also having a good likelihood of eliminating much of the downside, i.e. the premia won’t be arbitraged away, despite a good likelihood of diversifying the risk. Diversifiable risk is arbitraged away by the market, so whatever measure of factor risk is successfully diversified away by diversifying across factors should also have an associated premium arbitraged away commensurately.

[jclear]

Risk arbitrage is very dangerous to do. Risk arbitrage that might span over a decade is very expensive to do. Do you realize you can get a free lunch from convexity? But you won’t be able to eat that free lunch because the cost of making STRIPS is too high.

[nisiprius]

[Edited] This posting had been a comment about the article is still giving an access error at etf.com. Larry Swedroe sent me a PM with an explanation, and says he is rewriting it and reposting it and hopefully will have that done shortly.

[larryswedroe]

Jalbert
I agree with your logic, but it hasn't happened despite many decades of this knowledge out there, and IMO it's behavioral issues that prevent it from ever happening, things like tracking error.

Packer
64-17 annual correlation of size to beta is 0.26 and value to beta is -.25 -call it what you like

[Rick Ferri]

There is nothing “simple” about factor investing. It’s a sophisticated quantitative stock picking and weighting strategy that is always turning over. There’s nothing simple about that.

To call factor investing simple is on par with active managers calling their product a “passive index fund” because they first create the portfolio on paper and call it an index before implementing it in a fund or ETF.

Rick Ferri

[CULater]

There is nothing “simple” about factor investing. It’s a sophisticated quantitative stock picking and weighting strategy that is always turning over. There’s nothing simple about that.

To call factor investing simple is on par with active managers calling their product a “passive index fund” because they first create the portfolio on paper and call it an index before implementing it in a fund or ETF.

Rick Ferri

I've heard factor investing described as "active management with an algorithm."

[international001]

Isn't it the same that cap weighting (with a TTM fund)? Just a different algorithm

I also do my own active management if I have a 60/40 portfolio that I re-balance every year

[larryswedroe]

Just question, so owning a Vanguard small value index fund is not simple? Rhetorical

[jalbert]

Jalbert
I agree with your logic, but it hasn't happened despite many decades of this knowledge out there, and IMO it's behavioral issues that prevent it from ever happening, things like tracking error.

Would a small-cap value fund be considered more “diversified across factors” than a market index fund? There have been two major bear markets since the publication of the 3-factor model by Fama-French in 1992. Small-cap value overperformed in one and underperformed in the other.

But my original point was not to confuse historical outcomes with future expectations. I think we saw in 2008 that historical sample correlations are not robust estimations of actual correlation.

[jalbert]

Just question, so owning a Vanguard small value index fund is not simple? Rhetorical

Owning the fund is simple. Management and administration of the index it tracks is not so simple.

[larryswedroe]

Jalbert, yes it is more diversified by factors, but it also has higher expected returns allowing you to lower your market beta exposure and increase term exposure as well. So you have more size, more value and more term and less beta, creating a more diversified, more of a risk parity strategy, which benefits from the correlation diversification and the shifting regimes of correlation I mentioned. That's where the benefits really come from, otherwise just adding more risk and more expected return basically, and maybe even more beta.

and managing a small value index fund or a non index fund is pretty simple, computers basically can do it, hardly need even humans once the rules established. Just need humans to set the rules if you will. It's why strategies are highly replicable and why all index funds have virtually the same returns once you account for the difference in fees. If it was not simple than that would not be the case

Now there are some skills needed, but they are same for TSM fund, like what to do when get large cash flows in --do you buy the individual stocks or futures so can patiently trade in.
Larry

[Random Walker]

http://thebamalliance.com/pdfs/Effectiv ... wedroe.pdf

I thought this thread would get more traction. TSMers like simplicity, and Larry presents a 3 fund portfolio that is more diversified across the factors shown to drive returns than the typical BH 3 fund portfolios. Above I’ve linked what I think are 3 of the best pages of investment reading that I have ever encountered. In the essay Larry makes the case for looking at diversification from a different point of view. This essay helps emphasize the significance of Larry’s simple factor portfolio. I’m also going to start a separate thread on Effective Diversification In A 3 Factor World.

Dave

[matjen]

I thought this thread would get more traction.

Dave I still can't get access to the article for some reason so that is keeping me from chiming in with my "Taylor Swedroe Portfolio!"

viewtopic.php?t=250534&start=50#p3953102

[Random Walker]

Oh ya, I had forgotten that access to the article was lost. I think Larry contacted the ETF.com people about the issue.

Dave

[Angst]

Oh ya, I had forgotten that access to the article was lost. I think Larry contacted the ETF.com people about the issue.

Dave

Google has a cached version of it here:

https://webcache.googleusercontent.com/ ... irefox-b-1

I don't believe you have to be logged into ETF.com to read it either, at least I didn't. If there's anyone who still can't get it, I don't mind PM'ing you the text. I don't figure I should paste the entire article in a post, should I...?

[azanon]

The alternative to factor investing, though, is proportionally owning more of what has done best in the past (aka Market-Cap weighted index, like S&P 500 or Total Stock market). So from a certain POV, anything you do is active. Since I'm forced to choose, I don't want to take the choice of owing proportionally more of yesterday's winners.

I have to agree with Larry regarding the ease of basic factor investing, or at least some factors like Value. How many milliseconds does it take a computer to screen for P/E, P/B, or whatever, then tell that computer to buy x% of whatever the screen comes up with. I actually like knowing that there's no chance that Google, Apple, and nVidia will come up from the screen. Now if I could go back 10 years ago, I want those 3!