Rick Ferri wrote: ↑
Thu Jun 06, 2019 9:07 pm
Food for thought.
Here is what Fama and French really
say about Smart Beta:
Smart Beta is Silly Talk
If you're going to go this route, and I'm not saying you should are shouldn't, but if you do, know what this is, know the cost, and know the risk.
I remember the thread where you and Larry argued over the definition of beta. My understanding is that Beta was the volatility of the market itself. I agreed with you and Larry sent me a personal message saying he was right and you were wrong. A couple of math geeks told me Larry was correct.
I do think this is silly semantics and I personally would be with the historical definition of beta which has been defined at the volatility of the S&P 500. It just seems confusing to have multiple betas out there, it muddles the discussion. So I agree with Rick and this one. The cycle will probably repeat with another Personal Message from Larry and being set straight (again) by the math geeks.
I think Larry would say something like this: market factor explained something like 70% of market returns so you had potential alpha of 30% or so. Three factor model of market, size, and value explained over 90% of returns so potential alpha is less than 10%. Now we have momentum and profitability/quality and now over 95% of market returns are explained. So alpha is probably now potentially 3-4%. Larry would probably define alpha as excess investment returns that cannot be explained by factors.
What is weird is that Larry would say that the market factor and beta are not the same thing. But on the other hand, I think even he has used the terms interchangeably. Beta is sometimes mentioned as a factor.
The thing is, most people understand the volatility of the market itself and that some stocks are more volatile than the market and that some stocks are less volatile than the market. The traditional definition of beta makes the discussion much easier. When you have multiple betas, that creates more variables that investors have to wrap their brains around and thus more difficult to understand. Hence my comments that this just muddles the discussion.
So to summarize the debate, Rick would say Beta is market volatility, Larry would say there is multiple betas based on market, size, value, momentum, quality and that alpha is what is left over. I think that will save another big thread on this.
I am with Rick on this one. You beta believe it!
But then again, I have been right on so many things lately, it will probably be years before I am right about anything again!
A fool and his money are good for business.