Fama quotes

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exodusing
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Fama quotes

Post by exodusing »

Does market efficiency imply prices are correct (whatever that may mean)? People usually say no, it does not. Here's a Fama quote on the subject:

"In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.” “Random Walks in Stock-Market Prices,” Financial Analysts Journal, 1965, quoted in In Pursuit of the Perfect Portfolio.

More generally:

“Before 1992, before we did ‘The Cross-Section of Expected Stock Returns,’ I’d have said everybody should hold the market portfolio. Now I’d say no, your taste might cause you to tilt a little more towards smaller or value or whatever. I still think the market is the centerpiece, and most people should sit there because it’s a cheap way to go. ... In aggregate, people have to hold the market portfolio. That’s it, and that’s an efficient portfolio in any model you want to think of.” Fama, quoted in In Pursuit of the Perfect Portfolio.
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burritoLover
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Re: Fama quotes

Post by burritoLover »

Fama:
"It was a time when people were talking about perhaps an oncoming recession, which turned out not to have happened. In hindsight, that was a big mistake; but in hindsight, every price is wrong."
billaster
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Re: Fama quotes

Post by billaster »

Fama is a real fanatic about the Efficient Market Hypothesis and he really does believe that market prices are always right. He doesn't believe in the existence of market bubbles or at least to the extent that they are impossible to recognize when they are happening. He doesn't consider the dot com bust to be a bubble because some good companies like Amazon came out of it. He denied the housing bubble because he reasoned that most house buyers are extremely careful for the largest expenditure of their lives. Since bubbles can't exist, nothing should be done about them.

I find this sort of fatalism dangerous.
ScubaHogg
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Re: Fama quotes

Post by ScubaHogg »

I’ve heard multiple interviews at this point with heavy hitter academics and they can’t even seem to agree on what “efficient” means in EMH.

It’s utterly bizarre to have a foundational concept in a discipline mean whatever we feel like it should mean on any given day

As a guideline for behavior EMH is useful. As a literal, academic description of prices it’s laughable

(Lest we forget, EMH was a concept invented in an office about how things should be. AFAIK before it was published there was no empirical work to see if that’s how things actually were)
Last edited by ScubaHogg on Tue May 30, 2023 9:49 am, edited 1 time in total.
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ScubaHogg
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Re: Fama quotes

Post by ScubaHogg »

billaster wrote: Tue May 30, 2023 9:45 am Since bubbles can't exist, nothing should be done about them.

I find this sort of fatalism dangerous.
Even if you agree bubbles exist it doesn’t follow that “something” should be done about them, unless you believe in Super Agents who are above normal human fallacies
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billaster
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Re: Fama quotes

Post by billaster »

Fama has also stated his regrets about the weak, semi-strong and strong versions of the EMH that became a cult outgrowth of a single paper he wrote in the 1960s. He believes in a single strong version and that the market price is always right.
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Re: Fama quotes

Post by muffins14 »

billaster wrote: Tue May 30, 2023 9:52 am Fama has also stated his regrets about the weak, semi-strong and strong versions of the EMH that became a cult outgrowth of a single paper he wrote in the 1960s. He believes in a single strong version and that the market price is always right.
Isn’t it not “right”, but rather just a belief that all information is priced in immediately?
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Taylor Larimore
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Re: Fama quotes

Post by Taylor Larimore »

Bogleheads:

Eugene Fama, like seven other Nobel Laureates, recommends that we invest in total market index funds.

What Nobel Laureate's say:
Douglas Diamond: "Asked what he’ll do with his share of the prize money, Diamond said he’ll probably put it in a total market index fund."

Eugene Fama: "Whether you decide to tilt toward value depends on whether you are willing to bear the associated risk...The market portfolio is always efficient...For most people, the market portfolio is the most sensible decision."

Daniel Kahneman: "Investors shouldn't delude themselves about beating the market. They're just not going to do it. It's just not going to happen."

Harry Markowitz: "A foolish attempt to beat the market and get rich quickly will make one's broker rich and oneself much less so."

Merton Miller: "Most people might just as well buy a share of the whole market, which pools all the information, than delude themselves into thinking they know something the market doesn't"

Paul Samuelson: "The most efficient way to diversify a stock portfolio is with a low-fee index fund. Statistically, a broadly based stock index fund will outperform most actively managed equity portfolios."

William Sharpe: "You may think your opinion is superior, but it pays to be humble, investing in the market rather than trying to beat it."

Robert Shiller: "A portfolio approximating the market may be the most important portfolio."
___________________________________________________________________________________________________________

What other experts say:

viewtopic.php?f=10&t=156579

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SamB-Ari
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Re: Fama quotes

Post by SamB-Ari »

I find Burton Malkiel's statement on the EMH to be best:
I think what media gets wrong is the idea that efficient markets means that market prices are always right. That's not the case. In fact, market prices are always wrong. How could they be right? In theory, the price is the discounted present value of all of the future cash flows. These cash flows can only be estimated with enormous amounts of error. Some people are going to estimate them too high. Others too low. Market prices are always wrong. What the efficient market hypothesis means is that nobody can be sure whether they're too high or too low.
Basically, there are two ideas behind the so-called efficient market hypothesis. The first one is that information gets recorded into stock prices without delay...second idea of the efficient market hypothesis, and that is that there are no arbitrage opportunities. There is no obvious opportunity for excess risk-adjusted profits that the market gives you.
EMH does not mean the market price is right. It cannot be. I also don't believe Fama believes this. However, in an efficient market where all information is known and transparent to the entire market, the price is the aggregate of all market participants estimates of future cash flows. When new information comes out, the price immediately reflects the estimated impacted from that information resulting in no arbitrage opportunities.

Again, this only applies to markets that are efficient. Not every market is and so observations of inefficiency or mispricing is to be expected, but does not invalidate EMH. Essentially, we should all want all markets to eventually be the most efficient version it can be (as index investors). It also means that I actively try to avoid inefficient markets. :)
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Logan Roy
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Re: Fama quotes

Post by Logan Roy »

I think once we understand an idea, it's more worthwhile focusing on the arguments against.. Robert Shiller wrote a number of papers basically arguing that the level of stock price volatility tended to be far greater than would be predicted by changes to future cashflows based on information the market's processing.

I think the ARK ETF – at least most of the high growth stocks it contains – may be an example of that. You can witness the effect liquidity had on share prices – these businesses weren't all tripling their future cashflows over stimulus cheques – and then how quickly share prices lost most of that value when the prospect of tightening came along. Not that they shouldn't follow this dynamic – but the range of price moves suggests human behaviour: confirmation bias, investors following each other into crowded trades, etc.

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psteinx
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Re: Fama quotes

Post by psteinx »

exodusing wrote: Tue May 30, 2023 9:23 am “Before 1992, before we did ‘The Cross-Section of Expected Stock Returns,’ I’d have said everybody should hold the market portfolio. Now I’d say no, your taste might cause you to tilt a little more towards smaller or value or whatever. I still think the market is the centerpiece, and most people should sit there because it’s a cheap way to go. ... In aggregate, people have to hold the market portfolio. That’s it, and that’s an efficient portfolio in any model you want to think of.” Fama, quoted in In Pursuit of the Perfect Portfolio.
The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever. If all/most of the tilting fans here should tilt towards SV because RETURNS RETURNS RETURNS, who should be tilting away from it? How often do we see tilting fans say, "You, Bob Smith, should tilt towards large growth (i.e. away from SV) because of your particular risk profile.

I don't have a particular problem with folks saying markets are (sometimes) inefficient and you might be able to beat the market in various ways - I try to do so myself. But to try to unify "efficient markets" with advocacy for factor tilting, where the latter is basically always a one-way street, doesn't make sense to me.
rkhusky
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Re: Fama quotes

Post by rkhusky »

What does it mean for a price to be right or wrong? Is it connected to a value 10 or 20 years in the future? Or it connected to a value at each moment of time?

I think that if I sell a stock for $100 when there was a buyer willing to pay $110 that I didn’t connect with, then I sold at the wrong price. On the other hand, if I sell my stock for $100 when there were no other buyers willing to give me 1 penny more than that, then I sold at the right price.

An efficient market is one where I get the maximum price available at that moment when I want to sell, and where I get the minimum possible price when I want to buy.
Opinika
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Re: Fama quotes

Post by Opinika »

I found Seth Klarman's thoughts on efficient markets and indexing intriguing. From Margin of Safety page 53

"Indexing is a dangerously flawed strategy for several reasons.
First, it becomes self-defeating when more and more
investors adopt it. Although indexing is predicated on efficient
markets, the higher the percentage of all investors who index,
the more inefficient the markets become as fewer and fewer
investors would be performing research and fundamental analysis.
Indeed, at the extreme, if everyone practiced indexing,
stock prices would never change relative to each other because
no one would be left to move them."


That's a subtle criticism that I've not heard often articulated.
Gaston
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Re: Fama quotes

Post by Gaston »

billaster wrote: Tue May 30, 2023 9:45 am Fama is a real fanatic about the Efficient Market Hypothesis .
I would be interested in seeing a source for this. I’ve read a number of his papers and listened to him speak on a number of podcasts. While he is a proponent of the semi-strong version of EMH, I’ve never heard champion the strong version of EMH (that markets are always efficient). In fact, I’ve heard him say many times that markets are not consistently efficient.
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Re: Fama quotes

Post by Gaston »

SamB-Ari wrote: Tue May 30, 2023 10:10 am I find Burton Malkiel's statement on the EMH to be best:
I think what media gets wrong is the idea that efficient markets means that market prices are always right. That's not the case. In fact, market prices are always wrong. How could they be right? In theory, the price is the discounted present value of all of the future cash flows. These cash flows can only be estimated with enormous amounts of error. Some people are going to estimate them too high. Others too low. Market prices are always wrong. What the efficient market hypothesis means is that nobody can be sure whether they're too high or too low.
I completely agree. Dr Malkiel lays this out pretty clearly in his book, A Random Walk Down Wallstreet. He explains why, even if markets are efficient, prices often will be wrong. He then goes on to point out that even when prices are wrong, it doesn't help the investor, because the investor has no way of knowing which prices are correct and which ones are wrong. His bottom line: Invest in low cost, broad cased, market cap weighted index funds.
Last edited by Gaston on Tue May 30, 2023 8:31 pm, edited 1 time in total.
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tobyy
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Re: Fama quotes

Post by tobyy »

psteinx wrote: Tue May 30, 2023 12:02 pm The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever.
Never? Many people advise to buy and hold the s&p500, which basically means tilting to large cap, because blue-chip companies are seen as safer than smaller companies.
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Re: Fama quotes

Post by psteinx »

tobyy wrote: Tue May 30, 2023 2:02 pm
psteinx wrote: Tue May 30, 2023 12:02 pm The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever.
Never? Many people advise to buy and hold the s&p500, which basically means tilting to large cap, because blue-chip companies are seen as safer than smaller companies (and they are safer indeed according to Fama).
Incorrect.

Small/Value tilting is defined by overweighting, RELATIVE TO THE MARKET, small and/or value.

For an efficient market/risk-based advocacy of French/Fama's ideas, practitionaers would need to advocate for an equivalent amount of dollars overweighted, RELATIVE TO THE MARKET, in large and/or growth.
tobyy
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Re: Fama quotes

Post by tobyy »

psteinx wrote: Tue May 30, 2023 2:05 pm
tobyy wrote: Tue May 30, 2023 2:02 pm
psteinx wrote: Tue May 30, 2023 12:02 pm The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever.
Never? Many people advise to buy and hold the s&p500, which basically means tilting to large cap, because blue-chip companies are seen as safer than smaller companies (and they are safer indeed according to Fama).
Incorrect.

Small/Value tilting is defined by overweighting, RELATIVE TO THE MARKET, small and/or value.

For an efficient market/risk-based advocacy of French/Fama's ideas, practitionaers would need to advocate for an equivalent amount of dollars overweighted, RELATIVE TO THE MARKET, in large and/or growth.
Since small cap companies are completely missing in the sp500, large cap companies are overweighted relative to the market.
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exodusing
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Re: Fama quotes

Post by exodusing »

Opinika wrote: Tue May 30, 2023 12:49 pm I found Seth Klarman's thoughts on efficient markets and indexing intriguing. From Margin of Safety page 53

"Indexing is a dangerously flawed strategy for several reasons.
First, it becomes self-defeating when more and more
investors adopt it. Although indexing is predicated on efficient
markets, the higher the percentage of all investors who index,
the more inefficient the markets become as fewer and fewer
investors would be performing research and fundamental analysis.
Indeed, at the extreme, if everyone practiced indexing,
stock prices would never change relative to each other because
no one would be left to move them."


That's a subtle criticism that I've not heard often articulated.
It's a common criticism. The usual answers are that a very high percentage of investing would have to be indexed before this is a problem, probably well into the 90s, and if it were to be a problem there would then be a higher return to active management (e.g., due to less competition) and therefore there would be more active management until we are back to efficiency.
Gaston
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Re: Fama quotes

Post by Gaston »

Opinika wrote: Tue May 30, 2023 12:49 pm I found Seth Klarman's thoughts on efficient markets and indexing intriguing. From Margin of Safety page 53

"Indexing is a dangerously flawed strategy for several reasons.
First, it becomes self-defeating when more and more
investors adopt it. Although indexing is predicated on efficient
markets, the higher the percentage of all investors who index,
the more inefficient the markets become as fewer and fewer
investors would be performing research and fundamental analysis.
Indeed, at the extreme, if everyone practiced indexing,
stock prices would never change relative to each other because
no one would be left to move them."


That's a subtle criticism that I've not heard often articulated.
Wow, not sure where to start. There are two main theories on capital asset pricing, EMH and Behavioral. Indexing is not predicated solely on EMH. It likewise has roots in behavioral finance. It also is predicated on other factors, such as keeping costs low, keeping turnover low, eliminating manager risk, eliminating company risk, mitigating sector risk, eschewing market timing, etc, etc, etc.

It might be true that "if everyone practiced indexing, stock prices would never change relative to each other because no one would be left to move them", but we are far, far away from that point. All the big names (Malkiel, French, Fama, Schiller, Sharpe, Merton, Asness) that I'm aware of have said that markets still will be efficient even if indexing reaches 90%, and we're nowhere near that number.

What is true, however, is that if we went back to the pre-indexing days, active managers would be richer and the rest of us would be poorer. I don't know who Seth Klarman is. He might be an honest, upright guy. But his arguments sound all too similar to those of active managers who begrudge the fact that they can't beat passive investing.
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alex_686
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Re: Fama quotes

Post by alex_686 »

billaster wrote: Tue May 30, 2023 9:45 am Fama is a real fanatic about the Efficient Market Hypothesis and he really does believe that market prices are always right. He doesn't believe in the existence of market bubbles or at least to the extent that they are impossible to recognize when they are happening. He doesn't consider the dot com bust to be a bubble because some good companies like Amazon came out of it. He denied the housing bubble because he reasoned that most house buyers are extremely careful for the largest expenditure of their lives. Since bubbles can't exist, nothing should be done about them.

I find this sort of fatalism dangerous.
Have you listened to any of his lectures? He is kind of famed for spending his first day lecturing in grad school tearing down EMH. I think his position is more nuanced than you may think. He doesn't think the market is perfectly efficient and has spent a fair amount of time thinking on how profit seeking agents make the market as efficient as it is.

Since you mentioned the dot.com bubble lets stay on that for a bit. If you were in the dot.com bubble, and you knew you were in a bubble, what should you do? I am not sure what I would do. I was on the margin desk back then. I saw lots of smart people bet that the bubble would burst and get crushed and the bubble continued to expand. I saw lots of smart people then stay away from the tech sector and lag far behind the indexes.

There are 2 different flavors of EMH. One which says that the market generates the correct economic price. This is a fairly high bar. The second one is a bit more relaxed, which says that the market price is the actionable price. i.e., that even if you know you are in a bubble you still can't do anything about it. Further, it is hard to know in you are in a bubble and how to pop said bubble.
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psteinx
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Re: Fama quotes

Post by psteinx »

tobyy wrote: Tue May 30, 2023 2:08 pm
psteinx wrote: Tue May 30, 2023 2:05 pm
tobyy wrote: Tue May 30, 2023 2:02 pm
psteinx wrote: Tue May 30, 2023 12:02 pm The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever.
Never? Many people advise to buy and hold the s&p500, which basically means tilting to large cap, because blue-chip companies are seen as safer than smaller companies (and they are safer indeed according to Fama).
Incorrect.

Small/Value tilting is defined by overweighting, RELATIVE TO THE MARKET, small and/or value.

For an efficient market/risk-based advocacy of French/Fama's ideas, practitionaers would need to advocate for an equivalent amount of dollars overweighted, RELATIVE TO THE MARKET, in large and/or growth.
Since small cap companies are completely missing in the sp500, large cap companies are overweighted relative to the market.
While the S&P 500 is often used as a shorthand for the US market (in part because there's not a broadly accepted TSM index), in fact the baseline investment of a US investor investing in the US market should, IMO, be TSM, not S&P 500.

In any case, the claims of Fama and the like are generally not limited to filling in an S&P 500 holding with an extended market holding and/or switching to TSM.
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Re: Fama quotes

Post by rkhusky »

tobyy wrote: Tue May 30, 2023 2:08 pm
psteinx wrote: Tue May 30, 2023 2:05 pm
tobyy wrote: Tue May 30, 2023 2:02 pm
psteinx wrote: Tue May 30, 2023 12:02 pm The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever.
Never? Many people advise to buy and hold the s&p500, which basically means tilting to large cap, because blue-chip companies are seen as safer than smaller companies (and they are safer indeed according to Fama).
Incorrect.

Small/Value tilting is defined by overweighting, RELATIVE TO THE MARKET, small and/or value.

For an efficient market/risk-based advocacy of French/Fama's ideas, practitionaers would need to advocate for an equivalent amount of dollars overweighted, RELATIVE TO THE MARKET, in large and/or growth.
Since small cap companies are completely missing in the sp500, large cap companies are overweighted relative to the market.
1) It depends on where you draw the boundaries. In Morningstar’s formulation, the S&P 500 has an allocation to small caps.

2) The S&P 500 is not the whole US market.

3) The market has no tilt relative to the market.
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Re: Fama quotes

Post by alex_686 »

psteinx wrote: Tue May 30, 2023 2:34 pm While the S&P 500 is often used as a shorthand for the US market (in part because there's not a broadly accepted TSM index), in fact the baseline investment of a US investor investing in the US market should, IMO, be TSM, not S&P 500.
Why do you say that?

First, as a technical point, I think you mean the CRSP indexes. That is a benchmark that TSM follows.

Second, as a modest counter argument, the S&P 500 has a long a deep history. There is the theoretical index, actual fund performance, and a host of derivatives that shed additional light on the subject. The data quality is much much higher.

As a specific point, because of the low liquidity at the lower market-cap end of the index it is very hard to figure out if one could practically replicate the index without suffering distortions in pricing. Heck, TSM doesn't even try to fully replicate its CRSP index.
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Taylor Larimore
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Re: Fama quotes

Post by Taylor Larimore »

Opinika wrote: ↑Tue May 30, 2023 5:49 pm
I found Seth Klarman's thoughts on efficient markets and indexing intriguing. From Margin of Safety page 53

"Indexing is a dangerously flawed strategy for several reasons.
Opinika:

Why am I not surprised to Google this:
"Seth Klarman is the CEO and Portfolio Manager of The Baupost Group, LLC, which currently manages approximately $28 billion on behalf of individual and institutional clients."
Most investment management companies hate index funds because it is difficult to make money using them.

Best wishes.
Taylor
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psteinx
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Re: Fama quotes

Post by psteinx »

alex_686 wrote: Tue May 30, 2023 2:41 pm
psteinx wrote: Tue May 30, 2023 2:34 pm While the S&P 500 is often used as a shorthand for the US market (in part because there's not a broadly accepted TSM index), in fact the baseline investment of a US investor investing in the US market should, IMO, be TSM, not S&P 500.
Why do you say that?

First, as a technical point, I think you mean the CRSP indexes. That is a benchmark that TSM follows.

Second, as a modest counter argument, the S&P 500 has a long a deep history. There is the theoretical index, actual fund performance, and a host of derivatives that shed additional light on the subject. The data quality is much much higher.

As a specific point, because of the low liquidity at the lower market-cap end of the index it is very hard to figure out if one could practically replicate the index without suffering distortions in pricing. Heck, TSM doesn't even try to fully replicate its CRSP index.
I'm not sure exactly which part(s) of my claim you're objecting to.

In any case, we're drifting away from my original point, which is that those saying that the markets are efficient, and that tilting is good, within an efficient market standpoint, for risk reasons, seem to identify almost everyone as wanting to take the riskier side of the bet (value instead of growth, within either the TSM or the S&P 500) without identifying a contrasting group of investors, of similar $$$ size, who should for rational risk-related reasons take the opposite end of that bet (over-weighting value).
Gaston
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Re: Fama quotes

Post by Gaston »

A couple more Dr. Fama quotes:

Podcast host: “So even if value is theoretically a risk premium, if people believe it’s a profit opportunity, even if it is riskier, the premium can still go away?”
Dr. Fama: “Sure.”

------

Dr. Fama, in reference to the existence of risk premia: “It’s difficult to extract the signal from the noise in the data.”

------

Dr. French (Dr. Fama’s academic colleague): “People are crazy when they try to draw the inferences that they do from 3 or 5 years or even 10 years of performance on an asset class or any actively managed fund or a non-index fund.”

Source: Rational Reminder, episode 200 (Dr. Fama’s comments) and episode 100 (Dr. French's comment).
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tobyy
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Re: Fama quotes

Post by tobyy »

rkhusky wrote: Tue May 30, 2023 2:38 pm
tobyy wrote: Tue May 30, 2023 2:08 pm
psteinx wrote: Tue May 30, 2023 2:05 pm
tobyy wrote: Tue May 30, 2023 2:02 pm
psteinx wrote: Tue May 30, 2023 12:02 pm The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever.
Never? Many people advise to buy and hold the s&p500, which basically means tilting to large cap, because blue-chip companies are seen as safer than smaller companies (and they are safer indeed according to Fama).
Incorrect.

Small/Value tilting is defined by overweighting, RELATIVE TO THE MARKET, small and/or value.

For an efficient market/risk-based advocacy of French/Fama's ideas, practitionaers would need to advocate for an equivalent amount of dollars overweighted, RELATIVE TO THE MARKET, in large and/or growth.
Since small cap companies are completely missing in the sp500, large cap companies are overweighted relative to the market.
1) It depends on where you draw the boundaries. In Morningstar’s formulation, the S&P 500 has an allocation to small caps.

2) The S&P 500 is not the whole US market.

3) The market has no tilt relative to the market.
1) I use the definition of small cap by MSCI (large and mid cap companies cover 85% of the investable market, the rest is small cap companies). But wherever you draw the boundaries, small cap companies will be always underweighted in the s&p 500.

2,3) Correct, the s&p 500 is not the whole market, it is an index that includes the largest 500 companies. This is precisely the reason why it can (and does) have a tilt to large cap relative to the market. This can easily be checked using a factor regression analysis. The regression shows that VFINX (that tracks the s&p500) has a negative exposure to the small cap factor (SMB = -0.14), whereas VTSAX (that tracks the whole market) has an exposure close to zero.
Random Walker
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Re: Fama quotes

Post by Random Walker »

psteinx wrote: Tue May 30, 2023 12:02 pm
exodusing wrote: Tue May 30, 2023 9:23 am “Before 1992, before we did ‘The Cross-Section of Expected Stock Returns,’ I’d have said everybody should hold the market portfolio. Now I’d say no, your taste might cause you to tilt a little more towards smaller or value or whatever. I still think the market is the centerpiece, and most people should sit there because it’s a cheap way to go. ... In aggregate, people have to hold the market portfolio. That’s it, and that’s an efficient portfolio in any model you want to think of.” Fama, quoted in In Pursuit of the Perfect Portfolio.
The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever. If all/most of the tilting fans here should tilt towards SV because RETURNS RETURNS RETURNS, who should be tilting away from it? How often do we see tilting fans say, "You, Bob Smith, should tilt towards large growth (i.e. away from SV) because of your particular risk profile.

I don't have a particular problem with folks saying markets are (sometimes) inefficient and you might be able to beat the market in various ways - I try to do so myself. But to try to unify "efficient markets" with advocacy for factor tilting, where the latter is basically always a one-way street, doesn't make sense to me.
If you view a portfolio as a collection of risks, then an all TSM portfolio has net exposure to one risk, market beta. A tilted equity portfolio will have exposure to three risks which are each unique and independent from one another: market beta, size, relative price. It’s not necessarily about “returns, returns, returns”, it can be about diversification.

Dave
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exodusing
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Re: Fama quotes

Post by exodusing »

Random Walker wrote: Sat Jun 03, 2023 12:22 pm
psteinx wrote: Tue May 30, 2023 12:02 pm
exodusing wrote: Tue May 30, 2023 9:23 am “Before 1992, before we did ‘The Cross-Section of Expected Stock Returns,’ I’d have said everybody should hold the market portfolio. Now I’d say no, your taste might cause you to tilt a little more towards smaller or value or whatever. I still think the market is the centerpiece, and most people should sit there because it’s a cheap way to go. ... In aggregate, people have to hold the market portfolio. That’s it, and that’s an efficient portfolio in any model you want to think of.” Fama, quoted in In Pursuit of the Perfect Portfolio.
The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever. If all/most of the tilting fans here should tilt towards SV because RETURNS RETURNS RETURNS, who should be tilting away from it? How often do we see tilting fans say, "You, Bob Smith, should tilt towards large growth (i.e. away from SV) because of your particular risk profile.

I don't have a particular problem with folks saying markets are (sometimes) inefficient and you might be able to beat the market in various ways - I try to do so myself. But to try to unify "efficient markets" with advocacy for factor tilting, where the latter is basically always a one-way street, doesn't make sense to me.
If you view a portfolio as a collection of risks, then an all TSM portfolio has net exposure to one risk, market beta. A tilted equity portfolio will have exposure to three risks which are each unique and independent from one another: market beta, size, relative price. It’s not necessarily about “returns, returns, returns”, it can be about diversification.

Dave
There are many definitions of diversification. Whether being exposed to these factors gives one the benefits normally associated with diversification is far from clear.

Are there academic papers or interviews from Fama, French, et al. that claim a factor tilted portfolio is more diversified? That would seem contrary to the major factor models, which do not include a diversification term.
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Re: Fama quotes

Post by rkhusky »

Factor investing is about increasing risk, with the hope of higher returns. It is accomplished by concentrating all or a portion of your portfolio into a subset of the market, which is the opposite of diversification.
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Re: Fama quotes

Post by exodusing »

rkhusky wrote: Sat Jun 03, 2023 1:16 pm Factor investing is about increasing risk, with the hope of higher returns. It is accomplished by concentrating all or a portion of your portfolio into a subset of the market, which is the opposite of diversification.
Yes.
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Re: Fama quotes

Post by rkhusky »

tobyy wrote: Sat Jun 03, 2023 12:04 pm Correct, the s&p 500 is not the whole market, it is an index that includes the largest 500 companies.
The S&P 500 has selection criteria that keeps/has kept some of the 500 largest out of the index. For example, Tesla was kept out for awhile, even though it was a very large company, maybe in the top 10. Tesla distorted the completion index for quite awhile.

Also note that factor regression also requires arbitrarily choosing the boundary between large and small stocks.
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Re: Fama quotes

Post by tobyy »

rkhusky wrote: Sat Jun 03, 2023 1:47 pm
tobyy wrote: Sat Jun 03, 2023 12:04 pm Correct, the s&p 500 is not the whole market, it is an index that includes the largest 500 companies.
Also note that factor regression also requires arbitrarily choosing the boundary between large and small stocks.
The boundary used by the regression is the one drawn by Fama, the regression shows that the s&p 500 has a negative exposure to the small cap factor in the Fama factor model. The boundary is arbitrary in the sense that you could design a new equity pricing model using a different definition for the small cap factor. Then you could apply a factor regression using this new model. But I don't see why you would want to do that, since the Fama factor model does a very good job in explaining the returns of equity portfolios.
Last edited by tobyy on Sat Jun 03, 2023 3:21 pm, edited 2 times in total.
Random Walker
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Re: Fama quotes

Post by Random Walker »

exodusing wrote: Sat Jun 03, 2023 12:30 pm
Random Walker wrote: Sat Jun 03, 2023 12:22 pm
psteinx wrote: Tue May 30, 2023 12:02 pm
exodusing wrote: Tue May 30, 2023 9:23 am “Before 1992, before we did ‘The Cross-Section of Expected Stock Returns,’ I’d have said everybody should hold the market portfolio. Now I’d say no, your taste might cause you to tilt a little more towards smaller or value or whatever. I still think the market is the centerpiece, and most people should sit there because it’s a cheap way to go. ... In aggregate, people have to hold the market portfolio. That’s it, and that’s an efficient portfolio in any model you want to think of.” Fama, quoted in In Pursuit of the Perfect Portfolio.
The fundamental problem with this thoughtline is, in practice, Fama and others basically never advise folks to TILT AWAY from small/value/whatever. If all/most of the tilting fans here should tilt towards SV because RETURNS RETURNS RETURNS, who should be tilting away from it? How often do we see tilting fans say, "You, Bob Smith, should tilt towards large growth (i.e. away from SV) because of your particular risk profile.

I don't have a particular problem with folks saying markets are (sometimes) inefficient and you might be able to beat the market in various ways - I try to do so myself. But to try to unify "efficient markets" with advocacy for factor tilting, where the latter is basically always a one-way street, doesn't make sense to me.
If you view a portfolio as a collection of risks, then an all TSM portfolio has net exposure to one risk, market beta. A tilted equity portfolio will have exposure to three risks which are each unique and independent from one another: market beta, size, relative price. It’s not necessarily about “returns, returns, returns”, it can be about diversification.

Dave
There are many definitions of diversification. Whether being exposed to these factors gives one the benefits normally associated with diversification is far from clear.

Are there academic papers or interviews from Fama, French, et al. that claim a factor tilted portfolio is more diversified? That would seem contrary to the major factor models, which do not include a diversification term.
I don’t know about specific claims in academic papers with regard to factors and diversification. But we can simply look at the equity factors in the context of modern portfolio theory. Adding independent and unique sources of risk/return to a portfolio should push the portfolio northwest towards the elusive efficient frontier. What a potential addition to a portfolio contributes depends on expected returns, volatility, correlations. You can add to that when correlations tend to change, and of course costs as well.

Not academic paper, but Larry Swedroe has written in his books and various essays where he progressively tilts away from TSM and increases Sharpe ratios. The final step in those exercises is maintaining tilt, decreasing overall equity exposure, increasing exposure to safe bonds, increasing Sharpe. So if one believes size and value are risk premiums with associated increased expected returns, he can further diversify his portfolio across unique risks by increasing exposure to term risk with more safe bonds.

Dave

PS actually here is a link or two:
https://alphaarchitect.com/2019/04/inve ... ain-world/
https://www.aqr.com/-/media/AQR/Documen ... ted-vF.pdf
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Re: Fama quotes

Post by Random Walker »

rkhusky wrote: Sat Jun 03, 2023 1:16 pm Factor investing is about increasing risk, with the hope of higher returns. It is accomplished by concentrating all or a portion of your portfolio into a subset of the market, which is the opposite of diversification.
Completely disagree. I think it’s about looking at diversification differently. A typical 60/40 TSM/BND portfolio has 85-90% of its risk wrapped up in a single factor: equity market beta. If one tries to keep expected return of a portfolio about the same as 60/40 TSM, he can tilt to equity asset classes with higher expected return, decrease overall equity exposure, increase exposure to term with safe bonds. These are all steps in the direction of risk parity. The risks are more evenly spread across market beta, size, value, term.

Dave
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Re: Fama quotes

Post by rkhusky »

Random Walker wrote: Sat Jun 03, 2023 3:29 pm
rkhusky wrote: Sat Jun 03, 2023 1:16 pm Factor investing is about increasing risk, with the hope of higher returns. It is accomplished by concentrating all or a portion of your portfolio into a subset of the market, which is the opposite of diversification.
Completely disagree. I think it’s about looking at diversification differently. A typical 60/40 TSM/BND portfolio has 85-90% of its risk wrapped up in a single factor: equity market beta. If one tries to keep expected return of a portfolio about the same as 60/40 TSM, he can tilt to equity asset classes with higher expected return, decrease overall equity exposure, increase exposure to term with safe bonds. These are all steps in the direction of risk parity. The risks are more evenly spread across market beta, size, value, term.

Dave
That might be true, if the risks were spread across different companies, but they are not, they are piled on top of each other in the same company. You are increasing risk by concentrating in a subset of the market, such that the companies all have similar characteristics in terms of the factors. Again, the opposite of diversification. Diversification reduces risk, it doesn’t increase risk.
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Re: Fama quotes

Post by Random Walker »

rkhusky wrote: Sat Jun 03, 2023 3:42 pm
Random Walker wrote: Sat Jun 03, 2023 3:29 pm
rkhusky wrote: Sat Jun 03, 2023 1:16 pm Factor investing is about increasing risk, with the hope of higher returns. It is accomplished by concentrating all or a portion of your portfolio into a subset of the market, which is the opposite of diversification.
Completely disagree. I think it’s about looking at diversification differently. A typical 60/40 TSM/BND portfolio has 85-90% of its risk wrapped up in a single factor: equity market beta. If one tries to keep expected return of a portfolio about the same as 60/40 TSM, he can tilt to equity asset classes with higher expected return, decrease overall equity exposure, increase exposure to term with safe bonds. These are all steps in the direction of risk parity. The risks are more evenly spread across market beta, size, value, term.

Dave
That might be true, if the risks were spread across different companies, but they are not, they are piled on top of each other in the same company. You are increasing risk by concentrating in a subset of the market, such that the companies all have similar characteristics in terms of the factors. Again, the opposite of diversification. Diversification reduces risk, it doesn’t increase risk.
Like I said, factor investing does require looking at diversification differently. Effectively need to look at stocks and portfolios as baskets of risks.
Dave
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Re: Fama quotes

Post by exodusing »

Random Walker wrote: Sat Jun 03, 2023 3:17 pm I don’t know about specific claims in academic papers with regard to factors and diversification. But we can simply look at the equity factors in the context of modern portfolio theory. Adding independent and unique sources of risk/return to a portfolio should push the portfolio northwest towards the elusive efficient frontier. What a potential addition to a portfolio contributes depends on expected returns, volatility, correlations. You can add to that when correlations tend to change, and of course costs as well.

Not academic paper, but Larry Swedroe has written in his books and various essays where he progressively tilts away from TSM and increases Sharpe ratios. The final step in those exercises is maintaining tilt, decreasing overall equity exposure, increasing exposure to safe bonds, increasing Sharpe. So if one believes size and value are risk premiums with associated increased expected returns, he can further diversify his portfolio across unique risks by increasing exposure to term risk with more safe bonds.

Dave

PS actually here is a link or two:
https://alphaarchitect.com/2019/04/inve ... ain-world/
https://www.aqr.com/-/media/AQR/Documen ... ted-vF.pdf
Modern portfolio theory has volatility as the only source of risk. Factor models are a move away from MPT. You don't move NW in multifactor models. See https://www.chicagofed.org/publications ... 9/3qepart4

Fama has said the market portfolio is always efficient. Look at the factor models - the highest expected return would be from all SV (according the the FF 3FM and associated research), which would seem rather undiversified.

rkhusky has it exactly right.
Last edited by exodusing on Sat Jun 03, 2023 4:46 pm, edited 1 time in total.
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Re: Fama quotes

Post by tobyy »

exodusing wrote: Sat Jun 03, 2023 12:30 pm Are there academic papers or interviews from Fama, French, et al. that claim a factor tilted portfolio is more diversified? That would seem contrary to the major factor models, which do not include a diversification term.
Historically factors have been introduced to explain the difference in returns of different portfolios in term of sources of risk other than market risk, not to improve diversification. Because factors are cyclical and different factors work at different times, there are claims that by diversifying over different factors one might be able to improve the risk-adjused returns of a portfolio. But as far as I know it's a recent idea and there is no consensus yet in the academia. See for instance this paper or this paper.
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Re: Fama quotes

Post by exodusing »

rkhusky wrote: Sat Jun 03, 2023 3:42 pm
Random Walker wrote: Sat Jun 03, 2023 3:29 pm
rkhusky wrote: Sat Jun 03, 2023 1:16 pm Factor investing is about increasing risk, with the hope of higher returns. It is accomplished by concentrating all or a portion of your portfolio into a subset of the market, which is the opposite of diversification.
Completely disagree. I think it’s about looking at diversification differently. A typical 60/40 TSM/BND portfolio has 85-90% of its risk wrapped up in a single factor: equity market beta. If one tries to keep expected return of a portfolio about the same as 60/40 TSM, he can tilt to equity asset classes with higher expected return, decrease overall equity exposure, increase exposure to term with safe bonds. These are all steps in the direction of risk parity. The risks are more evenly spread across market beta, size, value, term.

Dave
That might be true, if the risks were spread across different companies, but they are not, they are piled on top of each other in the same company. You are increasing risk by concentrating in a subset of the market, such that the companies all have similar characteristics in terms of the factors. Again, the opposite of diversification. Diversification reduces risk, it doesn’t increase risk.
You're only saying that because you're using a standard definition of diversification. If you used a different definition you might come to a different conclusion.
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Re: Fama quotes

Post by Random Walker »

https://images.slideplayer.com/13/39273 ... lide_4.jpg

Which portfolio would you choose randomly: circle, triangle, square, diamond?
TSM is a single asset class.

BTW Roger Gibson’s Asset Allocation: Balancing Financial Risk is one of my all time favorite investing books. The specific asset classes are relatively unimportant. The concept of mixing less than perfectly correlated assets in a portfolio is the important point.

Dave
Last edited by Random Walker on Sat Jun 03, 2023 4:58 pm, edited 1 time in total.
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Re: Fama quotes

Post by BitTooAggressive »

SamB-Ari wrote: Tue May 30, 2023 10:10 am I find Burton Malkiel's statement on the EMH to be best:
I think what media gets wrong is the idea that efficient markets means that market prices are always right. That's not the case. In fact, market prices are always wrong. How could they be right? In theory, the price is the discounted present value of all of the future cash flows. These cash flows can only be estimated with enormous amounts of error. Some people are going to estimate them too high. Others too low. Market prices are always wrong. What the efficient market hypothesis means is that nobody can be sure whether they're too high or too low.
Basically, there are two ideas behind the so-called efficient market hypothesis. The first one is that information gets recorded into stock prices without delay...second idea of the efficient market hypothesis, and that is that there are no arbitrage opportunities. There is no obvious opportunity for excess risk-adjusted profits that the market gives you.
EMH does not mean the market price is right. It cannot be. I also don't believe Fama believes this. However, in an efficient market where all information is known and transparent to the entire market, the price is the aggregate of all market participants estimates of future cash flows. When new information comes out, the price immediately reflects the estimated impacted from that information resulting in no arbitrage opportunities.

Again, this only applies to markets that are efficient. Not every market is and so observations of inefficiency or mispricing is to be expected, but does not invalidate EMH. Essentially, we should all want all markets to eventually be the most efficient version it can be (as index investors). It also means that I actively try to avoid inefficient markets. :)
Yeah who is it that does the $100 dollar bill on the sidewalk. You can either pick it up fast or not pick it up because if it was real somebody would have already taken it.
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Re: Fama quotes

Post by tennisplyr »

Opinika wrote: Tue May 30, 2023 12:49 pm I found Seth Klarman's thoughts on efficient markets and indexing intriguing. From Margin of Safety page 53

"Indexing is a dangerously flawed strategy for several reasons.
First, it becomes self-defeating when more and more
investors adopt it. Although indexing is predicated on efficient
markets, the higher the percentage of all investors who index,
the more inefficient the markets become as fewer and fewer
investors would be performing research and fundamental analysis.
Indeed, at the extreme, if everyone practiced indexing,
stock prices would never change relative to each other because
no one would be left to move them."


That's a subtle criticism that I've not heard often articulated.
Then, we must be thankful for those who do not follow the herd, not critical of them.
“Those who move forward with a happy spirit will find that things always work out.” -Retired 13 years 😀
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Re: Fama quotes

Post by Random Walker »

tennisplyr wrote: Sat Jun 03, 2023 5:01 pm
Opinika wrote: Tue May 30, 2023 12:49 pm I found Seth Klarman's thoughts on efficient markets and indexing intriguing. From Margin of Safety page 53

"Indexing is a dangerously flawed strategy for several reasons.
First, it becomes self-defeating when more and more
investors adopt it. Although indexing is predicated on efficient
markets, the higher the percentage of all investors who index,
the more inefficient the markets become as fewer and fewer
investors would be performing research and fundamental analysis.
Indeed, at the extreme, if everyone practiced indexing,
stock prices would never change relative to each other because
no one would be left to move them."


That's a subtle criticism that I've not heard often articulated.
Then, we must be thankful for those who do not follow the herd, not critical of them.
Prices are set at the margin. A small number of active traders may be all that is needed in presence of large number passive indexers to still keep markets efficient. On top of that, there has been huge shift to passive. The people remaining in the active game are the very best-selling and buying with each other.

Dave
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Re: Fama quotes

Post by rkhusky »

Random Walker wrote: Sat Jun 03, 2023 3:58 pm Like I said, factor investing does require looking at diversification differently. Effectively need to look at stocks and portfolios as baskets of risks.
Dave
But you can’t invest in a particular risk within a company, you invest in the whole company.

Diversification means having different things. It doesn’t mean having all the same thing.
Last edited by rkhusky on Sat Jun 03, 2023 7:54 pm, edited 1 time in total.
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Re: Fama quotes

Post by rkhusky »

exodusing wrote: Sat Jun 03, 2023 4:18 pm
rkhusky wrote: Sat Jun 03, 2023 3:42 pm
Random Walker wrote: Sat Jun 03, 2023 3:29 pm
rkhusky wrote: Sat Jun 03, 2023 1:16 pm Factor investing is about increasing risk, with the hope of higher returns. It is accomplished by concentrating all or a portion of your portfolio into a subset of the market, which is the opposite of diversification.
Completely disagree. I think it’s about looking at diversification differently. A typical 60/40 TSM/BND portfolio has 85-90% of its risk wrapped up in a single factor: equity market beta. If one tries to keep expected return of a portfolio about the same as 60/40 TSM, he can tilt to equity asset classes with higher expected return, decrease overall equity exposure, increase exposure to term with safe bonds. These are all steps in the direction of risk parity. The risks are more evenly spread across market beta, size, value, term.

Dave
That might be true, if the risks were spread across different companies, but they are not, they are piled on top of each other in the same company. You are increasing risk by concentrating in a subset of the market, such that the companies all have similar characteristics in terms of the factors. Again, the opposite of diversification. Diversification reduces risk, it doesn’t increase risk.
You're only saying that because you're using a standard definition of diversification. If you used a different definition you might come to a different conclusion.
Rather than take a common word and redefine it to mean the opposite, factor proponents should come up with a different word for the concept.
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Re: Fama quotes

Post by Random Walker »

rkhusky wrote: Sat Jun 03, 2023 7:52 pm
exodusing wrote: Sat Jun 03, 2023 4:18 pm
rkhusky wrote: Sat Jun 03, 2023 3:42 pm
Random Walker wrote: Sat Jun 03, 2023 3:29 pm
rkhusky wrote: Sat Jun 03, 2023 1:16 pm Factor investing is about increasing risk, with the hope of higher returns. It is accomplished by concentrating all or a portion of your portfolio into a subset of the market, which is the opposite of diversification.
Completely disagree. I think it’s about looking at diversification differently. A typical 60/40 TSM/BND portfolio has 85-90% of its risk wrapped up in a single factor: equity market beta. If one tries to keep expected return of a portfolio about the same as 60/40 TSM, he can tilt to equity asset classes with higher expected return, decrease overall equity exposure, increase exposure to term with safe bonds. These are all steps in the direction of risk parity. The risks are more evenly spread across market beta, size, value, term.

Dave
That might be true, if the risks were spread across different companies, but they are not, they are piled on top of each other in the same company. You are increasing risk by concentrating in a subset of the market, such that the companies all have similar characteristics in terms of the factors. Again, the opposite of diversification. Diversification reduces risk, it doesn’t increase risk.
You're only saying that because you're using a standard definition of diversification. If you used a different definition you might come to a different conclusion.
Rather than take a common word and redefine it to mean the opposite, factor proponents should come up with a different word for the concept.
I think that for most all of us the layman’s definition of diversification is “don’t put all your eggs in one basket”, doesn’t get more simple than that. For TSMers that means invest in the whole market, lots of stocks, eliminate single stock risk. For factor (and dare I say Alt too) proponents we think “don’t put all our eggs in a single risk basket”, and that risk basket is market beta. We try to spread our risks across unique and independent sources, a move in the direction of risk parity. And still our long only portfolios are dominated by market beta. Also BTW, us factor proponents effectively eliminate single stock risk with our funds. So we don’t need another word. We just need to explain that we are diversifying across risks rather than number of stocks only.

Dave
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Re: Fama quotes

Post by rkhusky »

Random Walker wrote: Sat Jun 03, 2023 11:53 pm
I think that for most all of us the layman’s definition of diversification is “don’t put all your eggs in one basket”, doesn’t get more simple than that. For TSMers that means invest in the whole market, lots of stocks, eliminate single stock risk. For factor (and dare I say Alt too) proponents we think “don’t put all our eggs in a single risk basket”, and that risk basket is market beta. We try to spread our risks across unique and independent sources, a move in the direction of risk parity. And still our long only portfolios are dominated by market beta. Also BTW, us factor proponents effectively eliminate single stock risk with our funds. So we don’t need another word. We just need to explain that we are diversifying across risks rather than number of stocks only.

Dave
With factor investing, you are putting all your eggs in one basket, because your basket of stocks all have the same characteristics in terms of the factors and screens employed.

Here’s an analogy: I have six colors with which to paint Easter eggs: red, blue, yellow, green, purple, and orange. After painting eggs, I divide them into six baskets, with the first basket containing eggs with one color, the second basket containing eggs with two colors, etc, with the sixth basket containing eggs with all six colors. Is a collection of eggs containing just the sixth basket more diverse than a collection with all six baskets? I think not. Perhaps you can argue that a single egg from the sixth basket is more diverse than one from another basket, but that is different than a whole collection of eggs.

I do agree that alt investing increases diversity because you are adding different investments with different risks.
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Re: Fama quotes

Post by burritoLover »

rkhusky wrote: Sun Jun 04, 2023 7:38 am
Random Walker wrote: Sat Jun 03, 2023 11:53 pm
I think that for most all of us the layman’s definition of diversification is “don’t put all your eggs in one basket”, doesn’t get more simple than that. For TSMers that means invest in the whole market, lots of stocks, eliminate single stock risk. For factor (and dare I say Alt too) proponents we think “don’t put all our eggs in a single risk basket”, and that risk basket is market beta. We try to spread our risks across unique and independent sources, a move in the direction of risk parity. And still our long only portfolios are dominated by market beta. Also BTW, us factor proponents effectively eliminate single stock risk with our funds. So we don’t need another word. We just need to explain that we are diversifying across risks rather than number of stocks only.

Dave
With factor investing, you are putting all your eggs in one basket, because your basket of stocks all have the same characteristics in terms of the factors and screens employed.

Here’s an analogy: I have six colors with which to paint Easter eggs: red, blue, yellow, green, purple, and orange. After painting eggs, I divide them into six baskets, with the first basket containing eggs with one color, the second basket containing eggs with two colors, etc, with the sixth basket containing eggs with all six colors. Is a collection of eggs containing just the sixth basket more diverse than a collection with all six baskets? I think not.

I do agree that alt investing increases diversity because you are adding different investments with different risks.
A total market fund is entirely dominated by only the market factor - it has zero loading to value, size, investment, and profitability factors. By tilting the portfolio to these different factors, you get additional diversification (over total market) because each has a low or negative correlation to the market factor and to each other (see chart below). Stocks split by these characteristics respond differently than the market (and each other) during different business cycles and economic regimes.

Now, having said that and having read your posts before - I would put you in the camp that these factors are just data-mined and have no real significance. If that is true, there's no point in really having a discussion - we can't talk about different colored eggs in baskets if you think there's only one colored egg that exists.

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