Why factor investing isn't working

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abc132
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Re: Why factor investing isn't working

Post by abc132 » Thu Jul 11, 2019 2:02 pm

larryswedroe wrote:
Thu Jul 11, 2019 7:47 am
ABC
don't have time to address each issue but
And yet you said that over time more thoughtful decision making should prevail. An investor should know if the likely/expected pay off period is 10 years, 20 years, 100 years, or 500 years so that they can pick a strategy that is appropriate for their personal situation. What is true for the individual is not true for the strategy as a whole. So while our individual results may not be indicative of a good strategy, the combined results of all those using a strategy should be able to show the predicted metrics of a good strategy.

I'm certainly not holding you personally accountable for answering these specific questions, but I would expect the factor tilt experts to be able to do so as a whole.
This is EXACTLY what one should do, and it can be done via reviewing MCS outcomes, showing the estimated odds of successful outcomes, achieving your goals be that not running out of money while alive or leaving a certain size bequeth. That is how one decides on the right AA and right withdrawal rate best for their situation. That should answer I think all your questions.


Larry
That is what I do, but I do not currently use factor investing consciously in my plan, although my allocation will obviously have some tilts due to number of funds (~10) and the way I accumulate/rebalance (mostly through additions, but also through changing life situations).

I'm asking where the expected value for factor investing can be found, and where I can find the expected time period expect to see those gains, and where anyone has published such probability distributions? Can anyone point me to these publications? There should be a plethora of such results if this is exactly what one should do. The probability distribution is what I am looking for - not net average values, which are less useful for risk assessment.

These results would be the basis for choosing whether or not factor investing is appropriate for my situation. There are nuances, as Larry talks about the ability to increase bond percentage. Regardless of the nuances used, net or expected outcomes should be able to be able to be clearly communicated for factor investing, and it should be trivial to show probability distributions, even at level of one representative case that shows how factor investing adds value.

I'd be happy to read such publications if anyone can't point me to them. I want to see either a distribution of possible outcomes for representative case(s), or an ability to describe how one should properly build a MCS to include factor tilting intelligently rather than as a fool. Assume the creation of the actual MCS is trivial.
Last edited by abc132 on Thu Jul 11, 2019 2:09 pm, edited 3 times in total.

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Re: Why factor investing isn't working

Post by abc132 » Thu Jul 11, 2019 2:06 pm

dcabler wrote:
Thu Jul 11, 2019 1:46 pm

+1 Especially since this horse was previously beaten to death in the other umpteen times this subject has come up in the past. Actually kind of surprised that a moderator hasn't decided that it's run its course and has locked it....
I'm still asking for specific deliverables, and I am finding value in the responses.

I would appreciate it if those uniterested simply tune out.

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vineviz
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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 2:09 pm

schooner wrote:
Thu Jul 11, 2019 1:21 pm
vineviz wrote:
Thu Jul 11, 2019 1:09 pm
schooner wrote:
Thu Jul 11, 2019 12:04 pm
Ok, really, say the US equity market return is 10% then the average passive investor also earns 10% (putting aside the few basis points to own a Vanguard Total Market Fund).
Slow down and think this through.

Let's go ahead and assume that the US equity market return IS actually 10%: that's the cap-weighted return of every publicly traded stock.

What additional (unstated) assumptions must you make to get from there to a conclusion that "the average passive investor also earns 10%"?
Sure, Sharpe makes the following assumption: "A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market."

So if we are talking about the US equities market, the passive investor may buy and hold the Vanguard Total Stock Market Index Fund. They may enter the market or exit the market at any given time. But their performance will match the market performance during that set time period. Putting aside the few basis point expense ratio and other small quirks. If you want to quantify this, Vanguard published the tracking error for its funds.

All of the other investors are defined as active participants in the US equities market. They may be factor investors, trade on fundamentals, or perform some type of "technical analysis." But as a group, their average performance, BEFORE FEES, must equal the average passive return during a given time frame.

This must be a true statement because there are only two groups who participate in the market: passive (as defined above) and active (defined as not passive).
This is an examples of “assuming the conclusion”: constructing the definitions to ensure the desired outcome.

Are you sincerely willing to say that people like Bogle, who use S&P 500 funds instead of TSM, are not “passive investors”?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by schooner » Thu Jul 11, 2019 2:19 pm

vineviz wrote:
Thu Jul 11, 2019 2:09 pm
schooner wrote:
Thu Jul 11, 2019 1:21 pm
vineviz wrote:
Thu Jul 11, 2019 1:09 pm
schooner wrote:
Thu Jul 11, 2019 12:04 pm
Ok, really, say the US equity market return is 10% then the average passive investor also earns 10% (putting aside the few basis points to own a Vanguard Total Market Fund).
Slow down and think this through.

Let's go ahead and assume that the US equity market return IS actually 10%: that's the cap-weighted return of every publicly traded stock.

What additional (unstated) assumptions must you make to get from there to a conclusion that "the average passive investor also earns 10%"?
Sure, Sharpe makes the following assumption: "A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market."

So if we are talking about the US equities market, the passive investor may buy and hold the Vanguard Total Stock Market Index Fund. They may enter the market or exit the market at any given time. But their performance will match the market performance during that set time period. Putting aside the few basis point expense ratio and other small quirks. If you want to quantify this, Vanguard published the tracking error for its funds.

All of the other investors are defined as active participants in the US equities market. They may be factor investors, trade on fundamentals, or perform some type of "technical analysis." But as a group, their average performance, BEFORE FEES, must equal the average passive return during a given time frame.

This must be a true statement because there are only two groups who participate in the market: passive (as defined above) and active (defined as not passive).
This is an examples of “assuming the conclusion”: constructing the definitions to ensure the desired outcome.

Are you sincerely willing to say that people like Bogle, who use S&P 500 funds instead of TSM, are not “passive investors”?
Bogle picked the SP500 because it was a good approximation of the total market back in the 1970s. And despite some friendly quibbles, the two funds are very similar (since they are both market cap and the largest companies dominate by market cap).

See: https://www.cbsnews.com/news/john-c-bog ... ck-market/

I am not making this stuff up. This was an observation made by Bill Sharpe, who won the Nobel Prize in Economics and helped create CAPM.

You can deny basic arithmetic. I really can't argue with that one. But the fact remains that the average active manager's performance must equal the average passive manager's performance, net fees. And factor investing is one of many active strategies (you are literally tilting towards certain stocks). Factor investors are placing a bet that they can beat other active strategies. They've pulled up a seat to the poker game.
Last edited by schooner on Thu Jul 11, 2019 2:28 pm, edited 1 time in total.

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Re: Why factor investing isn't working

Post by schooner » Thu Jul 11, 2019 2:20 pm

abc132 wrote:
Thu Jul 11, 2019 2:06 pm
dcabler wrote:
Thu Jul 11, 2019 1:46 pm

+1 Especially since this horse was previously beaten to death in the other umpteen times this subject has come up in the past. Actually kind of surprised that a moderator hasn't decided that it's run its course and has locked it....
I'm still asking for specific deliverables, and I am finding value in the responses.

I would appreciate it if those uniterested simply tune out.
ABC123 seems to know a lot more about statistics than me. I really want Larry or someone else to answer his question

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vineviz
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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 2:46 pm

schooner wrote:
Thu Jul 11, 2019 2:19 pm
Bogle picked the SP500 because it was a good approximation of the total market back in the 1970s. And despite some friendly quibbles, the two funds are very similar (since they are both market cap and the largest companies dominate by market cap).
AFAIK, Bogle remained invested in the S&P 500 fund long after total stock market was available.

But no matter. The question remains: is an investor today who buys only VOO instead of total stock market an "active investor" or a "passive investor" in your view?

Lots of Bogleheads feel content using just the S&P 500: are they making an active bet, or are you modifying your original claim from "average return of passive investors must equal the average return of active investors" to "average return of passive investors should approximate the average return of active investors"?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 2:51 pm

abc132 wrote:
Thu Jul 11, 2019 2:02 pm
I'd be happy to read such publications if anyone can't point me to them. I want to see either a distribution of possible outcomes for representative case(s), or an ability to describe how one should properly build a MCS to include factor tilting intelligently rather than as a fool. Assume the creation of the actual MCS is trivial.
Any paper published on equity risk factors will include most of the summary statistics you need: not just mean factor return but also the standard deviation of factor returns and possibly the correlation of factor returns (if the paper examines more than one factor).

But you can get everything you need in one place: PortfolioVisualizer provides not only the mean return and the standard deviation of return for all the common factors, but they also provide a correlation matrix for the factors.

You can use those data to explore the probability distributions in whatever way you want.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by schooner » Thu Jul 11, 2019 2:56 pm

vineviz wrote:
Thu Jul 11, 2019 2:46 pm
schooner wrote:
Thu Jul 11, 2019 2:19 pm
Bogle picked the SP500 because it was a good approximation of the total market back in the 1970s. And despite some friendly quibbles, the two funds are very similar (since they are both market cap and the largest companies dominate by market cap).
AFAIK, Bogle remained invested in the S&P 500 fund long after total stock market was available.

But no matter. The question remains: is an investor today who buys only VOO instead of total stock market an "active investor" or a "passive investor" in your view?

Lots of Bogleheads feel content using just the S&P 500: are they making an active bet, or are you modifying your original claim from "average return of passive investors must equal the average return of active investors" to "average return of passive investors should approximate the average return of active investors"?
Did you read the article? Bogle specifically says, "To enable investors to make a commitment to the entire stock market, which I consider as the full fruition of the index fund concept. But adjustment of stocks between the two index funds was required as stocks moved in and out of the 500, creating portfolio turnover and potential tax-inefficiencies. So, in 1992 we created the all-in-one Total (U.S.) Stock Market Index Fund."

Even the total market fund is an approximation just like the SP500. It's 99.99% the way there but isn't 100%. Nothing in life is perfect. The idea is to own a market cap weighted index. In good faith. Roth and Bogle get it. They're not trying to beat the market through some fancy factor foot work.

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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 3:14 pm

schooner wrote:
Thu Jul 11, 2019 2:56 pm
Even the total market fund is an approximation just like the SP500.
I think you missed the question I asked, so I'll repeat it:
Lots of Bogleheads feel content using just the S&P 500: are they making an active bet, or are you modifying your original claim from "average return of passive investors must equal the average return of active investors" to "average return of passive investors should approximate the average return of active investors"?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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nedsaid
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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 3:18 pm

AlohaJoe wrote:
Thu Jul 11, 2019 12:23 am
nedsaid wrote:
Thu Jul 11, 2019 12:04 am
AlohaJoe wrote:
Wed Jul 10, 2019 11:54 pm
nedsaid wrote:
Wed Jul 10, 2019 11:32 pm

In 1999, Jack Bogle calculated the future estimated returns of stocks to be 2% for the next decade and that the returns for bonds would be 6%-7%. He was uncannily right except that stocks returned about zero from 2000-2012. His model took into account economic (business) return
And in 2001 he calculated that future estimated returns would be -2% but they were actually +2.9%, so he was off by 5 percentage points.

In 2002 he calculated that future returns would be 2.3% but they were actually 7.1%.

In 1989 he calculated that future returns would be 9.4% but they were actually 18.2%

Bogle's forecasting model has been a bigger failure than factor investing. He data fit a model that backtested well and has consistently failed since publication in 1990.
There is just no way to calculate speculative return correctly. Bogle's model is as good as any out there but even then the best he can do is predict a range of returns. People can be more optimistic than what you would expect and they are can be more pessimistic than what you expect.
That's true but I'm making a different point. Go look at his model vs. reality for 1905-1990. It doesn't always get it right but it is never wrong for long and rarely wrong by more than 1%. As an example from 1952-1956 his model has a cumulative error of just 2.8% over 5 years.

What's more his errors were symmetrical. Just as likely to overestimate as underestimate.

Around 1990 -- when he first published his model -- all of that changed. His model never underestimates any more. The errors are larger and more frequent.

His model has clearly failed out of sample.
This is what I mean that markets are dynamic. There was a time when stocks yielded more than bonds, the rationale being that stocks were riskier than bonds and thus should yield more. This stopped being true in the 1950's as I recall. I think bond yield exceeded stock yields in the 1920's for a while too. I could have used a comparison of yields as a market indicator and put out a sell recommendation when the lines crossed in the 1950's. The market perceived risks differently, the valuation model changed, and this indicator was no longer valid.

Another metric I have been posting about is the declining importance of book value. Don't want to write another lengthy post on this, I have posted on this extensively, but because of changes in the economy and the increasing importance of intellectual property this metric is less and less important. Big difference between an information economy and an industrial economy.

Yet another example of change is that P/E ratios keep climbing. That is yet another thread.

It is clear that things have changed and we need a new model for predicting stock returns. But how do you accurately guess speculative return?
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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 3:22 pm

abc132 wrote:
Thu Jul 11, 2019 1:08 am
nedsaid wrote:
Thu Jul 11, 2019 12:02 am
Abc132, what I am trying to tell you is you are asking for the impossible. One reason being is that there is unpredictability to human emotion, people can do really weird and irrational stuff in the short term and there is just no way to predict that. As I said above, economic or business return is relatively easier to predict. Speculative return, you might as well flip a coin. All you know with speculative return is that there is a reversion to the mean that will occur sooner or later. Trouble is no one knows how soon or how late.

You are desiring precision that just isn't there. Shoot, earnings themselves are not a precise number. Accounting involves judgment and frankly educated guesses, particularly when preparing accruals. My example of John Bogle's projections for the 2000's were pretty good but he missed it. He projected 2% annual returns for the US Stock Market and as I recall, returns were -1% a year. He got it mostly right and that is as good as you are going to get.

Investing isn't about certainties, investing is about probabilities. About the best you can do is to tilt the odds in your favor best you can but there are just no guarantees. Some folks just can't get past this. All we can do is study the past and from that make reasonable projections about the future. An educated guess is a lot better than a purely uninformed guess.

So sorry sports fans out there if this disillusions you. Investing is just not a math problem or an engineering problem to be solved. One big reason is human nature and human behavior. Sorry to break this news to you but you may as well find this out now.
I'm stating that probabilities can be quantified, and that measures of uncertainty and confidence intervals are routinely used to put numerical values on expectations for decision making around uncertainty. Looking at the range of human behavior does in fact provide meaningful information about past uncertainty, and how far human behavior can deviate things from expected or fair values. We have new tools through social media, Alexa, etc, that give unprecedented information about human behavior. Computer decisions are being made using easily quantifiable decisions, and as I understand it represent nearly as big of a chunk of trades as active human decisions.

Tilting implies the ability to respond to the market in a way better than just taking what the market gives as a whole.

Saying probabilities are in one's favor without the ability to quantify how much they are in one's favor shows a weak understanding of what strategies are actually good, or which of the good strategies are near the top. That leaves no way to choose between "odds are good" strategies.

Many strategies devolve into simple data mining of the past. They are touted as good because of past performance. Most of these strategies would be severely diminished if they had to state the confidence interval with which they can deliver future performance that looks like the past, or if they were held accountable over their chosen time period for delivering on specific metrics they advocate. It seems likely to me that the reasons they don't do so is not because the mathematics are impossible, but rather because money is being made from convincing people that their idea is good. The actual ability of an expert to provide useful and actionable information seems to be severely limited.
Then why aren't the quantitative strategies producing superior returns?
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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 3:24 pm

YRT70 wrote:
Thu Jul 11, 2019 9:11 am
nedsaid wrote:
Wed Jul 10, 2019 12:04 pm
My take is that during the long secular bear markets that diversifying across factors helps about 2/3 of the time. The Small/Value tilting would have helped during 1968-1984 and during 2000-2012. It would not have helped from 1929-1946. If you look at it in another way, just looking at the bear markets where you were down 50% or more: factor tilting would not have helped in the aftermath of 1929, would have helped in 1973-74, helped in 2000-2002, but did not help in 2008-2009. So it appears that depending on how you look at it, Small/Value factor tilting will help you 2/3 of the time during the long secular bear markets (where markets are essentially flat for years with big drops and rallies in between) or 1/2 of the time when the markets drop 50% or more.
This seems like a strong argument in favour of tilting. Is no one opposing it?
It is a strong argument for tilting but it doesn't help you all of the time in the bear markets. This shows that even good market strategies don't always work.
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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 3:28 pm

marcopolo wrote:
Thu Jul 11, 2019 8:54 am
I have not studied this topic extensively, mainly just read some of the papers referenced on various threads here. But out of curiosity, and a desire to learn, do you know if people have studied how stationary those statistics are?
As you might imagine, the stationarity of various financial statistics is a quite robust field of study. More relevant for high-frequency traders than long-term investors, since short-term data exhibit far less stationarity than aggregated data do. Thank you, Central Limit Theorem.

Interestingly, equity return covariances are much less stable under the single-factor CAPM model than under the three-factor Fama-French model. Bartz et al. wrote a dense but interesting paper on directional variance adjustments (DVA): https://journals.plos.org/plosone/artic ... ne.0067503

They found that DVA offered improvements in some metrics but not in others. For instance, a more stable covariance matrix should lead to lower portfolio turnover, but Bartz et al. found that Fama-French actually had lower turnover than both CAPM and DVA in their tests.

Obviously it is difficult to conduct formal stationarity tests on long-term data because we end up with fewer independent samples than we'd like. But none of the research I've read leads me to conclude that non-stationarity is likely to be a problem for long-term investors.

On a similar note, there is some evidence that investors prefer to avoid assets that exhibit coskewness with the market and that some traditional risk factors like size and value might partly be a proxy for coskewness risk. It's not terribly easy to explicitly visualize a coskewness matrix, though, and 2008-2009 illustrated that even many professional investors probably weren't paying enough attention to metrics like this. Even for those of us curious about such things, extreme downside shocks are not nearly common enough to form robust estimates for them.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 3:29 pm

nedsaid wrote:
Thu Jul 11, 2019 3:24 pm
It is a strong argument for tilting but it doesn't help you all of the time in the bear markets. This shows that even good market strategies don't always work.
If it worked for everyone all the time, there'd be no risk. Right?

And as they say: "no risk, no premium".

That's why multi-factor investors should not only be comfortable underperforming the market sometimes: they should expect to do so.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 3:45 pm

abc132 wrote:
Thu Jul 11, 2019 2:06 pm
dcabler wrote:
Thu Jul 11, 2019 1:46 pm

+1 Especially since this horse was previously beaten to death in the other umpteen times this subject has come up in the past. Actually kind of surprised that a moderator hasn't decided that it's run its course and has locked it....
I'm still asking for specific deliverables, and I am finding value in the responses.

I would appreciate it if those uniterested simply tune out.
You could look up Bill Bernstein. As I recall, he has done some work on future expected returns of different asset classes. Just enter something like future expected returns of asset classes into a search box and stuff will come up. I see Vanguard made some projections, SSGA has a paper on the subject, I see a scatterplot graph from Research Affiliates. I would check for any work Cliff Asness has done on this. Another source would be Dimensional Fund Advisors. I am sure lots of stuff will come up including expected returns from factors. You are going to have to do some research on your own. Sounds to me like you are asking for precision that you just are not going to get.
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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 4:01 pm

vineviz wrote:
Thu Jul 11, 2019 3:29 pm
nedsaid wrote:
Thu Jul 11, 2019 3:24 pm
It is a strong argument for tilting but it doesn't help you all of the time in the bear markets. This shows that even good market strategies don't always work.
If it worked for everyone all the time, there'd be no risk. Right?

And as they say: "no risk, no premium".

That's why multi-factor investors should not only be comfortable underperforming the market sometimes: they should expect to do so.
Yep, you have raised an essential point here. It is the "failures" that produce the premiums in the first place.

I don't know, I think the factors horse was beaten to death years ago and we keep whipping the skeleton. The poor thing didn't even get a decent burial.

Certain folks can't get past certain points, even if they are inaccurate. Someone keeps insisting that factor tilting is an active strategy despite numerous explanations that there are many low cost, lower turnover, and more passive factor products. The DFA strategies in my view are not 100% passive but pretty darned close, certainly much more passive than active. There is a continuum out there that ranges from passive to active.

People talk about oh how complex factor investing is and I have shown you can do Small/Value tilting with 4 funds. I think TrevH has done work on this 4 fund portfolio in the forum. You could get Size, Value, Momentum with a total of 5 funds. Canned portfolios out there, Coffeehouse is the simpler version, Merriman has a more complex version.

Others insist that Total Stock Market Index has all the factors and that is inaccurate as well.

Then the Efficient Market fanatics that say valuations don't matter, which down deep almost no one really believes.

The quants who want everything calculated out and projected forward to the 25th decimal point, expecting a precision that just cannot be there. Don't know how many times to say it, earnings are not precise. If you have imprecise input you will have imprecise output. The stats are very important but they aren't the only thing. Everything has its limitations.

So I think I am moving on to another thread. Thanks everyone.
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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 4:38 pm

nedsaid wrote:
Thu Jul 11, 2019 4:01 pm
People talk about oh how complex factor investing is and I have shown you can do Small/Value tilting with 4 funds. I think TrevH has done work on this 4 fund portfolio in the forum. You could get Size, Value, Momentum with a total of 5 funds.
If you limit the problem to just US stocks, you can get 5 factors with just two funds and a combined ER of 10 bps.

67% Vanguard Small-Cap Value ETF (VBR)
33% iShares Edge MSCI USA Momentum Fctr ETF (MTUM)
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by Gemini » Thu Jul 11, 2019 4:49 pm

vineviz wrote:
Thu Jul 11, 2019 4:38 pm
nedsaid wrote:
Thu Jul 11, 2019 4:01 pm
People talk about oh how complex factor investing is and I have shown you can do Small/Value tilting with 4 funds. I think TrevH has done work on this 4 fund portfolio in the forum. You could get Size, Value, Momentum with a total of 5 funds.
If you limit the problem to just US stocks, you can get 5 factors with just two funds and a combined ER of 10 bps.

67% Vanguard Small-Cap Value ETF (VBR)
33% iShares Edge MSCI USA Momentum Fctr ETF (MTUM)
What about funds for a comprehensive portfolio construction? A factor portfolio is challenging to implement for a DIY investor.

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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 5:29 pm

Gemini wrote:
Thu Jul 11, 2019 4:49 pm
What about funds for a comprehensive portfolio construction? A factor portfolio is challenging to implement for a DIY investor.
I don't think it NEEDS to be terribly challenging. It's never going to be as easy as a total market approach, where you could just buy a funds like Vanguard LifeStrategy Moderate Growth Fund (VSMGX) and be done with it.

But a DIY investor could easily cover all their US exposure with a single fund like Vanguard U.S. Multifactor ETF (VFMF). To add international exposure, either a broad fund like Vanguard Total International Stock ETF (VXUS) or something more specialized like Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) would be fine. Throw in a long-term US Treasury fund like Vanguard Long-Term Treasury ETF (VGLT) to cover the bonds and you're done: a three-fund DIY factor portfolio from Vanguard.

All of those ETFs are also available as mutual funds, if that's your thing.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by matjen » Thu Jul 11, 2019 6:23 pm

Gemini wrote:
Thu Jul 11, 2019 4:49 pm
What about funds for a comprehensive portfolio construction? A factor portfolio is challenging to implement for a DIY investor.
Although you would need DFA access let me toss out my "Taylor Swedroe" Portfolio as an option.

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

You could certainly replace the US side with the Vanguard fund mentioned above Vanguard U.S. Multifactor ETF (VFMF) and the International side with Schwab Fundamental International Small Company Index ETF (FNDC)
Last edited by matjen on Thu Jul 11, 2019 8:28 pm, edited 1 time in total.
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pascalwager
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Re: Why factor investing isn't working

Post by pascalwager » Thu Jul 11, 2019 8:10 pm

I've had a DFA account since June 1995 and I looked at the M* fund performance curves a few days ago to get a sense of the relative fund growths.

DFA Microcap Fund: 1094%
DFA Large Value Fund: 1000%
(S&P 500 index: 867%)
DFA Emerging Mkts Fund: 464%
DFA Int'l Small Co Fund: 438%
DFA Int'l Value Fund: 429%

The account hasn't been internally rebalanced since the end of 2011 (51/49 US/int'l) and has been at about 63/37 for a few years now. I combine it with Vanguard developed and emerging markets funds for an overall 50/50.

abc132
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Re: Why factor investing isn't working

Post by abc132 » Thu Jul 11, 2019 9:08 pm

nedsaid wrote:
Thu Jul 11, 2019 3:22 pm
abc132 wrote:
Thu Jul 11, 2019 1:08 am
nedsaid wrote:
Thu Jul 11, 2019 12:02 am
Abc132, what I am trying to tell you is you are asking for the impossible. One reason being is that there is unpredictability to human emotion, people can do really weird and irrational stuff in the short term and there is just no way to predict that. As I said above, economic or business return is relatively easier to predict. Speculative return, you might as well flip a coin. All you know with speculative return is that there is a reversion to the mean that will occur sooner or later. Trouble is no one knows how soon or how late.

You are desiring precision that just isn't there. Shoot, earnings themselves are not a precise number. Accounting involves judgment and frankly educated guesses, particularly when preparing accruals. My example of John Bogle's projections for the 2000's were pretty good but he missed it. He projected 2% annual returns for the US Stock Market and as I recall, returns were -1% a year. He got it mostly right and that is as good as you are going to get.

Investing isn't about certainties, investing is about probabilities. About the best you can do is to tilt the odds in your favor best you can but there are just no guarantees. Some folks just can't get past this. All we can do is study the past and from that make reasonable projections about the future. An educated guess is a lot better than a purely uninformed guess.

So sorry sports fans out there if this disillusions you. Investing is just not a math problem or an engineering problem to be solved. One big reason is human nature and human behavior. Sorry to break this news to you but you may as well find this out now.
I'm stating that probabilities can be quantified, and that measures of uncertainty and confidence intervals are routinely used to put numerical values on expectations for decision making around uncertainty. Looking at the range of human behavior does in fact provide meaningful information about past uncertainty, and how far human behavior can deviate things from expected or fair values. We have new tools through social media, Alexa, etc, that give unprecedented information about human behavior. Computer decisions are being made using easily quantifiable decisions, and as I understand it represent nearly as big of a chunk of trades as active human decisions.

Tilting implies the ability to respond to the market in a way better than just taking what the market gives as a whole.

Saying probabilities are in one's favor without the ability to quantify how much they are in one's favor shows a weak understanding of what strategies are actually good, or which of the good strategies are near the top. That leaves no way to choose between "odds are good" strategies.

Many strategies devolve into simple data mining of the past. They are touted as good because of past performance. Most of these strategies would be severely diminished if they had to state the confidence interval with which they can deliver future performance that looks like the past, or if they were held accountable over their chosen time period for delivering on specific metrics they advocate. It seems likely to me that the reasons they don't do so is not because the mathematics are impossible, but rather because money is being made from convincing people that their idea is good. The actual ability of an expert to provide useful and actionable information seems to be severely limited.
Then why aren't the quantitative strategies producing superior returns?
That seems a bit unrelated to my posts, as I never said that quant should beat the market. My theory is that the recent market has been trading on tweets rather than fundamentals, and when the things that cause trades to change are different, the models do poorly. The point is that quantitative trading has changed how the market performed, along with some other things like tweet storms and going after individual companies. I have no doubt the quants are re-tuning their models to take advantage of tweets. Advanced notice of news shows should be enough to capture a few percent per year, as they predict the tweets. I'm not in the business of trying to beat the market, so I'm still unclear why this is relevant to me or to the discussion.

What's your theory? Why is it relevant?

abc132
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Re: Why factor investing isn't working

Post by abc132 » Thu Jul 11, 2019 9:21 pm

nedsaid wrote:
Thu Jul 11, 2019 3:45 pm
abc132 wrote:
Thu Jul 11, 2019 2:06 pm
dcabler wrote:
Thu Jul 11, 2019 1:46 pm

+1 Especially since this horse was previously beaten to death in the other umpteen times this subject has come up in the past. Actually kind of surprised that a moderator hasn't decided that it's run its course and has locked it....
I'm still asking for specific deliverables, and I am finding value in the responses.

I would appreciate it if those uniterested simply tune out.
You could look up Bill Bernstein. As I recall, he has done some work on future expected returns of different asset classes. Just enter something like future expected returns of asset classes into a search box and stuff will come up. I see Vanguard made some projections, SSGA has a paper on the subject, I see a scatterplot graph from Research Affiliates. I would check for any work Cliff Asness has done on this. Another source would be Dimensional Fund Advisors. I am sure lots of stuff will come up including expected returns from factors. You are going to have to do some research on your own. Sounds to me like you are asking for precision that you just are not going to get.
Thanks!

I was hoping to get information here.

It's really surprising nobody can post the basic expectations of factor investing, or apply them to the original post. I will concede there will not be much actionable here without the ability to do so.

A clear definition or reference of "foolish" factor investing, and non-foolish factor investing would also be appreciated. Larry seemed to think this was very important.

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nedsaid
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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 9:38 pm

abc132 wrote:
Thu Jul 11, 2019 9:21 pm
nedsaid wrote:
Thu Jul 11, 2019 3:45 pm
abc132 wrote:
Thu Jul 11, 2019 2:06 pm
dcabler wrote:
Thu Jul 11, 2019 1:46 pm

+1 Especially since this horse was previously beaten to death in the other umpteen times this subject has come up in the past. Actually kind of surprised that a moderator hasn't decided that it's run its course and has locked it....
I'm still asking for specific deliverables, and I am finding value in the responses.

I would appreciate it if those uniterested simply tune out.
You could look up Bill Bernstein. As I recall, he has done some work on future expected returns of different asset classes. Just enter something like future expected returns of asset classes into a search box and stuff will come up. I see Vanguard made some projections, SSGA has a paper on the subject, I see a scatterplot graph from Research Affiliates. I would check for any work Cliff Asness has done on this. Another source would be Dimensional Fund Advisors. I am sure lots of stuff will come up including expected returns from factors. You are going to have to do some research on your own. Sounds to me like you are asking for precision that you just are not going to get.
Thanks!

I was hoping to get information here.

It's really surprising nobody can post the basic expectations of factor investing, or apply them to the original post.

A clear definition or reference of "foolish" factor investing, and non-foolish factor investing would also be appreciated. Larry seemed to think this was very important.
I went to a couple of Merriman seminars back in 2007-2008. They expected to beat the Vanguard Index funds with the DFA products by 2% a year and after their 1% Assets Under Management Fee, by 1% a year. That is what the good folks at Merriman thought at the time. They did say that in an environment where Large Growth outperformed that a Vanguard portfolio would beat a DFA portfolio. The broad indexes are chock full of the Large Mega-Cap Growth stocks, the top 100 stocks by market cap have just over 50% of the total market cap of the US Total Stock Market Index. They also said that if you used Vanguard factor products to substitute for DFA products that Vanguard would outperform DFA in a Large Growth environment we are seeing now. Indeed, Vanguard Small/Value Index has been beating the DFA Small Value product as Vanguard has larger market caps and less value loading.

My own expectations were this. I was unaware of any research that said that Small/Value underperformed the broad market over long time periods. I was about 50 years old at the time and figured I had an investing horizon of 30+ years. I figured that I had nothing to lose and potentially much to gain. My expectations were that I could add possibly 0.50% to 1.00% a year in performance by tilting. I figured I would save money by not paying the AUM fee and doing this myself. I also figured that by not using DFA products, I would get a bit less return. I would take an additional 0.50% a year in returns.

So what has happened is that we had a financial crisis and bear market in 2008-2009. We have been in a Large Growth environment since then. So what has happened is about what you would expect given the Large Growth environment.

Perhaps Vineviz can give you more help. I am not a quant or a stats jock, not my strong suit. But I gave you above the broad outlines of my expectations.

You could spring for a big purchase and just buy Larry's book on factors. That would be a help too.
A fool and his money are good for business.

fennewaldaj
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Re: Why factor investing isn't working

Post by fennewaldaj » Thu Jul 11, 2019 10:15 pm

vineviz wrote:
Thu Jul 11, 2019 10:05 am
HomerJ wrote:
Thu Jul 11, 2019 9:52 am
That's my problem with economic statistics.

The math is correct. But it still doesn't let you predict the future with any accuracy.
To be honest, I think the problem is that you think that what I wrote was a prediction.

If I have a fair coin, observing 50% probability of "heads" on the next flip of that coin is NOT a prediction.
I say this as someone why tilts to factors myself. I think you are being a bit too dismissive of HomerJs larger point. We certainly know what the past data says and what it predicts if the future closely resembles the past. And we know what could happen is described by ranges of outcomes. What we don't know is how likely the future is to resemble the past. So you have to step outside the data a bit and try to figure out how likely it is that the past and future are similar (of course this point applies to stocks being a higher return investment than bonds too). I think that the future is likely to resemble the past for value ect but i can't say that with anything approaching certainty. I am confident enough to invest my only money in small value funds ect but I would not be totally surprised if it turns out value is no longer a thing.

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JoMoney
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RTM

Post by JoMoney » Thu Jul 11, 2019 10:16 pm

26 years... Real world since factor fund inception... Small-Value no "premium" over Small-Blend...
Image

37+ years , Small no "premium" over S&P 500
Image
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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vineviz
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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 10:24 pm

abc132 wrote:
Thu Jul 11, 2019 9:21 pm
Thanks!

I was hoping to get information here.

It's really surprising nobody can post the basic expectations of factor investing, or apply them to the original post. I will concede there will not be much actionable here without the ability to do so.
It seems to be that quite a bit of information has been provided here. Example expectations were laid out, for instance, as well as several links to more detailed sources.

The “basic expectations” of using factors in investing have been pretty well spelled out, imho, to the extent possible in an forum where such discussions are made so difficult.

If there is something particular you are hoping for, a more specific request might help reveal it.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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nedsaid
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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 10:33 pm

vineviz wrote:
Thu Jul 11, 2019 10:24 pm
abc132 wrote:
Thu Jul 11, 2019 9:21 pm
Thanks!

I was hoping to get information here.

It's really surprising nobody can post the basic expectations of factor investing, or apply them to the original post. I will concede there will not be much actionable here without the ability to do so.
It seems to be that quite a bit of information has been provided here. Example expectations were laid out, for instance, as well as several links to more detailed sources.

The “basic expectations” of using factors in investing have been pretty well spelled out, imho, to the extent possible in an forum where such discussions are made so difficult.

If there is something particular you are hoping for, a more specific request might help reveal it.
Heck, the guy who wrote a book on Factors Investing only wrote several lengthy posts on the subject and patiently answered questions. If that isn't information, then I don't know what is. I guess some people won't take yes for an answer.
A fool and his money are good for business.

abc132
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Re: Why factor investing isn't working

Post by abc132 » Thu Jul 11, 2019 10:40 pm

I compared small value to total stock market in portfolio visualizer and here is what I got:

Year CAGR
1974-1979 +15.1%
1979-1984 +11.0%
1984-1989 +0.7%
1989-1994 -2.10%
1994-1999 -8.20%
1999-2004 +10.6%
2004-2009 -1.50%
2009-2014 0.90%
2014-2019 -3.00%

I couldn't get earlier data from portfolio visualizer, but that looks like a historical expected time period of ~15 years to see any additional expected performance. (2004-2019 under performed, so this could increase)

One has to believe that changes such as Amazon and Google are not taking away additional value from small businesses. The number of non employer small businesses have almost doubled in the past 20 years, but they do not seem to be receiving the market returns.

I'd be concerned that record store closures are a result of small companies loosing to big tech, and that is a trend likely to continue. I'd also consider the thought that those that succeed with these tools can also more easily move into the growth category, and small value may no longer be what it used to be.
Last edited by abc132 on Thu Jul 11, 2019 10:57 pm, edited 3 times in total.

abc132
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Re: Why factor investing isn't working

Post by abc132 » Thu Jul 11, 2019 10:41 pm

nedsaid wrote:
Thu Jul 11, 2019 10:33 pm
Heck, the guy who wrote a book on Factors Investing only wrote several lengthy posts on the subject and patiently answered questions. If that isn't information, then I don't know what is. I guess some people won't take yes for an answer.
I never got any predicted expectations, metrics for future success or failure, or predicted probabilities, which is what I was asking for the whole time. I do realize there is uncertainty in some of these answers, but that does not prevent their answer from including them.

I got some references to past historical data, which is largely meaningless to my current investment decisions.

Those that equate the past to future will not understand the difference.

I do appreciate the responses and time given, however. I already specifically called out that they were valuable to me.
Last edited by abc132 on Thu Jul 11, 2019 11:05 pm, edited 2 times in total.

Fryxell
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Re: Why factor investing isn't working

Post by Fryxell » Thu Jul 11, 2019 10:50 pm

schooner wrote:
Thu Jul 11, 2019 8:35 am

If factor investors really have found a map to El Dorado, why would you share it with everyone?

Investing is a zero-sum (or market sum) game. Every new factor investor diminishes the return of existing investors. There’s only a limited amount of gold, or market return.
Well, it’s not El Dorado. It’s more like the difference between stock and bond returns, which Bogleheads share with everyone. Anyone that invests in stocks thinking they will get greater returns is assuming that efficient markets have not arbitraged away the equity premium.

But yes, that’s why I generally don’t bother advocating for factor strategies. I’d rather people believe they are dead.

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Re: Why factor investing isn't working

Post by Fryxell » Thu Jul 11, 2019 10:56 pm

schooner wrote:
Thu Jul 11, 2019 9:36 am
If the goal of factor investing is to beat the market, why would Larry and other professionals advertise the trade strategy and risk crowding out the trade?
Why do Bogleheads advocate tilting to stocks to get greater returns? Why would they advertise the strategy and risk crowding out the equity premium trade?

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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 10:59 pm

fennewaldaj wrote:
Thu Jul 11, 2019 10:15 pm
I think you are being a bit too dismissive of HomerJs larger point. We certainly know what the past data says and what it predicts if the future closely resembles the past. And we know what could happen is described by ranges of outcomes. What we don't know is how likely the future is to resemble the past.
It's possible I'm missing his meaning.

What I THINK he was claiming is that anything short of absolute certainty about the future is equivalent to a completely uninformed guess. He said that's NOT what he meant, but I've not found an alternate interpretation.

That said, it's true that "what we don't know is how likely the future is to resemble the past" if by "know" you mean "be completely sure".

But when I said earlier that the best we can do is to make decisions now based on all available information, I hope I was clear that "all available information" includes information about how certain we are that our other information is reliable.

Going back to my fair coin example: if I've tested my coin 2500 times and got heads 1257 times then I think I can very reasonably conclude that the odds of heads on the next flip are pretty close to 50%. If I've tested my coin 4 times and got heads twice, I should be (and will be) much less confident in my estimated probability. And that's information I know.

If, after I test my coin, lock it in my desk drawer then I can be reasonably confident that it hasn't been tampered with during the time between my in-sample test and my future out-of-sample test. If I put the coin in a jar with 20 other similar coins on top of my desk and come back to retrieve it after a two-week vacation, I can be (and will be) much less confident that my in-sample coin is the same one I retrieve for my out-of-sample tests and/or is untampered.

This is all information I know, and can use, when I form my estimated probabilities about the outcome of future flips.

Could the future mean underlying return of factor premia be different in the future than in the past? Sure. Obviously. And with some data about the direction and magnitude of that difference, or a hypothesis about the cause and nature of that difference, we can definitely update our expectations. Or at the very least update the confidence interval around our expectations.

But I fail to see how helpful it is to throw our hands up in helplessness because we can't be "sure" that the future will look exactly like the past. Or act as if we live in a binary world, where estimates are either 100% accurate or 100% useless. I know that you don't think that's the world we live in, but sometimes it feels like others here do.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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nedsaid
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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 11:04 pm

abc132 wrote:
Thu Jul 11, 2019 9:08 pm
nedsaid wrote:
Thu Jul 11, 2019 3:22 pm
abc132 wrote:
Thu Jul 11, 2019 1:08 am
nedsaid wrote:
Thu Jul 11, 2019 12:02 am
Abc132, what I am trying to tell you is you are asking for the impossible. One reason being is that there is unpredictability to human emotion, people can do really weird and irrational stuff in the short term and there is just no way to predict that. As I said above, economic or business return is relatively easier to predict. Speculative return, you might as well flip a coin. All you know with speculative return is that there is a reversion to the mean that will occur sooner or later. Trouble is no one knows how soon or how late.

You are desiring precision that just isn't there. Shoot, earnings themselves are not a precise number. Accounting involves judgment and frankly educated guesses, particularly when preparing accruals. My example of John Bogle's projections for the 2000's were pretty good but he missed it. He projected 2% annual returns for the US Stock Market and as I recall, returns were -1% a year. He got it mostly right and that is as good as you are going to get.

Investing isn't about certainties, investing is about probabilities. About the best you can do is to tilt the odds in your favor best you can but there are just no guarantees. Some folks just can't get past this. All we can do is study the past and from that make reasonable projections about the future. An educated guess is a lot better than a purely uninformed guess.

So sorry sports fans out there if this disillusions you. Investing is just not a math problem or an engineering problem to be solved. One big reason is human nature and human behavior. Sorry to break this news to you but you may as well find this out now.
I'm stating that probabilities can be quantified, and that measures of uncertainty and confidence intervals are routinely used to put numerical values on expectations for decision making around uncertainty. Looking at the range of human behavior does in fact provide meaningful information about past uncertainty, and how far human behavior can deviate things from expected or fair values. We have new tools through social media, Alexa, etc, that give unprecedented information about human behavior. Computer decisions are being made using easily quantifiable decisions, and as I understand it represent nearly as big of a chunk of trades as active human decisions.

Tilting implies the ability to respond to the market in a way better than just taking what the market gives as a whole.

Saying probabilities are in one's favor without the ability to quantify how much they are in one's favor shows a weak understanding of what strategies are actually good, or which of the good strategies are near the top. That leaves no way to choose between "odds are good" strategies.

Many strategies devolve into simple data mining of the past. They are touted as good because of past performance. Most of these strategies would be severely diminished if they had to state the confidence interval with which they can deliver future performance that looks like the past, or if they were held accountable over their chosen time period for delivering on specific metrics they advocate. It seems likely to me that the reasons they don't do so is not because the mathematics are impossible, but rather because money is being made from convincing people that their idea is good. The actual ability of an expert to provide useful and actionable information seems to be severely limited.
Then why aren't the quantitative strategies producing superior returns?
That seems a bit unrelated to my posts, as I never said that quant should beat the market. My theory is that the recent market has been trading on tweets rather than fundamentals, and when the things that cause trades to change are different, the models do poorly. The point is that quantitative trading has changed how the market performed, along with some other things like tweet storms and going after individual companies. I have no doubt the quants are re-tuning their models to take advantage of tweets. Advanced notice of news shows should be enough to capture a few percent per year, as they predict the tweets. I'm not in the business of trying to beat the market, so I'm still unclear why this is relevant to me or to the discussion.

What's your theory? Why is it relevant?
We know exactly what the risks, returns, and all of that were in the past but we just can't predict the future with precision. We can project what we learned from the past and provide some estimates but again you are just asking for the impossible. A sudden unexpected geopolitical event could literally blow up all this analysis if let's say the Norks nuked Seattle or Putin's tanks rolled into Vilnius, Lithuania. Just don't know how even the best thinkers could account for this. You are just totally unrealistic and I am surprised that you don't realize this.

I go to bed every night and expect to wake up the next morning, so far, so good, but I don't know that 100% for sure. What can be done is calculate my life expectancy but that would be very accurate over a population as a whole but for an individual there are any number of outcomes. For example, my father has had a number of cardiac events, not a candidate for a very long life but he is still motoring on at age 89. I will just say the odds of him achieving this were pretty slim given his medical history. But he is still here. It is like the old joke about the Sicilian actuary. An actuary can tell you how many people will die next year, a Sicilian actuary will tell you WHO will die next year. What you are asking is the equivalent of knowing not only how many people will die next year but also who will die next year.

You made the point that folks ought to be able to make fairly accurate predictions. If that were so, the folks who run the quant funds ought to be beating the market based upon those accurate predictions. But their predictions didn't pan out and their funds did not outperform. And you said the reason why, things changed in the markets so the old models didn't work so well. The models need to be tweaked.

My belief is that the factors are based upon human nature and human behavior. The cycles of greed and fear. It is a combination of investor preferences and behavioral errors. Each new generation has to relearn the lessons the previous generation knew, there is always a new crop of suckers coming up. Others say that factors are a risk story. Probably factors are a combination of risk and behavior. My further assertion is that we can benefit from factors without a great deal of precision. I don't need this calculated out the the 25th decimal point.

We know, or perhaps think we know, some things based upon the academic research. We can reasonably predict that tilted portfolios will outperform market cap weighted portfolios given enough time. The thing is, the markets could take away the factors. The evidence suggests that the factor premiums have narrowed but not gone away. If memory serves me right, the premiums have narrowed by about a third. The research also suggests that we are not experiencing factor crowding except for Low Volatility. I would say that factor tilting is a reasonable bet with very good odds of success but we don't know that 100% for sure. As I said before, it is a preponderance of evidence and not proof beyond a reasonable doubt. We don't even know that the Equity Risk Premium will persist but market history and our knowledge of human nature and human behavior suggests that it will. If there was no uncertainty of outcomes, there would be no premium!

I think you are trying to be on all sides of all possible arguments thus trying to make yourself the smartest man in the room. But I am beginning to wonder if you understand the investing process at all. This is not engineering.
A fool and his money are good for business.

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JoMoney
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Re: Why factor investing isn't working

Post by JoMoney » Thu Jul 11, 2019 11:06 pm

Fryxell wrote:
Thu Jul 11, 2019 10:50 pm
... assuming that efficient markets have not arbitraged away the equity premium...
D'oh :oops:
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nedsaid
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Re: Why factor investing isn't working

Post by nedsaid » Thu Jul 11, 2019 11:10 pm

vineviz wrote:
Thu Jul 11, 2019 10:59 pm
fennewaldaj wrote:
Thu Jul 11, 2019 10:15 pm
I think you are being a bit too dismissive of HomerJs larger point. We certainly know what the past data says and what it predicts if the future closely resembles the past. And we know what could happen is described by ranges of outcomes. What we don't know is how likely the future is to resemble the past.
It's possible I'm missing his meaning.

What I THINK he was claiming is that anything short of absolute certainty about the future is equivalent to a completely uninformed guess. He said that's NOT what he meant, but I've not found an alternate interpretation.

That said, it's true that "what we don't know is how likely the future is to resemble the past" if by "know" you mean "be completely sure".

But when I said earlier that the best we can do is to make decisions now based on all available information, I hope I was clear that "all available information" includes information about how certain we are that our other information is reliable.

Going back to my fair coin example: if I've tested my coin 2500 times and got heads 1257 times then I think I can very reasonably conclude that the odds of heads on the next flip are pretty close to 50%. If I've tested my coin 4 times and got heads twice, I should be (and will be) much less confident in my estimated probability. And that's information I know.

If, after I test my coin, lock it in my desk drawer then I can be reasonably confident that it hasn't been tampered with during the time between my in-sample test and my future out-of-sample test. If I put the coin in a jar with 20 other similar coins on top of my desk and come back to retrieve it after a two-week vacation, I can be (and will be) much less confident that my in-sample coin is the same one I retrieve for my out-of-sample tests and/or is untampered.

This is all information I know, and can use, when I form my estimated probabilities about the outcome of future flips.

Could the future mean underlying return of factor premia be different in the future than in the past? Sure. Obviously. And with some data about the direction and magnitude of that difference, or a hypothesis about the cause and nature of that difference, we can definitely update our expectations. Or at the very least update the confidence interval around our expectations.

But I fail to see how helpful it is to throw our hands up in helplessness because we can't be "sure" that the future will look exactly like the past. Or act as if we live in a binary world, where estimates are either 100% accurate or 100% useless. I know that you don't think that's the world we live in, but sometimes it feels like others here do.
+1. You eloquently said what I tried but failed to say. A well informed and educated guess is a whole lot better than an uneducated, random guess.
A fool and his money are good for business.

abc132
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Re: Why factor investing isn't working

Post by abc132 » Thu Jul 11, 2019 11:19 pm

nedsaid wrote:
Thu Jul 11, 2019 11:04 pm


We know exactly what the risks, returns, and all of that were in the past but we just can't predict the future with precision. We can project what we learned from the past and provide some estimates but again you are just asking for the impossible. A sudden unexpected geopolitical event could literally blow up all this analysis if let's say the Norks nuked Seattle or Putin's tanks rolled into Vilnius, Lithuania. Just don't know how even the best thinkers could account for this. You are just totally unrealistic and I am surprised that you don't realize this.

I go to bed every night and expect to wake up the next morning, so far, so good, but I don't know that 100% for sure. What can be done is calculate my life expectancy but that would be very accurate over a population as a whole but for an individual there are any number of outcomes. For example, my father has had a number of cardiac events, not a candidate for a very long life but he is still motoring on at age 89. I will just say the odds of him achieving this were pretty slim given his medical history. But he is still here. It is like the old joke about the Sicilian actuary. An actuary can tell you how many people will die next year, a Sicilian actuary will tell you WHO will die next year. What you are asking is the equivalent of knowing not only how many people will die next year but also who will die next year.

You made the point that folks ought to be able to make fairly accurate predictions. If that were so, the folks who run the quant funds ought to be beating the market based upon those accurate predictions. But their predictions didn't pan out and their funds did not outperform. And you said the reason why, things changed in the markets so the old models didn't work so well. The models need to be tweaked.

My belief is that the factors are based upon human nature and human behavior. The cycles of greed and fear. It is a combination of investor preferences and behavioral errors. Each new generation has to relearn the lessons the previous generation knew, there is always a new crop of suckers coming up. Others say that factors are a risk story. Probably factors are a combination of risk and behavior. My further assertion is that we can benefit from factors without a great deal of precision. I don't need this calculated out the the 25th decimal point.

We know, or perhaps think we know, some things based upon the academic research. We can reasonably predict that tilted portfolios will outperform market cap weighted portfolios given enough time. The thing is, the markets could take away the factors. The evidence suggests that the factor premiums have narrowed but not gone away. If memory serves me right, the premiums have narrowed by about a third. The research also suggests that we are not experiencing factor crowding except for Low Volatility. I would say that factor tilting is a reasonable bet with very good odds of success but we don't know that 100% for sure. As I said before, it is a preponderance of evidence and not proof beyond a reasonable doubt. We don't even know that the Equity Risk Premium will persist but market history and our knowledge of human nature and human behavior suggests that it will. If there was no uncertainty of outcomes, there would be no premium!

I think you are trying to be on all sides of all possible arguments thus trying to make yourself the smartest man in the room. But I am beginning to wonder if you understand the investing process at all. This is not engineering.
Nedsaid, I feel you are completely mischaracterizing my posts, and it is not appreciated.

Barring some major single country event (war), we expect stocks to outperform bonds over a 30 year period and we can provide a value to that over performance. An expert can state how they expect bonds and stock to perform into the future, and they do so regularly, even if that value takes 10-20 years to materialize. Even if some experts get it wrong. Even if it takes time to materialize. I invest in stocks because of that expected over performance as compared to bonds. The time period in which it takes to materialize matters.

Experts can certainly make similar forward predictions about factor investing, and answers given over long enough time periods should become useful if their strategy is good. One key metric I asked for was how long we should expect to wait. I didn't ask for an exact number or a perfect prediction. I simply asked for the expected value. With no answer, I did some googling and came up with 15 years. But I am a total novice with regards to factor investing, and that 15 year answer has little to back it up. Nobody should use it.

I will ask you to stop stating requests for numerical values as requests for exact values. Please stop to listen. An expert can quickly give predictions without rigorous mathematical tools, and answers such as expected over performance within the next 15-30 years can include uncertainty and ranges. Error bands can be included in an answer.

Asking for numerical values does not mean they have to have any specific amount of preciseness.

I have very little factor investing knowledge. That should be clear by my questions. I am in no way trying to be the smartest man in the room. Very very far from it. Please take some time to listen before making such allegations. I am on no side of any argument, as I am simply seeking actionable information. I have formed no conclusions. I am not making any argument with respect to factor investing being good or bad.

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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 11:28 pm

abc132 wrote:
Thu Jul 11, 2019 10:41 pm
I got some references to past historical data, which is largely meaningless to my current investment decisions.
There's only one kind of data, and that is historical data.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by abc132 » Thu Jul 11, 2019 11:38 pm

vineviz wrote:
Thu Jul 11, 2019 11:28 pm
abc132 wrote:
Thu Jul 11, 2019 10:41 pm
I got some references to past historical data, which is largely meaningless to my current investment decisions.
There's only one kind of data, and that is historical data.
That is 100% false. Data is a set of values. We use historical data to help formulate future predictions. A future prediction is data. A prediction from an expert (hopefully) includes far more than just equating the past to the future. That is why I really respect a numerical prediction from an expert. They are putting their reputation on the line and showing confidence in their answer by assigning numerical values. They get to choose the level of exactness of their answer, which is also revealing. More importantly, their thought process becomes clear when they state/reference how they came up with that number value and tolerance. 10 year stock/bond predictions from experts are certainly different than their historical values. The "why" is very important.

The only data that is actionable is future expectations, which is partially derived from what we know from the past, but also includes things like uncertainty and how the present looks different than the past, and how the future is likely to look different than the present. An expert can make these decisions far far better than a novice because of their better overall grasp of the past, present, and future. The expert has more tools at their disposal, and knows how to use them appropriately. An expert should be able to handle multiple competing factors/decisions, where a novice is likely limited to one.
Last edited by abc132 on Thu Jul 11, 2019 11:58 pm, edited 1 time in total.

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Re: Why factor investing isn't working

Post by HomerJ » Thu Jul 11, 2019 11:45 pm

vineviz wrote:
Thu Jul 11, 2019 10:59 pm
fennewaldaj wrote:
Thu Jul 11, 2019 10:15 pm
I think you are being a bit too dismissive of HomerJs larger point. We certainly know what the past data says and what it predicts if the future closely resembles the past. And we know what could happen is described by ranges of outcomes. What we don't know is how likely the future is to resemble the past.
It's possible I'm missing his meaning.

What I THINK he was claiming is that anything short of absolute certainty about the future is equivalent to a completely uninformed guess. He said that's NOT what he meant, but I've not found an alternate interpretation.

That said, it's true that "what we don't know is how likely the future is to resemble the past" if by "know" you mean "be completely sure".

But when I said earlier that the best we can do is to make decisions now based on all available information, I hope I was clear that "all available information" includes information about how certain we are that our other information is reliable.

Going back to my fair coin example: if I've tested my coin 2500 times and got heads 1257 times then I think I can very reasonably conclude that the odds of heads on the next flip are pretty close to 50%. If I've tested my coin 4 times and got heads twice, I should be (and will be) much less confident in my estimated probability. And that's information I know.

If, after I test my coin, lock it in my desk drawer then I can be reasonably confident that it hasn't been tampered with during the time between my in-sample test and my future out-of-sample test. If I put the coin in a jar with 20 other similar coins on top of my desk and come back to retrieve it after a two-week vacation, I can be (and will be) much less confident that my in-sample coin is the same one I retrieve for my out-of-sample tests and/or is untampered.

This is all information I know, and can use, when I form my estimated probabilities about the outcome of future flips.

Could the future mean underlying return of factor premia be different in the future than in the past? Sure. Obviously. And with some data about the direction and magnitude of that difference, or a hypothesis about the cause and nature of that difference, we can definitely update our expectations. Or at the very least update the confidence interval around our expectations.

But I fail to see how helpful it is to throw our hands up in helplessness because we can't be "sure" that the future will look exactly like the past. Or act as if we live in a binary world, where estimates are either 100% accurate or 100% useless. I know that you don't think that's the world we live in, but sometimes it feels like others here do.
Your examples are good... Nothing is 100% accurate, I agree... Even the coin that was flipped 2500 times, but that one is pretty solid, so I can see investing based on what you think the odds are for that coin...

But I do say one would be absolutely foolish to bet a million dollars, money that took you decades to save, on the coin that you only flipped 4 times, or on the coin that sat in the jar, so you're not even sure it's the same coin.

That's very close to my point.

We have very limited data points, and instead of a coin with two possible outcomes, we have a complex system with dozens or even hundreds of world-wide variables, and the system changes with new laws and regulations, yet you treat all the past data points exactly the same.

We ARE talking about flipping the coin 4 times, AND it got put in a jar, and you might have a whole new coin now. 100 years of this very complex system, with changes to laws and regulations, and even changes in technology and civilization is very limited data.

It IS nearly equivalent to flipping the coin 4 times.

Like you said,
I should be (and will be) much less confident in my estimated probability.
I 100% agree with you. You absolutely should be much less confident. But instead you post with confidence about odds and the standard deviations, etc. going forward.

Do you really think 100 years of data on an extremely complex system with changing governments, changing laws, multiple world wars disrupting everything, new technologies, etc. etc. etc. is enough data to confidently state the odds of "this investment" beating "that investment" by 2.3% over the next 5 years?
Last edited by HomerJ on Thu Jul 11, 2019 11:52 pm, edited 1 time in total.
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Re: Why factor investing isn't working

Post by Fryxell » Thu Jul 11, 2019 11:51 pm

JoMoney wrote:
Thu Jul 11, 2019 11:06 pm

D'oh :oops:
You don’t even have to go back that far. From July 1999 to June 2019, long-term treasuries outperformed the US stock market, and with less volatility. That’s 20 years of equity under-performance. It’s even worse in risk-adjusted terms. The Sharpe ratio for equities was 0.37 compared to 0.52 for long-term treasuries. And the max drawdown for long-term treasuries was -17% compared with -51% for equities.

Source: https://www.portfoliovisualizer.com/bac ... 0&total3=0

Think about it, as of June 2019, equities have underperformed bonds for much longer than small value stocks have underperformed the total stock market.

Could it be that the equity premium has been arbitraged away? Why wouldn’t it, if we have efficient markets? A better question is: Why is equity investing not working?
Last edited by Fryxell on Thu Jul 11, 2019 11:57 pm, edited 2 times in total.

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Re: Why factor investing isn't working

Post by vineviz » Thu Jul 11, 2019 11:52 pm

abc132 wrote:
Thu Jul 11, 2019 11:19 pm
One key metric I asked for was how long we should expect to wait. I didn't ask for an exact number or a perfect prediction. I simply asked for the expected value.
I'm still not clear on what you mean by "how long we should expect to wait"?

Wait for what, exactly?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by HomerJ » Thu Jul 11, 2019 11:59 pm

nedsaid wrote:
Thu Jul 11, 2019 11:10 pm
vineviz wrote:
Thu Jul 11, 2019 10:59 pm
fennewaldaj wrote:
Thu Jul 11, 2019 10:15 pm
I think you are being a bit too dismissive of HomerJs larger point. We certainly know what the past data says and what it predicts if the future closely resembles the past. And we know what could happen is described by ranges of outcomes. What we don't know is how likely the future is to resemble the past.
It's possible I'm missing his meaning.

What I THINK he was claiming is that anything short of absolute certainty about the future is equivalent to a completely uninformed guess. He said that's NOT what he meant, but I've not found an alternate interpretation.

That said, it's true that "what we don't know is how likely the future is to resemble the past" if by "know" you mean "be completely sure".

But when I said earlier that the best we can do is to make decisions now based on all available information, I hope I was clear that "all available information" includes information about how certain we are that our other information is reliable.

Going back to my fair coin example: if I've tested my coin 2500 times and got heads 1257 times then I think I can very reasonably conclude that the odds of heads on the next flip are pretty close to 50%. If I've tested my coin 4 times and got heads twice, I should be (and will be) much less confident in my estimated probability. And that's information I know.

If, after I test my coin, lock it in my desk drawer then I can be reasonably confident that it hasn't been tampered with during the time between my in-sample test and my future out-of-sample test. If I put the coin in a jar with 20 other similar coins on top of my desk and come back to retrieve it after a two-week vacation, I can be (and will be) much less confident that my in-sample coin is the same one I retrieve for my out-of-sample tests and/or is untampered.

This is all information I know, and can use, when I form my estimated probabilities about the outcome of future flips.

Could the future mean underlying return of factor premia be different in the future than in the past? Sure. Obviously. And with some data about the direction and magnitude of that difference, or a hypothesis about the cause and nature of that difference, we can definitely update our expectations. Or at the very least update the confidence interval around our expectations.

But I fail to see how helpful it is to throw our hands up in helplessness because we can't be "sure" that the future will look exactly like the past. Or act as if we live in a binary world, where estimates are either 100% accurate or 100% useless. I know that you don't think that's the world we live in, but sometimes it feels like others here do.
+1. You eloquently said what I tried but failed to say. A well informed and educated guess is a whole lot better than an uneducated, random guess.
I guess my point is that the guesses are NOT well-informed or educated. They are still random shots in the dark.

There is not enough data points to draw well-informed or educated guesses, let alone the PRECISION estimates that some people are posting here.

They are 100% correct about the past. The math is correct. "This investment" DID beat "that investment" 64.567% of the time over 5-year periods.
But there is not enough data to tell if the future will repeat the same way.

The EXACT same way. The only way we're going to hit 64.567% again is if the next 100 years are an exact repeat of the past 100 years. And that's not going to happen.

I can roll a pair of loaded 20-sided dice 100 times, and tell you exactly how they came up in the past. That doesn't make me well-informed or educated. I can't tell you with confidence yet the odds of rolling certain numbers in the future.

There is not enough data points. (And again, I got NEW dice halfway through the 100 rolls, and yet I'm still using the first 50 rolls in my predictions).
Last edited by HomerJ on Fri Jul 12, 2019 12:06 am, edited 1 time in total.
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Re: Why factor investing isn't working

Post by abc132 » Fri Jul 12, 2019 12:02 am

vineviz wrote:
Thu Jul 11, 2019 11:52 pm
abc132 wrote:
Thu Jul 11, 2019 11:19 pm
One key metric I asked for was how long we should expect to wait. I didn't ask for an exact number or a perfect prediction. I simply asked for the expected value.
I'm still not clear on what you mean by "how long we should expect to wait"?

Wait for what, exactly?
Expected out performance as compared to total stock market. I showed an example of what I was looking for with stocks vs bonds, and I showed an example with small value vs total market. The expert gets to choose how they answer this, and what nuances they add to their answer. I would hope for a more nuanced answer than my simple examples. I would be overjoyed if the answer included additional metrics beyond performance. All of these are revealing and useful information for one interested in learning.
Last edited by abc132 on Fri Jul 12, 2019 12:02 am, edited 1 time in total.

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Re: Why factor investing isn't working

Post by vineviz » Fri Jul 12, 2019 12:02 am

abc132 wrote:
Thu Jul 11, 2019 11:38 pm
vineviz wrote:
Thu Jul 11, 2019 11:28 pm
abc132 wrote:
Thu Jul 11, 2019 10:41 pm
I got some references to past historical data, which is largely meaningless to my current investment decisions.
There's only one kind of data, and that is historical data.
That is 100% false.
You have a very different definition of "data" than I do. I use it in the context of scientific inquiry, to mean something that has been measured, not in the popular sense of being synonymous with "information" or "knowledge".

"Data" is the plural of "datum", which literally means "something given": it's a past participle of the Latin word "dare" (to give).

Maybe my years of studying Latin were wasted after all.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by abc132 » Fri Jul 12, 2019 12:04 am

vineviz wrote:
Fri Jul 12, 2019 12:02 am
abc132 wrote:
Thu Jul 11, 2019 11:38 pm
vineviz wrote:
Thu Jul 11, 2019 11:28 pm
abc132 wrote:
Thu Jul 11, 2019 10:41 pm
I got some references to past historical data, which is largely meaningless to my current investment decisions.
There's only one kind of data, and that is historical data.
That is 100% false.
You have a very different definition of "data" than I do. I use it in the context of scientific inquiry, to mean something that has been measured, not in the popular sense of being synonymous with "information" or "knowledge".

"Data" is the plural of "datum", which literally means "something given": it's a past participle of the Latin word "dare" (to give).

Maybe my years of studying Latin were wasted after all.
An expert making a prediction is something given. The nuances of the answer are also important, as they represent thought. Someones thought has happened prior to their post. There is certainly data there if you are willing to listen to it. I did mention the "why" was very important.
Last edited by abc132 on Fri Jul 12, 2019 12:10 am, edited 3 times in total.

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Re: Why factor investing isn't working

Post by JoMoney » Fri Jul 12, 2019 12:04 am

Fryxell wrote:
Thu Jul 11, 2019 11:51 pm
...
Could it be that the equity premium has been arbitraged away? Why wouldn’t it, if we have efficient markets?
Perhaps market's aren't as efficient at pricing "risk premiums" as some would hypothesize, leading to the "equity premium puzzle" which has puzzled them for some time. Maybe investors have preferences that differ from theory, or maybe it never existed to begin with and was an anomaly biased by the U.S. market data.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Why factor investing isn't working

Post by HomerJ » Fri Jul 12, 2019 12:09 am

vineviz wrote:
Fri Jul 12, 2019 12:02 am
abc132 wrote:
Thu Jul 11, 2019 11:38 pm
vineviz wrote:
Thu Jul 11, 2019 11:28 pm
abc132 wrote:
Thu Jul 11, 2019 10:41 pm
I got some references to past historical data, which is largely meaningless to my current investment decisions.
There's only one kind of data, and that is historical data.
That is 100% false.
You have a very different definition of "data" than I do. I use it in the context of scientific inquiry, to mean something that has been measured, not in the popular sense of being synonymous with "information" or "knowledge".

"Data" is the plural of "datum", which literally means "something given": it's a past participle of the Latin word "dare" (to give).

Maybe my years of studying Latin were wasted after all.
It's fine that you are using historical data. Just stop using future tense verbs when referring to historical data. That's all I ask. You must have learned about verb tenses when studying Latin.

Say "This happened 54% of the time in the past", NOT "This is 54% likely to happen".

And then we're all good.
Last edited by HomerJ on Fri Jul 12, 2019 12:12 am, edited 1 time in total.
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Re: Why factor investing isn't working

Post by vineviz » Fri Jul 12, 2019 12:10 am

abc132 wrote:
Fri Jul 12, 2019 12:02 am
vineviz wrote:
Thu Jul 11, 2019 11:52 pm
abc132 wrote:
Thu Jul 11, 2019 11:19 pm
One key metric I asked for was how long we should expect to wait. I didn't ask for an exact number or a perfect prediction. I simply asked for the expected value.
I'm still not clear on what you mean by "how long we should expect to wait"?

Wait for what, exactly?
Expected out performance as compared to total stock market. I showed an example of what I was looking for with stocks vs bonds, and I showed an example with small value vs total market. The expert gets to choose how they answer this, and what nuances they add to their answer. I would hope for a more nuanced answer than my simple examples. All of these are revealing and useful information for one interested in learning.
This still isn't clear to me, because it feels like these answers have been provided already.

You should expect a factor-positive portfolio to outperform the market portfolio tomorrow, with a probability just over 50%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next month with a probability just over 51%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next year with a probability of 52%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next five years with a probability of 54%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next five years with a probability of 54%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next 15 years with a probability of 65%.

And so on.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why factor investing isn't working

Post by HomerJ » Fri Jul 12, 2019 12:13 am

vineviz wrote:
Fri Jul 12, 2019 12:10 am
abc132 wrote:
Fri Jul 12, 2019 12:02 am
vineviz wrote:
Thu Jul 11, 2019 11:52 pm
abc132 wrote:
Thu Jul 11, 2019 11:19 pm
One key metric I asked for was how long we should expect to wait. I didn't ask for an exact number or a perfect prediction. I simply asked for the expected value.
I'm still not clear on what you mean by "how long we should expect to wait"?

Wait for what, exactly?
Expected out performance as compared to total stock market. I showed an example of what I was looking for with stocks vs bonds, and I showed an example with small value vs total market. The expert gets to choose how they answer this, and what nuances they add to their answer. I would hope for a more nuanced answer than my simple examples. All of these are revealing and useful information for one interested in learning.
This still isn't clear to me, because it feels like these answers have been provided already.

You should expect a factor-positive portfolio to outperform the market portfolio tomorrow, with a probability just over 50%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next month with a probability just over 51%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next year with a probability of 52%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next five years with a probability of 54%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next five years with a probability of 54%.

You should expect a factor-positive portfolio to outperform the market portfolio over the next 15 years with a probability of 65%.

And so on.
No, you can say a factor-positive portfolio out-performed the market portfolio over 15 year periods 65% of the time in the past.

That's it. That's all you can say with confidence. Past tense.
Last edited by HomerJ on Fri Jul 12, 2019 12:14 am, edited 1 time in total.
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