Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

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typical.investor
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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by typical.investor » Mon Sep 02, 2019 5:34 pm

Elysium wrote:
Mon Sep 02, 2019 5:19 pm
This is what the market has determined to be the correct representation, if you are saying the weighting is wrong, then you are going against the collective information available to millions of consumers who participate in making the economy.
Fine. You also said market weight is determined by economic footprint. Some don’t believe that multiple expansion (ie getting expensive for reasons not based on current returns) is a true measure of the footprint.

Elysium
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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by Elysium » Mon Sep 02, 2019 6:09 pm

typical.investor wrote:
Mon Sep 02, 2019 5:34 pm
Elysium wrote:
Mon Sep 02, 2019 5:19 pm
This is what the market has determined to be the correct representation, if you are saying the weighting is wrong, then you are going against the collective information available to millions of consumers who participate in making the economy.
Fine. You also said market weight is determined by economic footprint. Some don’t believe that multiple expansion (ie getting expensive for reasons not based on current returns) is a true measure of the footprint.
So you're saying some people believe there is mispricing. What are you going to do about it? If there is mispricing then the security value has been going up by a lot, and you are possibly selling them by re-balancing into bonds, perhaps you could reduce the equity exposure more than usual? say 10% more than you would do. Will this address the problem, or are you still going to be unsatisfied with it, and the only option is to include other sub-components in equal weight. What if you were wrong about the mispricing, and what if it takes several more years before the earnings catch up to meet the multiples. Amazon had high multiples for many many years, and barely any earnings to justify those, it took about 20 years for it to justify the price. Was the market wrong about Amazon, or is it wrong about it now. We would never know.

typical.investor
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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by typical.investor » Mon Sep 02, 2019 11:11 pm

Elysium wrote:
Mon Sep 02, 2019 6:09 pm
typical.investor wrote:
Mon Sep 02, 2019 5:34 pm
Elysium wrote:
Mon Sep 02, 2019 5:19 pm
This is what the market has determined to be the correct representation, if you are saying the weighting is wrong, then you are going against the collective information available to millions of consumers who participate in making the economy.
Fine. You also said market weight is determined by economic footprint. Some don’t believe that multiple expansion (ie getting expensive for reasons not based on current returns) is a true measure of the footprint.
So you're saying some people believe there is mispricing. What are you going to do about it? If there is mispricing then the security value has been going up by a lot, and you are possibly selling them by re-balancing into bonds, perhaps you could reduce the equity exposure more than usual? say 10% more than you would do. Will this address the problem, or are you still going to be unsatisfied with it, and the only option is to include other sub-components in equal weight. What if you were wrong about the mispricing, and what if it takes several more years before the earnings catch up to meet the multiples. Amazon had high multiples for many many years, and barely any earnings to justify those, it took about 20 years for it to justify the price. Was the market wrong about Amazon, or is it wrong about it now. We would never know.
I think most who think that equities have a tendency to get overpriced simply select some kind of value index and leave it at that. Or maybe they diversify internationally. And yeah probably rebalance back to their allocation if equities exceed a certain amount.

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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by Forester » Tue Sep 03, 2019 4:13 am

Elysium wrote:
Mon Sep 02, 2019 6:09 pm
typical.investor wrote:
Mon Sep 02, 2019 5:34 pm
Elysium wrote:
Mon Sep 02, 2019 5:19 pm
This is what the market has determined to be the correct representation, if you are saying the weighting is wrong, then you are going against the collective information available to millions of consumers who participate in making the economy.
Fine. You also said market weight is determined by economic footprint. Some don’t believe that multiple expansion (ie getting expensive for reasons not based on current returns) is a true measure of the footprint.
So you're saying some people believe there is mispricing. What are you going to do about it?
Trend following made a profit out of US CAPE 44 & two 50% drawdowns inside a decade.

If "risk" can be the risk of being different to the crowd then speculative manias are built in to human beings - Bitcoin as recently as 2017. In relative terms, all the buy-and-holders in 1999/2000 didn't lose, they broke even. If Bogleheads forum existed back then, the respectable opinion would be to stay the course and shovel money in to tech stocks at eye watering prices. After all, the total market contains all the value stocks and growth stocks weighted according to the wisdom of the crowd.

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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by columbia » Tue Sep 03, 2019 6:36 am

I started investing in 1996 and the US market has returned 8.82%/year since then. I can live with any “mispricing” of mega caps. :P

Elysium
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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by Elysium » Tue Sep 03, 2019 8:17 am

typical.investor wrote:
Mon Sep 02, 2019 11:11 pm
Elysium wrote:
Mon Sep 02, 2019 6:09 pm
typical.investor wrote:
Mon Sep 02, 2019 5:34 pm
Elysium wrote:
Mon Sep 02, 2019 5:19 pm
This is what the market has determined to be the correct representation, if you are saying the weighting is wrong, then you are going against the collective information available to millions of consumers who participate in making the economy.
Fine. You also said market weight is determined by economic footprint. Some don’t believe that multiple expansion (ie getting expensive for reasons not based on current returns) is a true measure of the footprint.
So you're saying some people believe there is mispricing. What are you going to do about it? If there is mispricing then the security value has been going up by a lot, and you are possibly selling them by re-balancing into bonds, perhaps you could reduce the equity exposure more than usual? say 10% more than you would do. Will this address the problem, or are you still going to be unsatisfied with it, and the only option is to include other sub-components in equal weight. What if you were wrong about the mispricing, and what if it takes several more years before the earnings catch up to meet the multiples. Amazon had high multiples for many many years, and barely any earnings to justify those, it took about 20 years for it to justify the price. Was the market wrong about Amazon, or is it wrong about it now. We would never know.
I think most who think that equities have a tendency to get overpriced simply select some kind of value index and leave it at that. Or maybe they diversify internationally. And yeah probably rebalance back to their allocation if equities exceed a certain amount.
If someone believed the market has a tendency to get mispriced, then they would actively seek securities they believe are fairly priced, that would be the most logical thing to do, and this is the domain of active value investors. This is not one of the top reasons I have seen why passive value investors seek to slice and dice into sub-components. In fact from what I have seen, most passive value investors do believe the market is very efficient in pricing, and that it is hard to detect market bubbles ahead of time. They believe the value premium is a risk factor, not due to mispricing.

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JoMoney
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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by JoMoney » Tue Sep 03, 2019 8:26 am

columbia wrote:
Tue Sep 03, 2019 6:36 am
I started investing in 1996 and the US market has returned 8.82%/year since then. I can live with any “mispricing” of mega caps. :P
It's happened in the past, like during the dot-com bubble, but as this this thread evidences we're a long way away from the sentiment towards large-caps being bubbly.... but I think it will happen again. Probably around the time all the portfolio alchemists realize that a carefully selected portfolio of big-name large-cap stalwarts has low correlation with the broad market, lower standard deviation, and higher returns than the broader market (over some selected time period)... then we'll start heading back to the "Nifty Fifty" era.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

Elysium
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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by Elysium » Tue Sep 03, 2019 8:29 am

Forester wrote:
Tue Sep 03, 2019 4:13 am
In relative terms, all the buy-and-holders in 1999/2000 didn't lose, they broke even. If Bogleheads forum existed back then, the respectable opinion would be to stay the course and shovel money in to tech stocks at eye watering prices. After all, the total market contains all the value stocks and growth stocks weighted according to the wisdom of the crowd.
Bogleheads did exist back in 1999/2000, they were called the Vanguard Diehards with the caption "Bogleheads unite" on the Morningstar site. You could still access the archives on that forum and see what the advice was back then. It was almost the same principles as now. There was no rush into buying tech stocks at exorbitant prices, instead develop an AA plan, save & invest regularly, buy broad market indexes at low cost, keep taxes and expenses low, do not try to time the market, etc were the ideas followed. If someone followed a proper plan and had the correct equity / bonds ratio using broad market indexes, then they would be re-balancing out of equities into bonds as they went up a lot during the second half of 90's. There were slice and dice proponents back then too discussing the merits of small value and REITS as diversifiers, they did look good for a while I must admit, but then we came back a full circle. While short periods like 7-8 years may make one strategy look better than others, 20-30 years is a long cycle to even out trends, and since most of us are investing for lot longer than that, these ups & down will look like small bumps.

typical.investor
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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by typical.investor » Tue Sep 03, 2019 8:36 am

Elysium wrote:
Tue Sep 03, 2019 8:17 am
typical.investor wrote:
Mon Sep 02, 2019 11:11 pm
Elysium wrote:
Mon Sep 02, 2019 6:09 pm
typical.investor wrote:
Mon Sep 02, 2019 5:34 pm
Elysium wrote:
Mon Sep 02, 2019 5:19 pm
This is what the market has determined to be the correct representation, if you are saying the weighting is wrong, then you are going against the collective information available to millions of consumers who participate in making the economy.
Fine. You also said market weight is determined by economic footprint. Some don’t believe that multiple expansion (ie getting expensive for reasons not based on current returns) is a true measure of the footprint.
So you're saying some people believe there is mispricing. What are you going to do about it? If there is mispricing then the security value has been going up by a lot, and you are possibly selling them by re-balancing into bonds, perhaps you could reduce the equity exposure more than usual? say 10% more than you would do. Will this address the problem, or are you still going to be unsatisfied with it, and the only option is to include other sub-components in equal weight. What if you were wrong about the mispricing, and what if it takes several more years before the earnings catch up to meet the multiples. Amazon had high multiples for many many years, and barely any earnings to justify those, it took about 20 years for it to justify the price. Was the market wrong about Amazon, or is it wrong about it now. We would never know.
I think most who think that equities have a tendency to get overpriced simply select some kind of value index and leave it at that. Or maybe they diversify internationally. And yeah probably rebalance back to their allocation if equities exceed a certain amount.
If someone believed the market has a tendency to get mispriced, then they would actively seek securities they believe are fairly priced, that would be the most logical thing to do, and this is the domain of active value investors. This is not one of the top reasons I have seen why passive value investors seek to slice and dice into sub-components. In fact from what I have seen, most passive value investors do believe the market is very efficient in pricing, and that it is hard to detect market bubbles ahead of time. They believe the value premium is a risk factor, not due to mispricing.
Risk or mispricing doesn't seem like much of a distinction to me. #1 The market is constantly pricing risk. It's what the market does. #2 There is no way to completely accurately price risk.

If you know the future, you could price it. If you don't know whether war will break out or not, you can discount current valuations for the possibility, but if it doesn't then securities will be cheap and if it does, they will likely turn out to have been wrong. Either way the best estimate pricing of the risk will turn out to have been wrong.

So sure value is largely a risk premium. And risks often get mis-priced. Is growth overvalued (mispriced), or are the risks it faces as it tries to justify it's valuations underestimated? Of course, if no risks show for longer than can be reasonable expected up, maybe it's cheap.

Chicken or egg?

If you don't believe me, see this Deloitte article entitled "Are you Mispricing Investment Risk?" which shows how CFOs often do just that due to not paying enough attention to the simple fact that the Equity Risk Premium changes which is caused by investors’ changing views of views. https://deloitte.wsj.com/riskandcomplia ... ment-risk/

So maybe your risk is priced right today, but then when perception of that risk changes, it no longer is. Mispricing or risk? A rose by any other name ...

Were Argentinean bonds mispriced last week or did the view of risks change? 'You say potato, I say potato!

Elysium
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Re: Rob Arnott on value investing and the Achilles' heel of market cap indexing (Morningstar podcast)

Post by Elysium » Tue Sep 03, 2019 10:08 am

typical.investor wrote:
Tue Sep 03, 2019 8:36 am
Elysium wrote:
Tue Sep 03, 2019 8:17 am
typical.investor wrote:
Mon Sep 02, 2019 11:11 pm
Elysium wrote:
Mon Sep 02, 2019 6:09 pm
typical.investor wrote:
Mon Sep 02, 2019 5:34 pm


Fine. You also said market weight is determined by economic footprint. Some don’t believe that multiple expansion (ie getting expensive for reasons not based on current returns) is a true measure of the footprint.
So you're saying some people believe there is mispricing. What are you going to do about it? If there is mispricing then the security value has been going up by a lot, and you are possibly selling them by re-balancing into bonds, perhaps you could reduce the equity exposure more than usual? say 10% more than you would do. Will this address the problem, or are you still going to be unsatisfied with it, and the only option is to include other sub-components in equal weight. What if you were wrong about the mispricing, and what if it takes several more years before the earnings catch up to meet the multiples. Amazon had high multiples for many many years, and barely any earnings to justify those, it took about 20 years for it to justify the price. Was the market wrong about Amazon, or is it wrong about it now. We would never know.
I think most who think that equities have a tendency to get overpriced simply select some kind of value index and leave it at that. Or maybe they diversify internationally. And yeah probably rebalance back to their allocation if equities exceed a certain amount.
If someone believed the market has a tendency to get mispriced, then they would actively seek securities they believe are fairly priced, that would be the most logical thing to do, and this is the domain of active value investors. This is not one of the top reasons I have seen why passive value investors seek to slice and dice into sub-components. In fact from what I have seen, most passive value investors do believe the market is very efficient in pricing, and that it is hard to detect market bubbles ahead of time. They believe the value premium is a risk factor, not due to mispricing.
Risk or mispricing doesn't seem like much of a distinction to me. #1 The market is constantly pricing risk. It's what the market does. #2 There is no way to completely accurately price risk.

If you know the future, you could price it. If you don't know whether war will break out or not, you can discount current valuations for the possibility, but if it doesn't then securities will be cheap and if it does, they will likely turn out to have been wrong. Either way the best estimate pricing of the risk will turn out to have been wrong.

So sure value is largely a risk premium. And risks often get mis-priced. Is growth overvalued (mispriced), or are the risks it faces as it tries to justify it's valuations underestimated? Of course, if no risks show for longer than can be reasonable expected up, maybe it's cheap.

Chicken or egg?

If you don't believe me, see this Deloitte article entitled "Are you Mispricing Investment Risk?" which shows how CFOs often do just that due to not paying enough attention to the simple fact that the Equity Risk Premium changes which is caused by investors’ changing views of views. https://deloitte.wsj.com/riskandcomplia ... ment-risk/

So maybe your risk is priced right today, but then when perception of that risk changes, it no longer is. Mispricing or risk? A rose by any other name ...

Were Argentinean bonds mispriced last week or did the view of risks change? 'You say potato, I say potato!
There are so many misconceptions in there to pin point one thing. But let's focus on risk. You are conflating speculative price changes that happens on a day to day basis as risk, this is largely driven by sentiments such as outlook for the economy, inflation, demand, growth, etc. Beyond that there are real numbers that drive returns, such as actual earnings growth, consumer demand, job growth, rate of inflation, etc. We cannot mix them together, as one is a voting machine and the other is a weighing machine as Benjamin Graham once said.

If you focus on actual figures, then market is pretty good at pricing it, not perfect, but good enough to prevent an individual to profit easily from it.

The fundamental premiums then are driven by how much is expected from taking on equity risk, or when you get down to it, how much is expected for investing your capital in a business. Essentially that is what you are doing, providing capital to U.S businesses when you invest in the S&P 500. Your return on capital is determined by how much risk premium is ideal for the kind of business. Naturally the premium for investing in Microsoft is going to be less than investing in the small IT service company, and this is what Value proponents claim. But you can also say that, the chance of Microsoft realizing the profit is higher than the small IT service company with high cost of capital. In other words, while there could be a Value premium, one may never realize it, or one may give up part of it to bankruptcies and liquidation.

Another way to look at it is comparing U.S Treasury with Junk Bonds. There is a premium in both, but the chance that you get that premium is much higher with UST than the Junk bond which may default. With SCV, this is what you are getting, stocks of companies with high cost of capital and risk of loss of capital, while with S&P 500 you have a much more higher chance of getting that equity premium.

Obviously, SCV proponents disagree and will point out to historic data. However, we are discussing future premiums and we do not know if it will persist, and if it persists how much can be expected since everyone knows about it.
Last edited by Elysium on Tue Sep 03, 2019 2:29 pm, edited 1 time in total.

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Taylor Larimore
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Rob Arnott

Post by Taylor Larimore » Tue Sep 03, 2019 11:14 am

Bogleheads:

Rob Arnott was once called the godfather of smart beta. However, his opinions seems to have changed. This is a link to one of his recent articles: Factor Investing Is 'Overhyped'

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Rob Arnott is a brilliant academic and the greatest marketer I've ever met."
"Simplicity is the master key to financial success." -- Jack Bogle

typical.investor
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Re: Rob Arnott

Post by typical.investor » Tue Sep 03, 2019 11:24 am

Taylor Larimore wrote:
Tue Sep 03, 2019 11:14 am
Bogleheads:

Rob Arnott was once called the godfather of smart beta. However, his opinions seems to have changed. This is a link to one of his recent articles: Factor Investing Is 'Overhyped'

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Rob Arnott is a brilliant academic and the greatest marketer I've ever met."
He did say factor investing is overhyped, but he wasn’t saying it isn’t potentionally worthwhile.

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Re: Rob Arnott

Post by abuss368 » Tue Sep 03, 2019 3:41 pm

Taylor Larimore wrote:
Tue Sep 03, 2019 11:14 am
Bogleheads:

Rob Arnott was once called the godfather of smart beta. However, his opinions seems to have changed. This is a link to one of his recent articles: Factor Investing Is 'Overhyped'

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Rob Arnott is a brilliant academic and the greatest marketer I've ever met."
Interesting. Thanks Taylor.
John C. Bogle - Two Fund Portfolio: Total Stock & Total Bond. "Simplicity is the master key to financial success."

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Re: Rob Arnott

Post by InvestInPasta » Mon Jan 13, 2020 6:52 pm

Taylor Larimore wrote:
Tue Sep 03, 2019 11:14 am
Jack Bogle's Words of Wisdom: "Rob Arnott is a brilliant academic and the greatest marketer I've ever met."
From the same interview :wink:
Jack Bogle speaking of Rob Arnott:
I wish I was as sure of anything as he is of everything.
- https://www.wsj.com/articles/rob-arnott ... 1493371801

Anyway I really appreciate that Arnott gives for free this valuation tool on his site:
https://interactive.researchaffiliates. ... ms=NOMINAL
When studying English I am lazier than my portfolio. Feel free to correct my english and investing mistakes.

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