Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

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lnp
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Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by lnp »

Why doesn’t everybody factor invest?
Is it because it only has better risk adjusted returns under the flawed CAPM model and actually would have similar risk adjusted returns under a five factor model?
Or why?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by firebirdparts »

I think everybody did, and that's why we don't see factor outperformance anymore. That's a simple idea, and somebody will say it's not strictly true, and that's fine. But it is largely true.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by muffins14 »

firebirdparts wrote: Tue Nov 30, 2021 6:52 am I think everybody did, and that's why we don't see factor outperformance anymore. That's a simple idea, and somebody will say it's not strictly true, and that's fine. But it is largely true.
It is strictly not true. If everyone did it, then everyone would hold the same portfolio, which would be the market portfolio, and there would be no portfolios that loaded on factors other than market beta, which would mean no one is investing in factors anymore.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by UpperNwGuy »

larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Because my investment goal from the beginning has been to own the market, not to try to beat the market.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by muffins14 »

larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Is it because it only has better risk adjusted returns under the flawed CAPM model and actually would have similar risk adjusted returns under a five factor model?
Or why?
The distribution of returns is different. For example value tends to have perhaps a slightly higher mean return, but has a negative skew such that it does even worse during economic downturns.

Some people are willing to give up a tiny bit of average return to explicitly avoid doing worse during downturns. For them, that’s preferable and they may stick with the broad market.

Value may also have higher dividends, which someone may not want in taxable.

Momentum may be hard to capture in long-only form after transaction costs.

Size may not be a great factor in isolation as much as in combination with other factors, so if you’re hesitant on value, maybe you’d also avoid small cap value
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by typical.investor »

larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Is it because it only has better risk adjusted returns under the flawed CAPM model and actually would have similar risk adjusted returns under a five factor model?
Or why?
Even assuming other factors are sure to outperform beta, I can not know whether the outperformance will happen in my holding period.

Sure there are rosy forecasts on how likely the outperformance is in five, ten, or twenty year periods, but the truth is surely that there is a risk that it doesn’t happen in your timeline.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by onourway »

Any deviation from total market investing will inevitably cause the investor to be faced with the question “Is this period of under-performance (relative to the total market) ‘normal’ or are things different this time? It’s only possible to tell with the benefit of hindsight, and those periods of poor performance may last decades. Most investors don’t really have the ability to hold a stinking investment that long, so they will end up tinkering based on ‘new’ data that supports their current flavor of the month.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by nisiprius »

The following is not evidence against the reality of factors. But it is evidence that factor investing is not a good idea for most investors.

Dimensional Fund Advisors (DFA) has Fama and French on its board of directors. It is more associated with passive factor investing than any other firm. This isn't their advice, this isn't anything they are saying, this is what they are actually doing when a worker trusts them with real retirement savings money to manage for them, and a forty-year time horizon over which to manage it:

Morningstar: Dimensional 2060 Target Date Retirement Income Fund (DRILX), Portfolio

Image

They invest it squarely within the "large blend" style box.

I am not charging DFA with hypocrisy or with insincerity. But I see only two likely explanations. The first is the one I actually believe:

1) They think most investors do not have the conviction to stick with a heavily tilted portfolio. In other words, tilted portfolios are unsuitable for most investors.

Either that, or this: It is, I think, generally accepted that factors have been subject to long periods of underperformance. In the case of value, we have been in one for about sixteen years so far (since 2005). In the case of the size factor, about thirty-seven (since 1984).

2) So my alternate explanation is that DFA is not itself willing to take the institutional or reputational risk that the retirement savings money they are managing might encounter one of those periods. They do not have the institutional risk tolerance for factor tilts. Not when they, rather than someone else, is taking responsibility for an entire portfolio.

Sometimes factor enthusiasts like to suggest that other factors are no different from "the market factor," and point out that it, too, is subject to long periods of bad performance. Well, this fund is 93.88% stocks. For whatever reasons, DFA, when given real retirement savings money to manage with a forty year time horizon, is willing to commit--heavily--to the market factor, and feels that young investors can accept this. But it is not willing to commit to small or value tilts.
Last edited by nisiprius on Tue Nov 30, 2021 7:50 am, edited 6 times in total.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by djm2001 »

Because an individual's investment portfolio doesn't tell the whole story of their risk exposure. An employee of a small-cap value company should probably short SCV.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by burritoLover »

Factors are just unique sources of risk that describe the differences in returns between two diversified portfolio. It isn't alpha. You are not "beating the market" in the sense that this is some free lunch - you are taking on more risk for greater potential returns but the general expectation is that these risk assets all have the same risk-adjusted return. So, asking why doesn't everybody factor invest is just like asking why isn't everyone invest in the 100% total stock market with no bonds.

There is some sense that you will be more diversified by investing in multiple factors. But like diversifying with only market portfolio, the multi-factor portfolio will have some elements underperforming while others are outperforming. It seems like the average DIY investors think factors are some magic return bullet and probably wouldn't stick with a multi-factor portfolio when some or all (less market) are underperforming. Multi-factor portfolios are a bad idea for average investors just like a market-cap weighted global portfolio is bad idea for them - they can't stick with it because they are constantly comparing it to the S&P 500 and a few years where the S&P outperforms, they end up bailing.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by JoMoney »

If "factors" exist, they are explained as being "RISK factors" they are a different measurement of risk then the single factor beta. They don't offer "better risk-adjusted returns", if you increase exposure to the risk factor the idea is you're taking more risk, a risk that's measured in ways other than the volatility relative to the market. If it has "better" risk-adjusted returns when measured with a factor regression, there's something unexplained going on, which is evidence against the idea of factors.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by muffins14 »

nisiprius wrote: Tue Nov 30, 2021 7:28 am The following is not evidence against the reality of factors. But it is evidence that factor investing is not a good idea for most investors:

Morningstar: DRILX Portfolio

Image

Dimensional Fund Advisors (DFA) has Fama and French on its board of directors. It is more associated with passive factor investing than any other firm. This isn't their advice, this isn't anything they are saying, this is what they are actually doing when a worker trusts them with real retirement savings money to manage for them. They invest it squarely within the "large blend" style box.

I am not charging DFA with hypocrisy or with insincerity. But I see only two likely explanations. The first is the one I actually believe:

1) They think most investors do not have the conviction to stick with a heavily tilted portfolio. In other words, tilted portfolios are unsuitable for most investors.

Either that, or this: It is, I think, generally accepted that factors have been subject to long periods of underperformance. In the case of value, we have been in one for about sixteen years so far (since 2005). In the case of the size factor, about thirty-seven (since 1984).

2) So my alternate explanation is that DFA is not itself willing to take the institutional or reputational risk that the retirement savings money they are managing might encounter one of those periods. They do not have the institutional risk tolerance for factor tilts. Not when they, rather than someone else, is taking responsibility for an entire portfolio.

Sometimes factor enthusiasts like to suggest that other factors are no different from "the market factor," and point out that it, too, is subject to long periods of bad performance. Well, this fund is 93.88% stocks. For whatever reasons, DFA, when given real retirement savings money to manage with a forty year time horizon, is willing to commit--heavily--to the market factor, and feels that young investors can accept this. But it is not willing to commit to small or value tilts.
DFA offers many products for many consumers. If you’re the best cheesecake maker in town, but 80% of the town wants vanilla cake with chocolate icing, you make the vanilla cake too because you’re a business and your job is to grow revenue.

I imagine if you’re a Fortune 500 company, you’re going to require the company you partner with for you 401k to have at least one vanilla target date fund or you wouldn’t make the deal
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by nedsaid »

nisiprius wrote: Tue Nov 30, 2021 7:28 am The following is not evidence against the reality of factors. But it is evidence that factor investing is not a good idea for most investors.

Dimensional Fund Advisors (DFA) has Fama and French on its board of directors. It is more associated with passive factor investing than any other firm. This isn't their advice, this isn't anything they are saying, this is what they are actually doing when a worker trusts them with real retirement savings money to manage for them, and a forty-year time horizon over which to manage it:

Morningstar: Dimensional 2060 Target Date Retirement Income Fund (DRILX), Portfolio

Image

They invest it squarely within the "large blend" style box.

I am not charging DFA with hypocrisy or with insincerity. But I see only two likely explanations. The first is the one I actually believe:

1) They think most investors do not have the conviction to stick with a heavily tilted portfolio. In other words, tilted portfolios are unsuitable for most investors.

Either that, or this: It is, I think, generally accepted that factors have been subject to long periods of underperformance. In the case of value, we have been in one for about sixteen years so far (since 2005). In the case of the size factor, about thirty-seven (since 1984).

2) So my alternate explanation is that DFA is not itself willing to take the institutional or reputational risk that the retirement savings money they are managing might encounter one of those periods. They do not have the institutional risk tolerance for factor tilts. Not when they, rather than someone else, is taking responsibility for an entire portfolio.

Sometimes factor enthusiasts like to suggest that other factors are no different from "the market factor," and point out that it, too, is subject to long periods of bad performance. Well, this fund is 93.88% stocks. For whatever reasons, DFA, when given real retirement savings money to manage with a forty year time horizon, is willing to commit--heavily--to the market factor, and feels that young investors can accept this. But it is not willing to commit to small or value tilts.
Just want to point out that the S&P 500 and Total Stock Market Index are in the Large Core Stylebox but just barely, the dot is almost on the Core/Growth border. Still Large Core but almost Large Growth. The DFA Target Date fund is right in the middle between Large Value and Large Growth, DFA is more "Core" than the "Core" S&P 500 and Total Stock Market Index. So the Value factor in DFA has pulled the dot a bit from left to right.
Last edited by nedsaid on Tue Nov 30, 2021 8:04 am, edited 1 time in total.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by wickywack »

The simplest answer is that factor investing hasn't out performed in the past few years and recency bias is a thing. It will likely have a period of over performance at some point in the future, and it might seem like "everyone" is back on board then. :-)

That said, I think it's more accurate to say factors *had* better risk-adjusted returns in the past. They may or may not in the future. There are a lot of differences of opinion on how likely that is. Some are confident that factors are fundamental and will persist, some believe they'll be arbitraged now that they're well-known, and some believe they were somewhat random / data-mined in the first place.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by nedsaid »

The Morningstar stylebox is sort of like the Rorschach test, where what you see in inkblots reveals things about your personality. I diagnose Nisiprius with a very strong anti-factors bias! :wink: He sees nothing where I see Value.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by tibbitts »

djm2001 wrote: Tue Nov 30, 2021 7:41 am Because an individual's investment portfolio doesn't tell the whole story of their risk exposure. An employee of a small-cap value company should probably short SCV.
I tried that I(well, not shorting, just underweighting) with technology, and that didn't work out that well for me. However I will say that through my 25 years or so of self-employment in tech, my income varied somewhat directly with tech stocks (and to some extent to the stock market in general.) During my last decade of employment, which was in a technology-related job but not working directly for the industry, there was no relationship between my income and any segment of the stock market.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by dbr »

I don't tilt away from a total market portfolio because I don't need to and I don't want to.

One could say that I don't see any utility in the off chance that risk adjusted returns will be better that way. My portfolio meets my objectives just fine.

A consideration here is that the return considered is a hypothetical expected return. Actual returns will be one particular random choice from a very wide range of possible returns "centered" as it were on the expected return. The predictability of certainly being better off with a factor designed portfolio is not high enough to be worth bothering. In fact, it is quite possible the actual performance of the factor portfolio will be worse.

I hate mantras but one I do offer is "Don't expect the expected return (or the expected risk)."
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Taylor Larimore »

larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Is it because it only has better risk adjusted returns under the flawed CAPM model and actually would have similar risk adjusted returns under a five factor model?
Or why?
larsnyborgpedersen:

I believe your statement that factor investing has "better risk adjusted returns" is industry marketing and incorrect. Read this:

https://web.archive.org/web/20170628202 ... proofs.pdf

And read this:

viewtopic.php?f=10&t=156579

Best wishes.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by HomerJ »

Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)
I see an "IF" in your statement.

That should answer your question.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Ben Mathew »

There are two big questions when it comes to factor investing:

1. Does the excess return to factors actually exist?

2. If it exists, is it fair compensation for risk (i.e. assets are correctly priced) or is it risk-adjusted excess return (i.e. assets are incorrectly priced)?

Depending on their answers to these two questions, you get different people doing different things:

- Some people don't believe there are excess returns to factors. So they don't factor invest.

- Some people believe there are excess returns, but it's fair compensation for risk. These people may or may not factor invest depending on whether or not their risk tastes are different from the average investor. And they should be equally likely to tilt in either direction--towards large growth if they like less risk / less return or towards small value if they like more risk / more return.

- Some people believe there are excess returns, and it's caused by underpricing of some assets and overpricing of other assets leading to excess risk-adjusted returns if you hold more of the underpriced assets. These people are likely to tilt at least a little bit. And they would tilt in one direction only -- in the direction of higher returns (so small value, not large growth).

So not everyone factor invests because not everyone has the same opinion about whether factor premiums exist and why they exist.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Dottie57 »

UpperNwGuy wrote: Tue Nov 30, 2021 6:58 am
larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Because my investment goal from the beginning has been to own the market, not to try to beat the market.
Thank you. Very BH answer.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by UpperNwGuy »

larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
OP, why are you not responding to all these answers to your question?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Beensabu »

It's been made clear to me that I simply don't understand it. Therefore, not doing it. How am I supposed to believe in something I don't understand?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by grabiner »

Ben Mathew wrote: Tue Nov 30, 2021 10:30 am There are two big questions when it comes to factor investing:

1. Does the excess return to factors actually exist?

2. If it exists, is it fair compensation for risk (i.e. assets are correctly priced) or is it risk-adjusted excess return (i.e. assets are incorrectly priced)?
And a third question: is it fair compensation for your personal risk? If value stocks do badly in economic downturns, then holding them is a bad deal if you might lose your job when that happens, but a good deal if your job is secure (or you are retired and have no job to lose).

That is my philosophy as a long-established value investor. I do believe that there is compensation for risk, and I prefer to take extra risk by investing in riskier stock rather than by investing in more stock. And I do have a secure job, so I don't worry about the correlation between value stocks and my salary.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by burritoLover »

Beensabu wrote: Tue Nov 30, 2021 8:18 pm It's been made clear to me that I simply don't understand it. Therefore, not doing it. How am I supposed to believe in something I don't understand?
So you fully understand everything you have invested in?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Triple digit golfer »

UpperNwGuy wrote: Tue Nov 30, 2021 6:58 am
larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Because my investment goal from the beginning has been to own the market, not to try to beat the market.
This is such a basic, simple premise of Bogleheads investing, and yet is largely lost many times.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Beensabu »

burritoLover wrote: Tue Nov 30, 2021 8:31 pm
Beensabu wrote: Tue Nov 30, 2021 8:18 pm It's been made clear to me that I simply don't understand it. Therefore, not doing it. How am I supposed to believe in something I don't understand?
So you fully understand everything you have invested in?
I hope so. I think I do. I know why I've made the choices I made, and I'm pretty confident that the reasons that I made them make sense. At least to me.

Why? Does it seem like I don't understand?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by burritoLover »

Beensabu wrote: Tue Nov 30, 2021 8:43 pm
burritoLover wrote: Tue Nov 30, 2021 8:31 pm
Beensabu wrote: Tue Nov 30, 2021 8:18 pm It's been made clear to me that I simply don't understand it. Therefore, not doing it. How am I supposed to believe in something I don't understand?
So you fully understand everything you have invested in?
I hope so. I think I do. I know why I've made the choices I made, and I'm pretty confident that the reasons that I made them make sense. At least to me.

Why? Does it seem like I don't understand?
No - I just think most don’t fully understand what they invest in. I don’t think you have to have an academic level of understanding
to invest in something.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Beensabu »

burritoLover wrote: Tue Nov 30, 2021 9:00 pm
Beensabu wrote: Tue Nov 30, 2021 8:43 pm
burritoLover wrote: Tue Nov 30, 2021 8:31 pm
Beensabu wrote: Tue Nov 30, 2021 8:18 pm It's been made clear to me that I simply don't understand it. Therefore, not doing it. How am I supposed to believe in something I don't understand?
So you fully understand everything you have invested in?
I hope so. I think I do. I know why I've made the choices I made, and I'm pretty confident that the reasons that I made them make sense. At least to me.

Why? Does it seem like I don't understand?
No - I just think most don’t fully understand what they invest in. I don’t think you have to have an academic level of understanding
to invest in something.
I certainly don't have an academic level of understanding when it comes to investing, but that doesn't preclude understanding what you invest in.

People should know why they've made the choices they've made and have some idea of the range of potential outcomes. That's how you stick to your plan, by understanding it. Then you're not surprised by the unexpected, because you already knew it was possible and accounted for it to some extent.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Apathizer »

I think there a couple reasons. Availability is one. Until recently, there weren't many good, widely available factor-slanted products. Thank you Avantis, for taking care of that. :D

I think the other is simplicity. Remember, not everyone is an investment geek, so I think many, perhaps most, DIY investors want to keep it simple with a simple, broadly diversified auto re-balancing fund. There seem to be few, if any, such factor funds.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by mikejuss »

Very few investors have the behavioral grit to hold onto factor investments over a lifetime.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by ivgrivchuck »

I am considering it.

If you look at historical risk-adjusted returns, factors have clearly paid off. The obvious question is if they are going to do that going forward. Some reasons why they might not to:

1) Factors might (at least partially) be result of data mining. If you try a thousand ways to model the stock market, one of the models is going to look good just by a chance.
2) Technological shift. Facebook, Amazon, Google, Tesla are examples of growth stocks that have been made possible by rapid technological progress. Maybe this technological shift favors growth?
3) Low interest rate environment is probably more favorable to growth than value.

That being said the historical data is pretty compelling and key factors seem to appear all around the World...

So... I haven't made up my mind yet, I'm considering starting to mildly tilt small value next year (VIOV), but still considering...
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by ivgrivchuck »

Taylor Larimore wrote: Tue Nov 30, 2021 10:12 am I believe your statement that factor investing has "better risk adjusted returns" is industry marketing and incorrect. Read this:

https://web.archive.org/web/20170628202 ... proofs.pdf
I have no background in economics, but I have some in mathematics and physics.

That "paper" (especially proof for theorem 3) is completely unsound. It even looks like some kind of academic joke.

No matter what one might thing about factor models, let's stick with solid arguments. I'm still undecided...
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by tetractys »

larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Is it because it only has better risk adjusted returns under the flawed CAPM model and actually would have similar risk adjusted returns under a five factor model?
Or why?
It’s not simple enough.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by 9-5 Suited »

Of all the commonly discussed forum topics, this one best fits the bill of “you makes your bets, you takes your chances.”

There have been great works from great minds outlining the benefits of factor investing and great works from great minds outlining the rationale for a total market approach.

I have emerged from the fray (hundreds of hours of reading/listening probably) with the belief that there’s enough to the underlying premise of a value factor risk premium that mixes well with TSM and bonds to justify investing a modest amount of my portfolio in it for the long haul.

If someone doesn’t do it, I completely support that. If someone goes ham and has one of those highly tilted portfolios they describe using its Fama French loading factors, I support that. The only thing I usually don’t support is the condescension the devotees of each camp sometimes visit upon each other.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by djm2001 »

ivgrivchuck wrote: Tue Nov 30, 2021 11:00 pm
That "paper" (especially proof for theorem 3) is completely unsound. It even looks like some kind of academic joke.
Which step in the proof of theorem 3 is unsound? Proofs 2 and 3 seem especially straightforward.

While the conclusion that US TSM is efficient is definitely false, it's because the premise is false, not because the proofs are flawed. The most flawed assumption is that the US stock market is an isolated system that does not interact with the rest of the investable universe (e.g., bonds, international stocks). If the paper had replaced US TSM with the global market portfolio, it would have been more credible... but then CAPM and FF3 would have been insufficient to model bonds.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by lnp »

UpperNwGuy wrote: Tue Nov 30, 2021 6:58 am
larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Because my investment goal from the beginning has been to own the market, not to try to beat the market.
Why is beating the market bad?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by mikejuss »

larsnyborgpedersen wrote: Wed Dec 01, 2021 10:25 am
UpperNwGuy wrote: Tue Nov 30, 2021 6:58 am
larsnyborgpedersen wrote: Tue Nov 30, 2021 6:09 am Why doesn’t everybody factor invest?
Because my investment goal from the beginning has been to own the market, not to try to beat the market.
Why is beating the market bad?
It's not bad; it's very hard to do over the long run and waste of time for most investors to try to do.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Ben Mathew »

grabiner wrote: Tue Nov 30, 2021 8:20 pm
Ben Mathew wrote: Tue Nov 30, 2021 10:30 am There are two big questions when it comes to factor investing:

1. Does the excess return to factors actually exist?

2. If it exists, is it fair compensation for risk (i.e. assets are correctly priced) or is it risk-adjusted excess return (i.e. assets are incorrectly priced)?
And a third question: is it fair compensation for your personal risk? If value stocks do badly in economic downturns, then holding them is a bad deal if you might lose your job when that happens, but a good deal if your job is secure (or you are retired and have no job to lose).

That is my philosophy as a long-established value investor. I do believe that there is compensation for risk, and I prefer to take extra risk by investing in riskier stock rather than by investing in more stock. And I do have a secure job, so I don't worry about the correlation between value stocks and my salary.
Agree. So the third question would be:

3. If factor premiums exist and is fair compensation for risk, then does your personal circumstances indicate the use factor tilts to arrive at your preferred risk profile instead of simply changing stock-bond ratios?

I believe that factor enthusiasts would claim that diversifying across the different risk dimensions is a better (lower risk) way to arrive at your preferred risk-return profile. So in that view, the answer to this question would usually be yes, unless there are specific personal circumstances blocking it.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by lnp »

nisiprius wrote: Tue Nov 30, 2021 7:28 am The following is not evidence against the reality of factors. But it is evidence that factor investing is not a good idea for most investors.

Dimensional Fund Advisors (DFA) has Fama and French on its board of directors. It is more associated with passive factor investing than any other firm. This isn't their advice, this isn't anything they are saying, this is what they are actually doing when a worker trusts them with real retirement savings money to manage for them, and a forty-year time horizon over which to manage it:

Morningstar: Dimensional 2060 Target Date Retirement Income Fund (DRILX), Portfolio

Image

They invest it squarely within the "large blend" style box.

I am not charging DFA with hypocrisy or with insincerity. But I see only two likely explanations. The first is the one I actually believe:

1) They think most investors do not have the conviction to stick with a heavily tilted portfolio. In other words, tilted portfolios are unsuitable for most investors.

Either that, or this: It is, I think, generally accepted that factors have been subject to long periods of underperformance. In the case of value, we have been in one for about sixteen years so far (since 2005). In the case of the size factor, about thirty-seven (since 1984).

2) So my alternate explanation is that DFA is not itself willing to take the institutional or reputational risk that the retirement savings money they are managing might encounter one of those periods. They do not have the institutional risk tolerance for factor tilts. Not when they, rather than someone else, is taking responsibility for an entire portfolio.

Sometimes factor enthusiasts like to suggest that other factors are no different from "the market factor," and point out that it, too, is subject to long periods of bad performance. Well, this fund is 93.88% stocks. For whatever reasons, DFA, when given real retirement savings money to manage with a forty year time horizon, is willing to commit--heavily--to the market factor, and feels that young investors can accept this. But it is not willing to commit to small or value tilts.
Couldn't this be because of different risk profiles? (Factor investing is seen as more risky)
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by lnp »

burritoLover wrote: Tue Nov 30, 2021 7:46 am Factors are just unique sources of risk that describe the differences in returns between two diversified portfolio. It isn't alpha. You are not "beating the market" in the sense that this is some free lunch - you are taking on more risk for greater potential returns but the general expectation is that these risk assets all have the same risk-adjusted return. So, asking why doesn't everybody factor invest is just like asking why isn't everyone invest in the 100% total stock market with no bonds.
But when the individual factors have the same risk-adjusted returns, doesn't it give a better risk-adjusted return when combining them? You know just like combining any two securities that are less than 100% correlated?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by ivgrivchuck »

djm2001 wrote: Wed Dec 01, 2021 6:45 am Which step in the proof of theorem 3 is unsound? Proofs 2 and 3 seem especially straightforward.
From theorem 3:
Suppose some other portfolio P has lower risk than TSM. Then we must have:
β1 ≤ 1
β2 ≤ 0
β3 ≤ 0
with strict inequality holding in at least one of the above inequalities.
This is not true.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by lnp »

dbr wrote: Tue Nov 30, 2021 9:06 am I hate mantras but one I do offer is "Don't expect the expected return (or the expected risk)."
I love this :D (I seem to have had this error in my mind sometimes)
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by lnp »

Beensabu wrote: Tue Nov 30, 2021 8:18 pm It's been made clear to me that I simply don't understand it. Therefore, not doing it. How am I supposed to believe in something I don't understand?
To be honest, I also still have a hard time understanding HOW these factors are risks, except for perhaps size factor and value factor.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by ivgrivchuck »

larsnyborgpedersen wrote: Wed Dec 01, 2021 10:40 am
burritoLover wrote: Tue Nov 30, 2021 7:46 am Factors are just unique sources of risk that describe the differences in returns between two diversified portfolio. It isn't alpha. You are not "beating the market" in the sense that this is some free lunch - you are taking on more risk for greater potential returns but the general expectation is that these risk assets all have the same risk-adjusted return. So, asking why doesn't everybody factor invest is just like asking why isn't everyone invest in the 100% total stock market with no bonds.
But when the individual factors have the same risk-adjusted returns, doesn't it give a better risk-adjusted return when combining them? You know just like combining any two securities that are less than 100% correlated?
That's what the theory says.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by burritoLover »

nisiprius wrote: Tue Nov 30, 2021 7:28 am The following is not evidence against the reality of factors. But it is evidence that factor investing is not a good idea for most investors.

Dimensional Fund Advisors (DFA) has Fama and French on its board of directors. It is more associated with passive factor investing than any other firm. This isn't their advice, this isn't anything they are saying, this is what they are actually doing when a worker trusts them with real retirement savings money to manage for them, and a forty-year time horizon over which to manage it:

Morningstar: Dimensional 2060 Target Date Retirement Income Fund (DRILX), Portfolio

They invest it squarely within the "large blend" style box.

I am not charging DFA with hypocrisy or with insincerity. But I see only two likely explanations. The first is the one I actually believe:

1) They think most investors do not have the conviction to stick with a heavily tilted portfolio. In other words, tilted portfolios are unsuitable for most investors.

Either that, or this: It is, I think, generally accepted that factors have been subject to long periods of underperformance. In the case of value, we have been in one for about sixteen years so far (since 2005). In the case of the size factor, about thirty-seven (since 1984).

2) So my alternate explanation is that DFA is not itself willing to take the institutional or reputational risk that the retirement savings money they are managing might encounter one of those periods. They do not have the institutional risk tolerance for factor tilts. Not when they, rather than someone else, is taking responsibility for an entire portfolio.

Sometimes factor enthusiasts like to suggest that other factors are no different from "the market factor," and point out that it, too, is subject to long periods of bad performance. Well, this fund is 93.88% stocks. For whatever reasons, DFA, when given real retirement savings money to manage with a forty year time horizon, is willing to commit--heavily--to the market factor, and feels that young investors can accept this. But it is not willing to commit to small or value tilts.
Why does Vanguard offer factor-based products then? Vanguard isn't associated with factor investing throughout their history like DFA yet they have small/mid/large cap value, multi-factor, and factor-focused funds available. Perhaps in both cases (DFA and Vanguard), they are simply offering funds that enough of their customers have asked for?
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by MAKsdad »

I am not interested in learning about the minutiae of the market to the point where I can exploit my knowledge. I want to put money in my "total market" fund and go about my day doing things I actually enjoy.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by Triple digit golfer »

MAKsdad wrote: Wed Dec 01, 2021 10:56 am I am not interested in learning about the minutiae of the market to the point where I can exploit my knowledge. I want to put money in my "total market" fund and go about my day doing things I actually enjoy.
Me too, the broadest public equity investment possible. That's why I use Total Stock and Total International Stock.
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by nisiprius »

larsnyborgpedersen wrote: Wed Dec 01, 2021 10:25 am...Why is beating the market bad?...
Why is winning the lottery bad?

It isn't.

You probably think you are taking a harmless verbal shortcut, but I think that when one part of your brain uses them, other parts of your brain get fooled. In this cases, you are muddling an operational strategy with a wished-for outcome.

"Winning the lottery" is a wished-for outcome.
"Playing the lottery" is a strategy for achieving that outcome.
"Winning the lottery" isn't bad.
"Playing the lottery" arguably is.

Of course "beating the market" is not bad, it's a good outcome. But it's a description of a wished-for outcome.

The appropriate question is about the meta-strategy of "trying to beat the market."

Trying to beat the market is arguably bad, because when active mutual fund managers have done it, if they keep at it for a decade or more, 85% of them have failed.

Image

If your goal is to match the market with no more than a few basis points of shortfall, the record shows that broad index funds have achieved that goal with very high reliability. You can be pretty darn sure of very nearly matching the market, if you adopt that as your goal.

If your goal is to beat the market over an investing lifetime, you'd be good or lucky to do that even half the time. In fact your best strategy might well be to invest in a total market index fund, then just before retiring take 10% of your portfolio to the casino and gamble it on one spin of a routlette wheel coming up red.

(And I bet someone is going to follow up with a claim that "black" is the better bet...)
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Re: Why doesn’t everybody factor invest? (If it has better risk-adjusted returns, then why not?)

Post by nisiprius »

larsnyborgpedersen wrote: Wed Dec 01, 2021 10:38 amCouldn't this be because of different risk profiles? (Factor investing is seen as more risky)
Yes.

Your question was "why doesn't everybody factor invest," and you have just given one plausible answer: "because of different risk profiles."

But it is stronger than that. Because this is a general purpose, complete retirement savings portfolio, DFA's actions indicate that they think that most customers for complete retirement savings portfolios have risk preferences that make a tilted portfolio inappropriate for them.

They believe these customers are OK with 93% of their money in stocks, and are willing to stake their reputation on that. But they do not believe these customers are OK with an investment that falls outside the "large blend" style box.
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