Question about performance of factor funds

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Question about performance of factor funds

Post by CULater » Wed Mar 13, 2019 9:01 am

I was just wondering if there are any data on the returns of "factor" funds since they started becoming popular in recent times and whether any of them have actually done any better than plain vanilla total market index funds. Any proof that they are working yet?
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Re: Question about performance of factor funds

Post by Jack FFR1846 » Wed Mar 13, 2019 9:04 am

It's a question of which factor you're talking about. Certainly you can find factor funds that beat the total market over some period of time. But you can also find other factor funds who have underperformed over that same period. Just like picking individual stocks, if you luck out and pick the one that overperforms, you win......until some future time period, when you lose.

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Re: Question about performance of factor funds

Post by Taylor Larimore » Wed Mar 13, 2019 9:07 am

CULater wrote:
Wed Mar 13, 2019 9:01 am
I was just wondering if there are any data on the returns of "factor" funds since they started becoming popular in recent times and whether any of them have actually done any better than plain vanilla total market index funds. Any proof that they are working yet?
CULater:

You can read data and my thoughts about "factor" funds here: Factor Investing

Best wishes.
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Re: Question about performance of factor funds

Post by vineviz » Wed Mar 13, 2019 9:35 am

CULater wrote:
Wed Mar 13, 2019 9:01 am
I was just wondering if there are any data on the returns of "factor" funds since they started becoming popular in recent times and whether any of them have actually done any better than plain vanilla total market index funds. Any proof that they are working yet?
This is possibly a much more complicated question than you expected it to be.

For one thing, ALL funds are factor funds: if a fund had no factor exposure at all, it'd have zero returns and no price volatility.

For another thing, there are important differences between pure (i.e. zero beta funds, which are generally long-short and therefore market neutral) factor returns and what are more commonly called "smart beta" funds (which generally end up with more exposure to the market factor than to other factors).

Third, a lot depends on what you mean by "working".

One of the earliest introductions of a robust suite of factor funds was the iShares S&P index ETFs which launched in 2000. Since then the major factor premiums (size, value, momentum, quality) have all been positive. The iShares S&P 500 Value ETF has captured enough of the value and quality premiums to outperform the iShares Core S&P 500 ETF. The iShares S&P Small-Cap 600 Value ETF has captured enough of the size, value, and quality premiums to outperform the iShares Core S&P 500 ETF. The iShares Core S&P Small-Cap ETF has captured enough of all four premiums to also outperform the iShares Core S&P 500 ETF.

The key to "working" is to maintain enough positive exposure to the targeted factors to overcome the drag created by transaction costs, factor decay, and negative exposure to non-targeted factors.
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Re: Question about performance of factor funds

Post by CULater » Wed Mar 13, 2019 11:18 am

One of the earliest introductions of a robust suite of factor funds was the iShares S&P index ETFs which launched in 2000. Since then the major factor premiums (size, value, momentum, quality) have all been positive. The iShares S&P 500 Value ETF has captured enough of the value and quality premiums to outperform the iShares Core S&P 500 ETF. The iShares S&P Small-Cap 600 Value ETF has captured enough of the size, value, and quality premiums to outperform the iShares Core S&P 500 ETF. The iShares Core S&P Small-Cap ETF has captured enough of all four premiums to also outperform the iShares Core S&P 500 ETF.
I don't see this. According to performance results on Portfolio Visualizer, the S&P500 has outperformed the shares S&P 500 Value and the iShares core small cap 600 has outperformed the iShares small cap 600 value since Jan 2001. Most of the outperformance has been in the last 3 years.
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Re: Question about performance of factor funds

Post by hdas » Wed Mar 13, 2019 11:20 am

CULater wrote:
Wed Mar 13, 2019 9:01 am
I was just wondering if there are any data on the returns of "factor" funds since they started becoming popular in recent times and whether any of them have actually done any better than plain vanilla total market index funds. Any proof that they are working yet?
Check Dimson tally in latest CS yearbook. :greedy
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Re: Question about performance of factor funds

Post by garlandwhizzer » Wed Mar 13, 2019 12:02 pm

vineviz wrote:

One of the earliest introductions of a robust suite of factor funds was the iShares S&P index ETFs which launched in 2000.
Vineviz then goes on to show that both the small and value premiums have been positive since 2000. That proves nothing. It starts at 2000, the date of the collapse of the large cap growth tech bubble which inflated massively overblown PE and PE10 levels in LCG and were devastated over the next 3 years. Simple reversion to the mean would suggest that SCV which had massively underperformed LCG over the decade prior to 2000 would shine going forward after the bubble popped. Currently we do not have such an inflated bubble in LCG valuations some like AAPL and FB actually look like value stocks at present. Nor do we have compelling valuations of long neglected SCV like in 2000 when SCV PE was dramatically more attractive than now. Hence results going forward may look quite different.

Backtesting results are period dependent and picking 2000 as a starting point is cherry picking a date that makes the data on small and value look most compelling in recent decades. Also picking dates in very long term backtesting, including periods prior to the discovery and arbitrage of these premiums, may also give inaccurate and misleading results. Backtesting of cost free long short indexes gets promotions for the academics who "discover" them, and lines the pockets of the fund managers who market these funds, but it far less than certain that it will line the pockets of investors who buy them. Backtesting does not foretell, it only suggests.

Cliff Asness, an acknowledged factor expert, claims that the small factor doesn't exist now and never has existed in a harvestable sense after costs. Trading costs and frictions in the SCV space in addition to the increased fees of SCV funds eat up whatever alpha was there. Likewise value funds in general have mostly underperformed over the last 15 years as markets have become dominated by full time professionals who know about these factors and no obvious LCG bubble has occurred. Small value investing has worked well on cost free backtesting over long periods in the past. Whether it will continue to outperform after costs in the future, and if so by what amount relative to less expenses cap weight indexes, is IMO not as certain as the academics who derive factors and the fund managers who market them suggest.

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Re: Question about performance of factor funds

Post by vineviz » Wed Mar 13, 2019 12:07 pm

CULater wrote:
Wed Mar 13, 2019 11:18 am
One of the earliest introductions of a robust suite of factor funds was the iShares S&P index ETFs which launched in 2000. Since then the major factor premiums (size, value, momentum, quality) have all been positive. The iShares S&P 500 Value ETF has captured enough of the value and quality premiums to outperform the iShares Core S&P 500 ETF. The iShares S&P Small-Cap 600 Value ETF has captured enough of the size, value, and quality premiums to outperform the iShares Core S&P 500 ETF. The iShares Core S&P Small-Cap ETF has captured enough of all four premiums to also outperform the iShares Core S&P 500 ETF.
I don't see this. According to performance results on Portfolio Visualizer, the S&P500 has outperformed the shares S&P 500 Value and the iShares core small cap 600 has outperformed the iShares small cap 600 value since Jan 2001. Most of the outperformance has been in the last 3 years.
I made the comparison from fund inception, in 2000, and you'll likely see different numbers if you choose a different start date (e.g. 2001).

Factor premiums have returns that move in cycles because each factor represents a different source of of risk. Just as we don't expect market beta to produce positive returns every year, we don't don't expect value, size, quality, or momentum to do that either.

Over its full existence (Aug, 2000 to Jan, 2019) the iShares S&P Small-Cap 600 Value ETF has had more exposure to beta, size, value, and quality factors than the S&P 500 and slightly less exposure to momentum. It has also had lower alpha (probably because of higher turnover, market impact costs, etc.).

Here's a graph showing the effect of the various factor exposures (expressed in bps/month).

Image

And the cumulative effect.

Image
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Re: Question about performance of factor funds

Post by vineviz » Wed Mar 13, 2019 12:14 pm

garlandwhizzer wrote:
Wed Mar 13, 2019 12:02 pm
vineviz wrote:
One of the earliest introductions of a robust suite of factor funds was the iShares S&P index ETFs which launched in 2000.
Vineviz then goes on to show that both the small and value premiums have been positive since 2000. That proves nothing.
Backtesting results are period dependent and picking 2000 as a starting point is cherry picking a date that makes the data on small and value look most compelling in recent decades. Also picking dates in very long term backtesting, including periods prior to the discovery and arbitrage of these premiums, may also give inaccurate and misleading results.
I'm not sure you know what "cherry picking" means. I showed the full history of the funds in question, from the first month they existed until the most recent.

And every one of the factors I discussed had been "discovered" decades before BlackRock launched these funds in 2000. If they hadn't been known, how would S&P have designed indexes to capture them?
garlandwhizzer wrote:
Wed Mar 13, 2019 12:02 pm
Cliff Asness, an acknowledged factor expert, claims that the small factor doesn't exist now and never has existed in a harvestable sense after costs. Trading costs and frictions in the SCV space in addition to the increased fees of SCV funds eat up whatever alpha was there.
Literally nothing in there is true. The size premium doesn't depend on whether Asness believes in it or not, and plenty of people with more expertise than he has have poked holes in his argument.
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Re: Question about performance of factor funds

Post by Ketawa » Wed Mar 13, 2019 12:40 pm

Where is the statement about Asness coming from? I don't remember this at all. Asness on the small factor in 2015: The Small-Firm Effect Is Real, and It's Spectacular

Several of his AQR associates wrote an article in the JPM in 2018: Fact, Fiction, and the Size Effect. Last paragraph of the intro:
Based on the facts we uncover, size does not appear to be on equal footing with other prominent factors, such as value, momentum, and defensive/quality investing. The returns to size are far less stable, less persistent, and less robust than these other factors. Although we do not completely deny the existence of a size effect, and we certainly do not advocate actively betting against or shorting it, we also do not believe that size on its own is a key factor for constructing portfolios. We believe the size effect captures part of a broader effect—an illiquidity premium—that can add value at the margin in conjunction with other factors, but in which it is also (by definition) more difficult and expensive to trade. On its own, a size factor is not a particularly strong source of expected returns in practice, despite its prominence in the literature and the attention it has received from the investment world.
Based on this, I see no reason not to use QSMLX (possibly switching to VFMF) or the TSP S Fund for the majority of my domestic equities.

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Re: Question about performance of factor funds

Post by CULater » Wed Mar 13, 2019 12:47 pm

vineviz wrote:
Wed Mar 13, 2019 12:07 pm
CULater wrote:
Wed Mar 13, 2019 11:18 am
One of the earliest introductions of a robust suite of factor funds was the iShares S&P index ETFs which launched in 2000. Since then the major factor premiums (size, value, momentum, quality) have all been positive. The iShares S&P 500 Value ETF has captured enough of the value and quality premiums to outperform the iShares Core S&P 500 ETF. The iShares S&P Small-Cap 600 Value ETF has captured enough of the size, value, and quality premiums to outperform the iShares Core S&P 500 ETF. The iShares Core S&P Small-Cap ETF has captured enough of all four premiums to also outperform the iShares Core S&P 500 ETF.
I don't see this. According to performance results on Portfolio Visualizer, the S&P500 has outperformed the shares S&P 500 Value and the iShares core small cap 600 has outperformed the iShares small cap 600 value since Jan 2001. Most of the outperformance has been in the last 3 years.
I made the comparison from fund inception, in 2000, and you'll likely see different numbers if you choose a different start date (e.g. 2001).

Factor premiums have returns that move in cycles because each factor represents a different source of of risk. Just as we don't expect market beta to produce positive returns every year, we don't don't expect value, size, quality, or momentum to do that either.

Over its full existence (Aug, 2000 to Jan, 2019) the iShares S&P Small-Cap 600 Value ETF has had more exposure to beta, size, value, and quality factors than the S&P 500 and slightly less exposure to momentum. It has also had lower alpha (probably because of higher turnover, market impact costs, etc.).

Here's a graph showing the effect of the various factor exposures (expressed in bps/month).

Image

And the cumulative effect.

Image
I guess I misunderstood. I thought you were comparing the SCV fund (IJS) to the SC fund (IJR). In this case, the SC fund has actually had a somewhat larger cumulative return than SCV since July 2000. That shows that the "value" tilt has done very little over that period for performance, but perhaps quality and small have. When comparing to the S&P500 you get an entirely different result with the S&P representing the proxy for the total market index.
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Re: Question about performance of factor funds

Post by Day9 » Thu Mar 14, 2019 12:00 pm

Didn't Asness author that crudely (or humorously depending on who you are) titled paper "Size Does Matter -- As long As You Control Your Junk" the point is the size factor exists as long as you filter out low quality companies. Sorry to be a victorian on this but paper titles like that show what a male-dominated field this is.
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Re: Question about performance of factor funds

Post by garlandwhizzer » Thu Mar 14, 2019 4:04 pm

Clarification on the question of whether Cliff Asness believes the size factor is real. The following is from an article in Institutional Investor, June 21 2018 entitled, Cliff Asness Knows Less Than He Thought. The article is worth a careful read.

https://www.institutionalinvestor.com/a ... he-thought

Direct quote from the article:
Cliff Asness and his co-founders built an asset management giant on their factor-investing expertise.

Now AQR Capital Management’s own researchers have determined that the “patriarch of the family of anomalies or factors” — the size effect — does not exist.

Asness reckoned with the information in a note published Wednesday on AQR’s website, titled after a Mark Twain quote, “It Ain’t What You Don’t Know That Gets You into Trouble.”

“There isn’t a pure size effect,” Asness wrote. “In fact, there never was a size effect.”

The original study observing outperformance by stocks with small market capitalizations versus large ones — the size factor — was published in 1981. The findings helped earn its author Rolf Banz his PhD from the University of Chicago’s business school, an institution deeply ingrained in AQR’s intellectual lineage. Asness, among many other senior employees, is an alumnus.

“Among other issues, the data used to discover it was flawed (though no fault of the author, that was the data back then) in a way that favored small stocks,” the AQR founder noted.

More accurate modern data show no additional premium for small stocks.
IMO it seems reasonable to conclude based on the above that whether the size factor exists or ever existed in a harvestable after cost sense is not at all clear at this time. It is possible that adding other factors to size like quality or value may produce a small/modest premium going forward.

As for value, I believe that the value factor in real large cap funds rather than cost-free long short portfolios--which are artificial constructs by academics trying to make a splash--have not shown a premium over the S&P 500 since the value factor was described. The iShares S&P 500 Value Index, IVE, has underperformed the iShares S&P500 Index Fund, IVV, since the value funds inception almost 19 years ago. Likewise VIVAX, Vanguard's LCV fund, has underperformed VFINX, their S&P 500 Index LCB Fund, since the inception of the value fund in 1992, more than 26 years ago. Talk about patience waiting for premium to show up, if you'd done that 26 years ago you'd still be waiting and underperforming beta.

The point I'm making is that it seems entirely reasonable to be skeptical and question the underlying assumptions of factor investing just as much as factor investors question the underlying assumptions of cap weighed index investing. There is a great deal of investing dogma out there and little in the way of skeptical and practical analysis of real funds looking to the future rather than the distant past. In my opinion the real results of real funds over a significant time span separate the wheat from the chaff better than academic models or explanations for why factors exist. Factors may well exist and be robust in long/short cost free backtesting studies, much less so, if at all, in real fund results which is presumably what investors are looking for.

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Re: Question about performance of factor funds

Post by vineviz » Thu Mar 14, 2019 5:38 pm

garlandwhizzer wrote:
Thu Mar 14, 2019 4:04 pm
IMO it seems reasonable to conclude based on the above that whether the size factor exists or ever existed in a harvestable after cost sense is not at all clear at this time. It is possible that adding other factors to size like quality or value may produce a small/modest premium going forward.
I think that if someone has already concluded the small cap premium is unclear, citing Asness is a pretty good way to justify that conclusion to their self.

On the other hand if you look at real-world data, evidence to the contrary isn't hard to spot. I attached a chart of S&P index funds above, but here's another approach.

Image

Source

Portfolio 1 is an equal-weighted portfolio of EVERY small cap fund whose data in PortfolioVisualizer begins in 1989 or earlier.

Portfolio 2 is the Vanguard Small Cap Index fund (NAESX).

Vanguard 500 Index (VFINX) is provided as a benchmark.

Sure, you might look at this real-world performance of an aggregate of nearly three dozen actual funds and conclude "that whether the size factor exists or ever existed in a harvestable after cost sense is not at all clear at this time."

It isn't the conclusion that I draw.
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Re: Question about performance of factor funds

Post by CULater » Fri Mar 15, 2019 9:12 am

vineviz wrote:
Thu Mar 14, 2019 5:38 pm
garlandwhizzer wrote:
Thu Mar 14, 2019 4:04 pm
IMO it seems reasonable to conclude based on the above that whether the size factor exists or ever existed in a harvestable after cost sense is not at all clear at this time. It is possible that adding other factors to size like quality or value may produce a small/modest premium going forward.
I think that if someone has already concluded the small cap premium is unclear, citing Asness is a pretty good way to justify that conclusion to their self.

On the other hand if you look at real-world data, evidence to the contrary isn't hard to spot. I attached a chart of S&P index funds above, but here's another approach.

Image

Source

Portfolio 1 is an equal-weighted portfolio of EVERY small cap fund whose data in PortfolioVisualizer begins in 1989 or earlier.

Portfolio 2 is the Vanguard Small Cap Index fund (NAESX).

Vanguard 500 Index (VFINX) is provided as a benchmark.

Sure, you might look at this real-world performance of an aggregate of nearly three dozen actual funds and conclude "that whether the size factor exists or ever existed in a harvestable after cost sense is not at all clear at this time."

It isn't the conclusion that I draw.
Is it size or sector weightings?
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Re: Question about performance of factor funds

Post by vineviz » Fri Mar 15, 2019 12:09 pm

CULater wrote:
Fri Mar 15, 2019 9:12 am
Is it size or sector weightings?
Are you asking whether some of the size premium might be attributable to the difference in sector makeups between the large cap and small cap universes?

Explicitly trying to control for that would be very difficult so I don't actually know. It's a reasonable hypothesis, and my rough calculations suggest that sector differences alone might account for something in the neighborhood of 15 to 20% of the size premium.

It'd be a interesting project to produce a reliable estimate of that effect.
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Re: Question about performance of factor funds

Post by cheezit » Fri Mar 15, 2019 12:33 pm

Other than the curve-fitting hypothesis, the mid-cap anomaly is the biggest challenge to the conventional view of the size factor, IMO. Cf. this and this. Nb. in the second analysis I used a DFA small-cap blend fund in place of an S&P 600 fund because I couldn't find any mutual fund or ETF that tracked the S&P 600 back to 1995 as I could for the S&P 500 (lots of things) and the S&P 400 (MDY); I think the DFA blend fund is a better substitute than something like NAESX (which doesn't have a quality filter or tilt like an S&P fund or a DFA fund would), and its factor loadings are quite close to those of IJR (a true S&P 600 fund), but if someone could find me an older fund that tracks the S&P 600 for a better comparison I'd be grateful.

That being said, there are two big caveats to consider: first, you could solve this easily by admitting factors may not be linear, and second, it may be the case that over very long periods the nonlinearity disappears. I recall that Random Walker has cited an analysis of CRSP data that showed the premium monotonically increasing as the size decile decreased, which goes against the recent (1972-present) outperformance of mid-caps while not necessarily implying that the size effect is linear, to the extent that it exists.

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Re: Question about performance of factor funds

Post by vineviz » Fri Mar 15, 2019 3:52 pm

cheezit wrote:
Fri Mar 15, 2019 12:33 pm
That being said, there are two big caveats to consider: first, you could solve this easily by admitting factors may not be linear, and second, it may be the case that over very long periods the nonlinearity disappears. I recall that Random Walker has cited an analysis of CRSP data that showed the premium monotonically increasing as the size decile decreased, which goes against the recent (1972-present) outperformance of mid-caps while not necessarily implying that the size effect is linear, to the extent that it exists.
More significant than those two caveats are these:

1) these funds do not (and aren't designed to) maintain constant factor exposure over their histories.

2) these funds contain exposure to multiple factors, not just size.

VIMSX, for instance, has had more exposure to the market beta factor, the quality factor, and AQR's "Bet Against Beta" factor than NAESX along with additional alpha having nothing to do with the factors.

So what seems to be a straight up comparison of one factor is really a complex multi factor problem.
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Re: Question about performance of factor funds

Post by garlandwhizzer » Fri Mar 15, 2019 5:58 pm

I agree that SC has had a strong run over the last decade and in fact over the last 19 years relative to the S&P 500. Whether that will continue going forward over the next 10 - 19 years is not clear to me. Historically there are multi-year cycles where SC beats LC typically followed by a multi-year cycle where LC beats SC. Whether we are at such an inflection point now I do not know, but it is certainly possible. I tend to question all dogma about investing but at heart I believe that it is likely, though not certain, that SCV tends to outperform long term although this may merely be payment for accepting more risk and volatility than LCB. In the absence of an obvious LCG bubble like we had in 2000 and which we don't have at present, TSM IMO should be the dominant core holding in any US portfolio. TSM tends now to be dominated by LCG and I believe that adding some portion of SCV to a TSM portfolio (25% in my case to 75% TSM), while not a necessity, nonetheless increases equity diversification whether it produces improved long term returns or not.

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Re: Question about performance of factor funds

Post by hdas » Sat Mar 16, 2019 7:50 am

Here’s a recent paper with some information relevant to this thread:
Alice’s Adventures in Factorland: Three Blunders That Plague Factor Investing
35 Pages
Posted: 17 Feb 2019
Robert D. Arnott
Research Affiliates, LLC

Campbell R. Harvey
Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Vitali Kalesnik
Research Affiliates LLC

Juhani T. Linnainmaa
USC Marshall School of Business; National Bureau of Economic Research (NBER)

Date Written: February 9, 2019

Abstract
Factor investing has failed to live up to its many promises. Its success is compromised by three problems that are often underappreciated by investors. First, many investors develop exaggerated expectations about factor performance as a result of data mining, crowding, unrealistic trading cost expectations, and other concerns. Second, for investors using naive risk management tools, factor returns can experience downside shocks far larger than would be expected. Finally, investors are often led to believe their factor portfolio is diversified. Diversification can vanish, however, in certain economic conditions, when factor returns become much more correlated. Factor investing is a powerful tool, but understanding the risks involved is essential before adopting this investment framework.
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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