Momentum and value paradox

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hungrywave
Posts: 93
Joined: Tue Apr 09, 2019 7:48 pm

Momentum and value paradox

Post by hungrywave » Fri Jun 14, 2019 4:40 pm

Dear BogleBranders,

If momentum and value are both expected to have increased risk and return relative to the broad US market, then why does combining the two result in a portfolio with minimal factor tilt?

I believe that Larry Swedroe has suggested that momentum and value tilts pair well in a portfolio and add factor diversity.

I understand that momentum and value and anti-correlated. Momentum tends to have negative value factor loading. Value tends to have negative momentum factor loading. Thus, when you combine the 2, the total portfolio's momentum and value loadings get closer to zero.

So, if a momentum fund and a value fund are each expected to perform well independently, then why, when combined, do their weakened factor tilts lead the portfolio to be expected to behave more similarly to the total market (but with extra costs)? Does the momentum fund overcome its own negative value loading and vice versa? Should I just ignore Portfolio Visualizer?

You can see this on Portfolio Visualizer with Vanguard U.S. Momentum Factor ETF (VFMO) and Vanguard Small-Cap Value ETF (VBR) (with the caveat that VFMO has only been around since early 2018) as well as with iShares Edge MSCI USA Momentum Factor ETF (MTUM) and iShares S&P Small-Cap 600 Value ETF (IJS).

Basically, I am considering a buy-and-hold portfolio of 25% VFMO, 25% VBR, 25% VSS, and 25% VWO. A similar portfolio has been proposed but my question was not answered there (Constructing a 100% equity diversified Factor portfolio).

Thank you!

:sharebeer

larryswedroe
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Location: St Louis MO

Re: Momentum and value paradox

Post by larryswedroe » Fri Jun 14, 2019 5:00 pm

Quick answer, the more you tilt to value the lower the MOM exposure, so most value funds have NEGATIVE MOM exposure. To minimize this issue fund families like DFA, Bridgeway and others use screens to eliminate stocks from their eligible buy list that exhibit negative momentum when they become value stocks. They wait until that ceases. Doing so trades off bit less value loading for lot less negative MOM< typically eliminating it. So the trade off should be higher returns. Also reduces turnover. At same time can slow down sales of stocks with positive MOM as they leave the eligible universe, by lowering their priority to sell when using algo programs to patiently trade.
Hope that helps

Topic Author
hungrywave
Posts: 93
Joined: Tue Apr 09, 2019 7:48 pm

Re: Momentum and value paradox

Post by hungrywave » Fri Jun 14, 2019 6:00 pm

larryswedroe wrote:
Fri Jun 14, 2019 5:00 pm
Quick answer, the more you tilt to value the lower the MOM exposure, so most value funds have NEGATIVE MOM exposure. To minimize this issue fund families like DFA, Bridgeway and others use screens to eliminate stocks from their eligible buy list that exhibit negative momentum when they become value stocks. They wait until that ceases. Doing so trades off bit less value loading for lot less negative MOM< typically eliminating it. So the trade off should be higher returns. Also reduces turnover. At same time can slow down sales of stocks with positive MOM as they leave the eligible universe, by lowering their priority to sell when using algo programs to patiently trade.
Hope that helps
Thank you, Mr. Swedroe! I am honored to have a response from you! (I enjoyed the interview with you on Resolve's Gestalt University podcast!)

Unfortunately, I don't have access to DFA and Bridgeway funds. Also, I am hesitant to stray from the Vanguard mothership.

Do you think that Vanguard's tilted (eg specific factor and small value) funds are too suboptimal to be worth using? Their low cost at least is appealing because that at least makes the downside of factors being wrong lower. Do you think Vanguards multi factor ETF (VFMF) is worth making the entirety of my US equity position?

larryswedroe
Posts: 15835
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Re: Momentum and value paradox

Post by larryswedroe » Sat Jun 15, 2019 9:11 am

There is no RIGHT answer on amount of tilting, and if you believe as I do that markets are highly (though not perfectly) efficient than all tilts should have same expected RISK adjusted return. So Vanguard's funds are fine in that respect, they do what they are supposed to do. The trade off is you cannot diversify across unique sources of risk as well, and that means you also have to hold more equity risk (because don't load as heavily on higher expected returning assets) and less safe bonds. So that creates more tail risk and more sequence risk. There are plenty of ETFs that can get you more exposure to Factors than vanguard does and they are generally very low cost.
Vanguard CANNOT deliver high tilts because they are too big. Just a fact of life. That's same problem DFA ran into, and though it's SV fund is half the market cap of Vanguard's and lower value metrics, it's 2x the market cap of Bridgeway and higher value metrics. Big gives scale and bit lower costs of course, but lose exposure, so it's trade off and have to evaluate cost per unit of exposure (as well as fund construction rules).
Hope that helps
Larry

Topic Author
hungrywave
Posts: 93
Joined: Tue Apr 09, 2019 7:48 pm

Re: Momentum and value paradox

Post by hungrywave » Wed Jun 19, 2019 12:50 pm

larryswedroe wrote:
Sat Jun 15, 2019 9:11 am
Big gives scale and bit lower costs of course, but lose exposure, so it's trade off and have to evaluate cost per unit of exposure (as well as fund construction rules).
Hope that helps
Larry
Thank you so much, Larry! Very helpful! :sharebeer

aristotelian
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Re: Momentum and value paradox

Post by aristotelian » Wed Jun 19, 2019 6:02 pm

I agree. Even if momentum and value are not negatively correlated, you at least have the dilution issue where the more tilts you have, the more you end up approaching total market, which defeats the purpose. If you are going to tilt, tilt hard, IMO.

Small sample size, but for 2014-2019, 30 MTUM/30 SLYV/40 VOO produces .99 correlation to total market.

Topic Author
hungrywave
Posts: 93
Joined: Tue Apr 09, 2019 7:48 pm

Re: Momentum and value paradox

Post by hungrywave » Wed Jun 19, 2019 10:31 pm

aristotelian wrote:
Wed Jun 19, 2019 6:02 pm
Even if momentum and value are not negatively correlated, you at least have the dilution issue where the more tilts you have, the more you end up approaching total market, which defeats the purpose.
I'm not sure the dilution argument makes sense if you are considering the different factors as separate asset classes. Each class has its own performance. Even if long momentum has negative value, it is still expected to outperform (ignoring costs). Thus, a portfolio with 2 funds - value and momentum - will work even if the value and momentum values of the entire portfolio are low.

My guess for why my theory might be true is that negative value has a relatively low impact in high momentum stocks and vice versa. Thus, it isn't quite fair to say that the negative value in a momentum fund can fully cancel the positive value in a value fund.

What do you think? I think the model would have to somehow account for a portfolio of 2 separate factors doing well even if those factors are anticorrelated.

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