Fama and French: The Five-Factor Model Revisited

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Fremdon Ferndock
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Fama and French: The Five-Factor Model Revisited

Post by Fremdon Ferndock »

So how well has Fama and French’s five-factor model explained returns over the decades? According to our analysis, only one factor has truly held up over all time periods.
hint: it isn't value and it isn't small

https://blogs.cfainstitute.org/investor ... revisited/
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Re: Fama and French: The Five-Factor Model Revisited

Post by Random Walker »

Fremdon Ferndock wrote: Sat Jan 15, 2022 9:19 am
So how well has Fama and French’s five-factor model explained returns over the decades? According to our analysis, only one factor has truly held up over all time periods.
hint: it isn't value and it isn't small

https://blogs.cfainstitute.org/investor ... revisited/
Explaining returns and delivering a premium are very different things. I believe the FF5 model has done an excellent job of explaining returns. Which factors have provided a positive premium over a given time period is a completely different issue. The authors conflate the two issues.

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Re: Fama and French: The Five-Factor Model Revisited

Post by JoMoney »

The "risk premium" model of returns is the failure, using a factor regression to look (in hind sight) at the exposures of a portfolio in the same way one might use a Morningstar style-box is at least some usefulness.
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Re: Fama and French: The Five-Factor Model Revisited

Post by rkhusky »

Random Walker wrote: Sat Jan 15, 2022 9:53 am Explaining returns and delivering a premium are very different things.
+1
The FF models don’t predict premiums, they use measured or predicted premiums to predict portfolio returns.
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Re: Fama and French: The Five-Factor Model Revisited

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This article concludes with anti-BH philosophy.
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Re: Fama and French: The Five-Factor Model Revisited

Post by drumboy256 »

This goes to show that Avantis is ahead of the curve again in terms of quality. Not surprising really.
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Re: Fama and French: The Five-Factor Model Revisited

Post by jeffyscott »

I found the linked, “There Is No Size Effect" by Clifford Asness, more interesting. I didn't know that the higher returns from small caps have now apparently been completely "explained" by their higher volatility (beta), after correcting errors in the original data.

As for value, calling it's demise based on a dozen years or so seems premature.

OTOH, it seems too soon to evaluate whether or not the two newer factors will survive their fairly recent "discovery".
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Re: Fama and French: The Five-Factor Model Revisited

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jeffyscott wrote: Sat Jan 15, 2022 10:42 am As for value, calling it's demise based on a dozen years or so seems premature.
Indeed. Almost exactly a year ago, I said that SCV was probably due for some outperformance in part due to so many declaring it to be 'dead', selling their SCV, etc. And in 2021, AVUV outperformed TSM by more than 15%.

My crystal ball is still in the shop, and their customer service is even worse than Vanguard's, but everyone should realize that it may take a long time for factor investing to pay off, and in this context, that can easily be over a decade.

Many appear to have forgotten how badly TSM did from 2000-2009 and how well SCV did back then.
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Re: Fama and French: The Five-Factor Model Revisited

Post by acegolfer »

willthrill81 wrote: Sat Jan 15, 2022 10:49 am Many appear to have forgotten how badly TSM did from 2000-2009 and how well SCV did back then.
I clearly remember that in early 2010's, everyone in this forum praised Larry portfolio. It's true that ppl suffer from recency bias.
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Re: Fama and French: The Five-Factor Model Revisited

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acegolfer wrote: Sat Jan 15, 2022 10:59 am
willthrill81 wrote: Sat Jan 15, 2022 10:49 am Many appear to have forgotten how badly TSM did from 2000-2009 and how well SCV did back then.
I clearly remember that in early 2010's, everyone in this forum praised Larry portfolio. It's true that ppl suffer from recency bias.
They also suffer badly from FOMO. Vanguard's VISVX returned 10% real from 2010-2021. Nobody should be complaining about that, and nobody should have been expecting more than that from any of their stock holdings. All the consternation has to do with the simple fact that U.S. LCG did far better than anyone thought that it would over that same period, which is almost certainly part of the reason that TSM has become so popular in recent years, despite its historically very erratic performance, far more erratic than SCV.
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Re: Fama and French: The Five-Factor Model Revisited

Post by nisiprius »

I have a huge problem with factor advocates, or anyone, saying a) that you have to be prepared to commit for decades to some strategy, while b) changing the strategy a couple of times a decade.

First, "Quality" is not one of the five Fama-French factors, which are "market," "size," "value," "profitability," and "investment."

Second, the constant changes in the story tell us is that financial researchers do not know when they have enough data to make actionable predictions.

This is accompanied by rhetorical maneuvers that walk back claims in subtle ways. And, of course, to be fair, it is not exactly the same people making the initial claims as the people saying later "we never said that."

As Robin Wigglesworth's book, Trillions, confirms, Dimensional Fund Advisors was founded on the size factor. The pure, unadorned size factor and nothing else, and a fund, DFSCX, now known as the DFA US Micro Cap Fund, to allow investors to reap the supposed benefits.

The size factor has been walked back progressively--it's important, just not quite as big as Banz thought; it's important, just not as strong as some others; it's important, but only in raw return, not risk-adjusted return; it's not important even in raw return, but we can "resurrect" it as a flavor enhancer for other factors.

And yet people still constantly post asking how to add small-caps (not small-cap value, just small-caps) to an S&P 500 fund.

Forty years after launch, despite a great start for the first three years,* DFSCX hasn't made a penny more than an S&P 500 index fund,

Image

and instead of saying "fund companies and advisors misapplied research and misled you," they say "O, the size factor? That old thing? Nobody ever really advocated that. Quit looking over there, look at this shiny new factor, hot off the press, this one is the real thing, commit to sticking to it for forty years, and see how that goes.

*I intentionally created my own chart to make sure I was crediting DFSCX with those first three good years, which PortfolioVisualizer doesn't include.
Last edited by nisiprius on Sat Jan 15, 2022 11:53 am, edited 1 time in total.
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Re: Fama and French: The Five-Factor Model Revisited

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willthrill81 wrote: Sat Jan 15, 2022 11:07 am
acegolfer wrote: Sat Jan 15, 2022 10:59 am
willthrill81 wrote: Sat Jan 15, 2022 10:49 am Many appear to have forgotten how badly TSM did from 2000-2009 and how well SCV did back then.
I clearly remember that in early 2010's, everyone in this forum praised Larry portfolio. It's true that ppl suffer from recency bias.
They also suffer badly from FOMO. Vanguard's VISVX returned 10% real from 2010-2021. Nobody should be complaining about that, and nobody should have been expecting more than that from any of their stock holdings. All the consternation has to do with the simple fact that U.S. LCG did far better than anyone thought that it would over that same period, which is almost certainly part of the reason that TSM has become so popular in recent years, despite its historically very erratic performance, far more erratic than SCV.
Yep. You are thinking what should not be thought and saying what should not be said. So I will join you, a lot of the drive for "simplicity" has been good old fashioned performance chasing. Total Market has done great, driven by the FAANG+Microsoft+Tesla. It isn't that Value has done poorly, it actually has done fairly well but not as well as Large Growth.

You can see this in the Morningstar Styleboxes. The broad indexes like Total Stock Market and the S&P 500 were once right in the middle Large Core with the dot right in the middle of the box between Growth and Value. The dot now is next to the Growth box but doesn't yet touch the border between Large Core and Large Growth. So you can see the shift in the broad indexes and Total Market and the S&P 500 have gone from solidly Large Core to almost Large Growth.

Co-ah ain't co-ah no mo'e. I jes' reckon I cain't say what my eyes are a seein', folks jist have to keep they-ah mouth shut, keep they-ah thinkin' to themselfs. That three fun' religin is plenty good fo' most folks aroun' he-ah, jist don't want to stir up too much trouble 'round these parts.

So don't say this too loud, I am sure you know who will arrive shortly to set us all straight. :wink:

To say that the performance of Total Stock Market has been far more erratic than Small Cap Value just simply can't be said. I am sure St. Jack is frowning from heaven. It goes against holy writ. I will just pretend I didn't see that. Too late.
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Re: Fama and French: The Five-Factor Model Revisited

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nisiprius wrote: Sat Jan 15, 2022 11:44 am...
Forty years after launch, despite a great start for the first three years, DFSCX hasn't made a penny more than an S&P 500 index fund...
And that doesn't even account for the fact that for the longest time, the only way to get access to DFA's secret-sauce index like non-index funds was to pay an advisor half a percent (or more) annually.

If one had looked to Vanguard's low cost small-cap index fund results would have been lower. Some people would discount the index fund as being poorly represented by the Russell 2000 over early years (despite the Russell 2000 + Russell 1000 perfectly representing the 'Total Market' Russell 3000) :?
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Re: Fama and French: The Five-Factor Model Revisited

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Fremdon Ferndock wrote: Sat Jan 15, 2022 9:19 am
So how well has Fama and French’s five-factor model explained returns over the decades? According to our analysis, only one factor has truly held up over all time periods.
hint: it isn't value and it isn't small

https://blogs.cfainstitute.org/investor ... revisited/
drumboy256 wrote: Sat Jan 15, 2022 10:37 am This goes to show that Avantis is ahead of the curve again in terms of quality. Not surprising really.
That's why I'm not so focused on SMB since it's actually the least statistically significant of the 5. Size is especially weak in ex-US and emerging markets. It's also important to distinguish between cheap companies with poor fundamentals and potentially under-priced ones relative to fundamentals. It's also important to distinguish between highly profitable growth companies and potentially over-priced ones as many SC growth companies are.
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Re: Fama and French: The Five-Factor Model Revisited

Post by nisiprius »

JoMoney wrote:...DFA's secret-sauce index...
Right, the magic factors that only work in the hands of a master.

If a factor is real, it should always work, even if it works better in some products than others.

The "caffeine factor" is real. You can get the stimulating effects whether you drink Dunkin' Donuts, Starbucks, (real) Hawaiian Kona, Maxwell House, or instant Taster's Choice. Maybe Cafe Quindio 100% Colombian Arabica Excelso Artisanal Cultivation Single Estate Coffee is "better" than the coffee from the rest stop vending machine, but the rest stop coffee will still keep you alert.
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Re: Fama and French: The Five-Factor Model Revisited

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nisiprius wrote: Sat Jan 15, 2022 11:44 am I have a huge problem with factor advocates, or anyone, saying a) that you have to be prepared to commit for decades to some strategy, while b) changing the strategy a couple of times a decade.

First, "Quality" is not one of the five Fama-French factors, which are "market," "size," "value," "profitability," and "investment."

Second, the constant changes in the story tell us is that financial researchers do not know when they have enough data to make actionable predictions.

This is accompanied by rhetorical maneuvers that walk back claims in subtle ways. And, of course, to be fair, it is not exactly the same people making the initial claims as the people saying later "we never said that."

As Robin Wigglesworth's book, Trillions, confirms, Dimensional Fund Advisors was founded on the size factor. The pure, unadorned size factor and nothing else, and a fund, DFSCX, now known as the DFA US Micro Cap Fund, to allow investors to reap the supposed benefits.

The size factor has been walked back progressively--it's important, just not quite as big as Banz thought; it's important, just not as strong as some others; it's important, but only in raw return, not risk-adjusted return; it's not important even in raw return, but we can "resurrect" it as a flavor enhancer for other factors.

And yet people still constantly post asking how to add small-caps (not small-cap value, just small-caps) to an S&P 500 fund.

Forty years after launch, despite a great start for the first three years,* DFSCX hasn't made a penny more than an S&P 500 index fund,

and instead of saying "fund companies and advisors misapplied research and misled you," they say "O, the size factor? That old thing? Nobody ever really advocated that. Quit looking over there, look at this shiny new factor, hot off the press, this one is the real thing, commit to sticking to it for forty years, and see how that goes.
The Size effect was real, it stopped working when too many people knew about it.

Quality has been known about for many years, Charlie Munger was one who knew about this and caused Warren Buffett to modify his strategy from a classic Benjamin Graham margin of safety approach. What Benjamin Graham saw was real but he helped the trend of greatly enlarging the discipline of security analysis, some say he created the discipline though I think there have always been people who try to figure out if market prices are correct. When too many smart and hard working securities analysts entered the field to determine the proper values of stocks, that "Margin of Safety" disappeared for the most part. The arrival of computers to aid with stock analysis didn't help either.

Size still works if you screen smaller stocks with some Quality criteria. There was a Morningstar video and article on this subject a few years ago. Cliff Asness said that Size still works if you screen out the junkier companies.

Markets are dynamic and investor preferences will shift around as investors try to capture various factor premiums. So you can see why the definitions of the various factors have shifted around a bit in response. No mystery here.

So I am not shocked that people have walked things back a bit, "I did not have relations with that Factor Premium." It is just human nature. What the researchers saw in the data when they did their studies was probably real, I think it was more than interpreting ink blots, but was is left out here is that people will respond to new knowledge. There are trillions of dollars searching the globe for any hint of mispricing in any sort of market, trillions that can move at the click of a mouse. You can just see what happens.

My gosh, investment funds are doing such things as buying trailer parks and even single family homes. The well dressed bidders competing with you in buying a new home may not have been fellow homeowners seeking a fancier home but representatives of hedge funds. Next thing you know, the hedgies will be flooding used car lots trying to outsmart the used car dealers. Next will be the new Larry Swedroe article that used cars are the new "must have" asset class. You read it here first.

So you probably need to combine factors a bit, the precise combination is a trade secret or proprietary information, but I don't believe the factors are dead. Eventually, even the professionals who ought to know better will make the behavioral errors that created the factor premiums in the first place.
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

nisiprius wrote: Sat Jan 15, 2022 11:44 am
This is accompanied by rhetorical maneuvers that walk back claims in subtle ways. And, of course, to be fair, it is not exactly the same people making the initial claims as the people saying later "we never said that."
I am shocked, just shocked that rhetorical maneuvers are going on in here.
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

The thing is, you would think that the Index Fund companies were somehow the paragon of virtue, somehow 99 44/100 percent pure like Ivory soap, or as pure as the wind driven snow.

Just want to remind folks that Vanguard changes its indexes all of the time, I think their "Total Indexes" are on their third index that their fund is following. So when we talk about the Total Stock Market, is it the Dow Jones Version, Wilshire, or CRSP? Fidelity has their own proprietary indexes that they use for their Zero funds.

So when we use Vanguard Index funds to do comparisons with factor funds, we have to realize that the benchmark used by the Index has probably changed three times. So the comparisons, while useful, are not perfect. Even Index Funds, like other things in finance, are a bit slippery.
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Re: Fama and French: The Five-Factor Model Revisited

Post by Seasonal »

nedsaid wrote: Sat Jan 15, 2022 12:17 pm The Size effect was real, it stopped working when too many people knew about it.
By the time any of us know about a factor, especially if we wait until it seems reliable, too many people know about it. Information disseminates very rapidly these days.
nedsaid wrote: Sat Jan 15, 2022 12:17 pm So you probably need to combine factors a bit, the precise combination is a trade secret or proprietary information, but I don't believe the factors are dead. Eventually, even the professionals who ought to know better will make the behavioral errors that created the factor premiums in the first place.
The market portfolio is a combination of all factors in a way that the market "regards" as appropriate.
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Re: Fama and French: The Five-Factor Model Revisited

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Seasonal wrote: Sat Jan 15, 2022 12:42 pm
nedsaid wrote: Sat Jan 15, 2022 12:17 pm The Size effect was real, it stopped working when too many people knew about it.
By the time any of us know about a factor, especially if we wait until it seems reliable, too many people know about it. Information disseminates very rapidly these days.
nedsaid wrote: Sat Jan 15, 2022 12:17 pm So you probably need to combine factors a bit, the precise combination is a trade secret or proprietary information, but I don't believe the factors are dead. Eventually, even the professionals who ought to know better will make the behavioral errors that created the factor premiums in the first place.
The market portfolio is a combination of all factors in a way that the market "regards" as appropriate.
The Market Portfolio by definition is the Market Factor. A market portfolio contains Value stocks, contains Small stocks, contains Quality stocks, and so on but does not contain the factors themselves except for the Market factor.

The thing is, if the Market portfolio contains all of the factors, then CAPM would explain 100% of the variances in return of stock portfolios, it only explains about 2/3 of the variances. If the Market Portfolio contains all of the factors, then all stock portfolios should perform about the same, adjusted for risk. We know that isn't true. This all started when researchers found that high volatility stocks performed less well than predicted and that low volatility stocks performed better than the CAPM model predicted. Clearly something else was at work here.
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Re: Fama and French: The Five-Factor Model Revisited

Post by km91 »

I don't see this discussed much but Fama French and other factor models are constructed as relative value long-short portfolios. To capture capture the size premium for example an investor needs to be long small stocks and short big stocks, the premium is the performance spread between small and big stocks. Does tilting towards this factor by holding something like a vanguard small cap or small cap value ETF actually capture the premium described by Fama French if the investor isn't short big or big growth companies as well?
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

nisiprius wrote: Sat Jan 15, 2022 12:10 pm
JoMoney wrote:...DFA's secret-sauce index...
Right, the magic factors that only work in the hands of a master.

If a factor is real, it should always work, even if it works better in some products than others.
This has been a frustration of those of us attempting to capture factor premiums. It is following the right guru, buying the right product, and loading the factors in the right combination.

I do my research, do the analysis, buy the "right" fund only to read 20 minutes later that I made the wrong decision. Particularly when I didn't want to pay an Advisor 1% a year for access to the right funds.

I am of the school of thought that good enough is good enough and close enough is close enough. Thus I have stuck to the factor products that I purchased and haven't chased the latest and greatest. Though I greatly admire the Avantis team and the products they are putting out there, I haven't switched to their funds.

I will say that if you seek to optimize factors, Avantis seems to be the best bet right now.
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Re: Fama and French: The Five-Factor Model Revisited

Post by abc132 »

The idea that someone may have to wait more than a decade for SCV to show a benefit is not going to move anyone new into investing into SCV. It is a construct in which someone falsely convinces themselves they just have to wait a decade plus and they will see the outperformance. It is a way to avoid looking at what the research since factor discovery has shown. The repeated mistakes will be measuring the past without looking at how acting on past information has actually performed, and altering method and strategy long before the period in which the method is supposed to materialize. A construct in which one can never be wrong is deeply flawed.


As someone skeptical of most predictions, here is what would convince me:
Show me how well the set of predictions match outcome
I don't mean one of five factors still working, I mean that the set of predictions were fundamentally correct - That the sum of factors identified have had a subsequent positive chance of giving outperformance, without alteration or bending to what did happen.

Can we really just wait long enough for the past to repeat itself with respect to SCV, without having to look at how well the entire set of factors have met predictions?

Can we really just pick the one of five predictions that showed a subsequent benefit and call that less than 50% outcome predictive?

If you are a SCV advocate, what data would convince you to change your course of action?
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Re: Fama and French: The Five-Factor Model Revisited

Post by rkhusky »

nedsaid wrote: Sat Jan 15, 2022 11:52 am You can see this in the Morningstar Styleboxes. The broad indexes like Total Stock Market and the S&P 500 were once right in the middle Large Core with the dot right in the middle of the box between Growth and Value. The dot now is next to the Growth box but doesn't yet touch the border between Large Core and Large Growth. So you can see the shift in the broad indexes and Total Market and the S&P 500 have gone from solidly Large Core to almost Large Growth.
This is just an artifact of discretization and how Morningstar calculates growth/value. Since growth/value is a relative measure, TSM should always be right in the middle.
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Re: Fama and French: The Five-Factor Model Revisited

Post by rkhusky »

nisiprius wrote: Sat Jan 15, 2022 11:44 am I have a huge problem with factor advocates, or anyone, saying a) that you have to be prepared to commit for decades to some strategy, while b) changing the strategy a couple of times a decade.
I was thinking of that when I was reading the ARK threads and how people were bailing from the sinking ship. I'm sure the managers are saying something like "Be patient. You have to be in it for the long run. You have to have faith. You might have to wait 40 years, but eventually there will be a payoff."
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Re: Fama and French: The Five-Factor Model Revisited

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rkhusky wrote: Sat Jan 15, 2022 1:43 pm
nedsaid wrote: Sat Jan 15, 2022 11:52 am You can see this in the Morningstar Styleboxes. The broad indexes like Total Stock Market and the S&P 500 were once right in the middle Large Core with the dot right in the middle of the box between Growth and Value. The dot now is next to the Growth box but doesn't yet touch the border between Large Core and Large Growth. So you can see the shift in the broad indexes and Total Market and the S&P 500 have gone from solidly Large Core to almost Large Growth.
This is just an artifact of discretization and how Morningstar calculates growth/value. Since growth/value is a relative measure, TSM should always be right in the middle.
Well then, why isn't the dot in the middle? Why is Morningstar putting the dot almost at the Core/Growth border? What is it you know that Morningstar doesn't?

I agree that TSM by definition should be in the middle, but Morningstar for some reason has moved the dot to the right. Obviously something has happened at Morningstar or something has happened to TSM. My guess is we are seeing the FAANG+Microsoft+Tesla effect.
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Re: Fama and French: The Five-Factor Model Revisited

Post by rkhusky »

nedsaid wrote: Sat Jan 15, 2022 1:50 pm I agree that TSM by definition should be in the middle, but Morningstar for some reason has moved the dot to the right. Obviously something has happened at Morningstar or something has happened to TSM. My guess is we are seeing the FAANG+Microsoft+Tesla effect.
If Morningtar is discretizing, such that each company can only be Growth or Value, then several of the giant companies being right on the edge of a boundary could cause distortions.

Here is a long description of the methodology. Doesn't appear that value/growth is a single measure.
https://www.morningstar.com/content/dam ... odolgy.pdf
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Re: Fama and French: The Five-Factor Model Revisited

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rkhusky wrote: Sat Jan 15, 2022 1:58 pm
nedsaid wrote: Sat Jan 15, 2022 1:50 pm I agree that TSM by definition should be in the middle, but Morningstar for some reason has moved the dot to the right. Obviously something has happened at Morningstar or something has happened to TSM. My guess is we are seeing the FAANG+Microsoft+Tesla effect.
If Morningtar is discretizing, such that each company can only be Growth or Value, then several of the giant companies being right on the edge of a boundary could cause distortions.

Here is a long description of the methodology. Doesn't appear that value/growth is a single measure.
https://www.morningstar.com/content/dam ... odolgy.pdf
It is all relative. For example, when the stock market drops by 50%, Morningstar doesn't say that now the market has a lot more Small Caps, the Stylebox weightings remain about the same. Also "Value" and "Growth" would also be relative. In recent years, Morningstar has dropped Small Cap from 9% to 6% of the US Market, that is the biggest adjustment I have seen them make.

That being said, it does raise an eyebrow when the dot for the S&P 500 and Total Stock Market Indexes move to the right. The Large Value, Large Core, and Large Growth weightings don't move very much at all but it seems like Morningstar wanted to communicate something by moving the dot. Maybe they are saying that valuations for Large Growth keep getting higher or that the Large Growth stocks are a higher proportion of the US Total Stock Market and S&P 500.

This discussion highlights the imperfection of measurement tools.
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Re: Fama and French: The Five-Factor Model Revisited

Post by acegolfer »

km91 wrote: Sat Jan 15, 2022 12:52 pm I don't see this discussed much but Fama French and other factor models are constructed as relative value long-short portfolios. To capture capture the size premium for example an investor needs to be long small stocks and short big stocks, the premium is the performance spread between small and big stocks. Does tilting towards this factor by holding something like a vanguard small cap or small cap value ETF actually capture the premium described by Fama French if the investor isn't short big or big growth companies as well?
In asset pricing theory, the risk-factors are on the multi-dimension efficient surface. Any long only SCV are not efficient and will contain idiosyncratic risks. The idiosyncratic risks are risks but aren't compensated by the higher expected return. In sum, when we use available SCV to invest, it won't be efficient (in the sense that it won't be on multi-dimension efficient surface).
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Re: Fama and French: The Five-Factor Model Revisited

Post by AlwaysLearningMore »

nisiprius wrote: Sat Jan 15, 2022 11:44 am I have a huge problem with factor advocates, or anyone, saying a) that you have to be prepared to commit for decades to some strategy, while b) changing the strategy a couple of times a decade.

First, "Quality" is not one of the five Fama-French factors, which are "market," "size," "value," "profitability," and "investment."

Second, the constant changes in the story tell us is that financial researchers do not know when they have enough data to make actionable predictions.

This is accompanied by rhetorical maneuvers that walk back claims in subtle ways. And, of course, to be fair, it is not exactly the same people making the initial claims as the people saying later "we never said that."

As Robin Wigglesworth's book, Trillions, confirms, Dimensional Fund Advisors was founded on the size factor. The pure, unadorned size factor and nothing else, and a fund, DFSCX, now known as the DFA US Micro Cap Fund, to allow investors to reap the supposed benefits.

The size factor has been walked back progressively--it's important, just not quite as big as Banz thought; it's important, just not as strong as some others; it's important, but only in raw return, not risk-adjusted return; it's not important even in raw return, but we can "resurrect" it as a flavor enhancer for other factors.

And yet people still constantly post asking how to add small-caps (not small-cap value, just small-caps) to an S&P 500 fund.

Forty years after launch, despite a great start for the first three years,* DFSCX hasn't made a penny more than an S&P 500 index fund,

Image

and instead of saying "fund companies and advisors misapplied research and misled you," they say "O, the size factor? That old thing? Nobody ever really advocated that. Quit looking over there, look at this shiny new factor, hot off the press, this one is the real thing, commit to sticking to it for forty years, and see how that goes.

*I intentionally created my own chart to make sure I was crediting DFSCX with those first three good years, which PortfolioVisualizer doesn't include.
This is a great post.
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Re: Fama and French: The Five-Factor Model Revisited

Post by Driver »

AlwaysLearningMore wrote: Sat Jan 15, 2022 3:09 pm
nisiprius wrote: Sat Jan 15, 2022 11:44 am I have a huge problem with factor advocates, or anyone, saying a) that you have to be prepared to commit for decades to some strategy, while b) changing the strategy a couple of times a decade.

First, "Quality" is not one of the five Fama-French factors, which are "market," "size," "value," "profitability," and "investment."

Second, the constant changes in the story tell us is that financial researchers do not know when they have enough data to make actionable predictions.

This is accompanied by rhetorical maneuvers that walk back claims in subtle ways. And, of course, to be fair, it is not exactly the same people making the initial claims as the people saying later "we never said that."

As Robin Wigglesworth's book, Trillions, confirms, Dimensional Fund Advisors was founded on the size factor. The pure, unadorned size factor and nothing else, and a fund, DFSCX, now known as the DFA US Micro Cap Fund, to allow investors to reap the supposed benefits.

The size factor has been walked back progressively--it's important, just not quite as big as Banz thought; it's important, just not as strong as some others; it's important, but only in raw return, not risk-adjusted return; it's not important even in raw return, but we can "resurrect" it as a flavor enhancer for other factors.

And yet people still constantly post asking how to add small-caps (not small-cap value, just small-caps) to an S&P 500 fund.

Forty years after launch, despite a great start for the first three years,* DFSCX hasn't made a penny more than an S&P 500 index fund,

Image

and instead of saying "fund companies and advisors misapplied research and misled you," they say "O, the size factor? That old thing? Nobody ever really advocated that. Quit looking over there, look at this shiny new factor, hot off the press, this one is the real thing, commit to sticking to it for forty years, and see how that goes.

*I intentionally created my own chart to make sure I was crediting DFSCX with those first three good years, which PortfolioVisualizer doesn't include.
This is a great post.
:beer
I've followed factor investing for all of my investing career and I agree. Great post Nisi!
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Re: Fama and French: The Five-Factor Model Revisited

Post by afan »

nedsaid wrote: Sat Jan 15, 2022 12:51 pm

The Market Portfolio by definition is the Market Factor. A market portfolio contains Value stocks, contains Small stocks, contains Quality stocks, and so on but does not contain the factors themselves except for the Market factor.

The thing is, if the Market portfolio contains all of the factors, then CAPM would explain 100% of the variances in return of stock portfolios, it only explains about 2/3 of the variances.
The market portfolio clearly contains all the factors because it contains all the stocks. I don't follow why this should make the CAPM explain all the variance. Among many other things, the current value of the market reflects a consensus estimate of future risk adjusted returns. To expect that to explain 100% of the variance would require that the estimate is perfect. It would require that nothing unexpected ever happens.

The unexpected happens all the time, so there is no reason for the CAPM to predict all future events. It had nothing to tell us in Jan 2019 about COVID. But COVID continues to have major effects on prices...

Regarding size, I believe it was in their first 5 factor paper where F&F said that size was no longer a significant part of the model.

Much of the original size effect was an illusion due to several problems with the data. Once corrected, much and perhaps all of the size effect went away.

I don't think Fama ever claimed that factors were a way to achieve increased risk adjusted returns. He has been consistent in his opinion that, to the extent that portfolios that overweight some factors may have increased returns, it is because they come with higher risk.
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

afan wrote: Sat Jan 15, 2022 3:47 pm
nedsaid wrote: Sat Jan 15, 2022 12:51 pm

The Market Portfolio by definition is the Market Factor. A market portfolio contains Value stocks, contains Small stocks, contains Quality stocks, and so on but does not contain the factors themselves except for the Market factor.

The thing is, if the Market portfolio contains all of the factors, then CAPM would explain 100% of the variances in return of stock portfolios, it only explains about 2/3 of the variances.
The market portfolio clearly contains all the factors because it contains all the stocks. I don't follow why this should make the CAPM explain all the variance. Among many other things, the current value of the market reflects a consensus estimate of future risk adjusted returns. To expect that to explain 100% of the variance would require that the estimate is perfect. It would require that nothing unexpected ever happens.

The unexpected happens all the time, so there is no reason for the CAPM to predict all future events. It had nothing to tell us in Jan 2019 about COVID. But COVID continues to have major effects on prices...

Regarding size, I believe it was in their first 5 factor paper where F&F said that size was no longer a significant part of the model.

Much of the original size effect was an illusion due to several problems with the data. Once corrected, much and perhaps all of the size effect went away.

I don't think Fama ever claimed that factors were a way to achieve increased risk adjusted returns. He has been consistent in his opinion that, to the extent that portfolios that overweight some factors may have increased returns, it is because they come with higher risk.
CAPM, the 3 factor, and 5 factors do not predict future events. I am not sure where you got this idea, no one makes this argument that I am aware of. The factor models could be used to produce estimates of future expected returns or perhaps be used in market simulations to predict how certain groups of stocks would behave under differing market scenarios. We all know that estimates and simulations are educated guesses of what might happen. No factor model or any market simulation is going to predict when or if Putin's tanks will roll into Vilnius, Lithuania. You are making a classic strawman argument here.

The best that models and simulations could do is make an estimate of the distribution of future returns, in other words projecting returns within certain ranges. No one is going to make exact predictions.

Factors have to do with the characteristics of stocks that explain the variances in returns among stock portfolios, they have nothing to do with predicting future events which is different from estimating future returns. For example, why does a High Tech stock perform differently than a Utility stock? The answer would be such things as Earnings Growth rates, consistency of earnings, strength of the balance sheet, market capitalization, investor enthusiasm for the stock, etc. The idea of Factor premiums is that over long periods of time stocks with certain characteristics will outperform the market itself. Certain negative characteristics will cause certain other stocks to underperform the market.

If factors other than the volatility of the market itself didn't exist, then all stocks would have the same risk adjusted returns and that just is not true. If what you say is true, the risk adjusted returns of Blue Chip stocks and the most speculative stocks (like those that trade on the Vancouver Stock Exchange or on the NASDAQ Bulletin Board) would be the same. It really wouldn't matter what type of stocks you invested in.

We all know that there are stocks so risky that investing in them will produce an almost guaranteed loss, sometimes up to 100%. These are the so-called Lottery Stocks from which you might get a big winner every once in a great while, but most all of them are complete duds. There is a point at which just increasing risk will actually start reducing your returns and not increase them. Investing in truly terrible companies and perhaps outright scams are not going to produce positive investing results unless you are doing something like pump and dump. I remember a teenage stock wizard who published an online newsletter for stocks with thin trading volumes. He would buy the stock, pump it up with his newsletter, and then sell his stocks while his subscribers were buying.

I got clued into factors because I could see that certain industry sectors within the U.S. Stock Market would perform differently from each other. The best stocks in the Pharmaceutical industry were considered Blue Chips because of their consistent earnings growth rate, they were growing stocks in a growing industry. Energy stocks, on the other hand were more volatile because they were more economically sensitive and were subject to the volatility of the underlying energy prices. Certain industries like Consumer Staples, were called defensive stocks because demand for their products didn't change much during recessions, what these companies produced were necessities. Other sectors like Housing, Wood Products, Automobiles were classic cyclical stocks because demand for their products rose and fell with the economy. Weird, but the Technology Sector used to be very cyclical but now tend to be the more classic Growth stocks.

Before factors were well known, people talked about investing styles. There was Growth, there was Value, there was Growth at a Reasonable Price, there were people who only invested in the safer Blue Chips, there were the cycle jockeys who played cyclical stocks and economic cycles. There were also the Momentum junkies and the trend followers. Investing styles, as well as Sector investing were the precursors to what the Academics call factor investing. The Academics better explained and better documented what investors had known or suspected for decades.

Total Market does not contain all of the factors though it does contain all of the stocks. Factors are a way of saying that different types of stocks behave differently. This has been known by investors for many decades and I am astonished that you don't realize this.

Going from memory, CAPM explained about 2/3 of the variance in returns from stock portfolios. The 3 factor model explained about 90% and the 5 factor model got it up to 96% or so.
Last edited by nedsaid on Sat Jan 15, 2022 7:13 pm, edited 4 times in total.
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Re: Fama and French: The Five-Factor Model Revisited

Post by 000 »

Who would've thought that backtesting doesn't work? :mrgreen:

Next up: the US equity index risk premium revisited. :twisted:
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Re: Fama and French: The Five-Factor Model Revisited

Post by rkhusky »

nedsaid wrote: Sat Jan 15, 2022 2:25 pm It is all relative. For example, when the stock market drops by 50%, Morningstar doesn't say that now the market has a lot more Small Caps, the Stylebox weightings remain about the same. Also "Value" and "Growth" would also be relative. In recent years, Morningstar has dropped Small Cap from 9% to 6% of the US Market, that is the biggest adjustment I have seen them make.

That being said, it does raise an eyebrow when the dot for the S&P 500 and Total Stock Market Indexes move to the right. The Large Value, Large Core, and Large Growth weightings don't move very much at all but it seems like Morningstar wanted to communicate something by moving the dot. Maybe they are saying that valuations for Large Growth keep getting higher or that the Large Growth stocks are a higher proportion of the US Total Stock Market and S&P 500.

This discussion highlights the imperfection of measurement tools.
The methodology for computing value/growth appears fairly complex. It uses Price-to-Projected Earnings, Price-to-Book, Price-to-Sales, Price-to-Cash Flow and Dividend Yield to compute a value score. And Long-Term Projected Earnings Growth , Book Value Growth, Sales Growth, Cash Flow Growth, and Historical Earnings Growth to compute a growth score.

Most of their 39-page document is explaining the value/growth calculations.

With something this complex, can you really trust that their definition of value/growth matches up with your expectations? And it's not clear what the sensitivity of the model is to various parameters choices.

They say they started using this methodology for US stocks in 2002.
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

rkhusky wrote: Sat Jan 15, 2022 7:31 pm
nedsaid wrote: Sat Jan 15, 2022 2:25 pm It is all relative. For example, when the stock market drops by 50%, Morningstar doesn't say that now the market has a lot more Small Caps, the Stylebox weightings remain about the same. Also "Value" and "Growth" would also be relative. In recent years, Morningstar has dropped Small Cap from 9% to 6% of the US Market, that is the biggest adjustment I have seen them make.

That being said, it does raise an eyebrow when the dot for the S&P 500 and Total Stock Market Indexes move to the right. The Large Value, Large Core, and Large Growth weightings don't move very much at all but it seems like Morningstar wanted to communicate something by moving the dot. Maybe they are saying that valuations for Large Growth keep getting higher or that the Large Growth stocks are a higher proportion of the US Total Stock Market and S&P 500.

This discussion highlights the imperfection of measurement tools.
The methodology for computing value/growth appears fairly complex. It uses Price-to-Projected Earnings, Price-to-Book, Price-to-Sales, Price-to-Cash Flow and Dividend Yield to compute a value score. And Long-Term Projected Earnings Growth , Book Value Growth, Sales Growth, Cash Flow Growth, and Historical Earnings Growth to compute a growth score.

Most of their 39-page document is explaining the value/growth calculations.

With something this complex, can you really trust that their definition of value/growth matches up with your expectations? And it's not clear what the sensitivity of the model is to various parameters choices.

They say they started using this methodology for US stocks in 2002.
Thank you for digging into this. I downloaded the White Paper but I just didn't want to tackle it today. I quite often will go to the summary anyways. When I see detailed math explanations and lots of formulas, my eyes glaze over. A quant I am not.

There is no precise definition of Growth or Value. It is more a range of characteristics that are different from the market itself. My shorthand definitions are: Value stocks trade at a discount to intrinsic value and Growth stocks are stocks that grow earnings at a faster rate than nominal GDP Growth.
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Re: Fama and French: The Five-Factor Model Revisited

Post by LadyGeek »

Is anyone willing to take a crack at updating the wiki? Fama and French five-factor model
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Re: Fama and French: The Five-Factor Model Revisited

Post by muffins14 »

This is a pretty weak article. Why are people so engrossed in it?

They choose some data since 1920 and some since 1960s. They don’t really explain their method at all, for how they create the baskets of stocks they say track the factors, and they claim to address the question “so how well has Fama and French’s five-factor model explained returns over the decades?“ but none of the analysis even addresses that, they just look wt what cumulative returns are highest. They don’t talk at all about explaining returns.

This article isn’t helpful for any decision making I think, unless you wanted to know what had the highest cumulative return from arbitrary and different start dates. That’s not a good way to build a portfolio
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

LadyGeek wrote: Sat Jan 15, 2022 7:54 pm Is anyone willing to take a crack at updating the wiki? Fama and French five-factor model
I would have some interest but I am not a quant and my grasp of statistics is limited. I focus more on the behavioral explanations of the factors and frame my arguments in narrative form. I also talk about some of the history of how all of this came about. My career background has mostly been Accounting and Tax, so I am good at basic math, it would be good to have someone who could better explain the more advanced concepts behind all of this. Stuff like statistics, range and distribution of outcomes.

There is a balance here, there needs to be enough math to get the theory across and yet tell it in an informative and entertaining fashion. It isn't easy to do.

Another way to approach it, would be a point vs. counterpoint discussion. Someone who advocates for factors and one who does not. Nisiprius has been great as a "counterpoint", he took on even Larry Swedroe using his graphs and real life examples of what could have been achieved with actual funds. JoMoney's "counterpoints" are quite good too. Not sure who the best factor advocate would be.

Simplegift does a good job of explaining these type of topics, not sure what his stance on factors is, but certainly would do a great job of presentation. Siamond is also good at explaining things like this.

One could also compile the "best of" posts explaining factors and also arguments for and against. I know speaking for myself, I post much of the same material over and over again in various threads. Were I doing this, I would go through the best threads and the best posts on this topic. Probably excellent material from Larry Swedroe's old posts.

I would also link to John Bogle's Telltale Chart speech and provide a summary. Somewhere Larry Swedroe responded to that speech in his many posts. That would also shed light.
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Re: Fama and French: The Five-Factor Model Revisited

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Just read the article again, what I would say is that the Quality factor makes both Size and Value work better and I wished the article had pointed that out. I think the future of factor investing is the combination of two or three additional factors beyond Market. Also, I think that combining factors too much can lead to a cancelling out effect and disappointing results. These discussions make me think of the famous Charley Munger quote that "I would rather buy a great company at a good price than a good company at a great price."
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Re: Fama and French: The Five-Factor Model Revisited

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nedsaid wrote: Sat Jan 15, 2022 8:39 pm Just read the article again, what I would say is that the Quality factor makes both Size and Value work better and I wished the article had pointed that out. I think the future of factor investing is the combination of two or three additional factors beyond Market. Also, I think that combining factors too much can lead to a cancelling out effect and disappointing results. These discussions make me think of the famous Charley Munger quote that "I would rather buy a great company at a good price than a good company at a great price."
I'm a pretty short timer so far into the value investing world but quality has been what I looked for in picking value funds. The RmW has been the focus of many new funds as well. I'm even hearing that DFA is exploring a profitability screened growth fund. That will be interesting.

I love that last quote you added in there and why some are surprised to see something like Apple in some value funds.
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

jason2459 wrote: Sat Jan 15, 2022 8:46 pm
nedsaid wrote: Sat Jan 15, 2022 8:39 pm Just read the article again, what I would say is that the Quality factor makes both Size and Value work better and I wished the article had pointed that out. I think the future of factor investing is the combination of two or three additional factors beyond Market. Also, I think that combining factors too much can lead to a cancelling out effect and disappointing results. These discussions make me think of the famous Charley Munger quote that "I would rather buy a great company at a good price than a good company at a great price."
I'm a pretty short timer so far into the value investing world but quality has been what I looked for in picking value funds. The RmW has been the focus of many new funds as well. I'm even hearing that DFA is exploring a profitability screened growth fund. That will be interesting.

I love that last quote you added in there and why some are surprised to see something like Apple in some value funds.
Yes, Quality is important even for Value investors. Companies are undervalued either because they are out of favor or because the company is running into problems. You want to pick up a true bargain and not something that is cheap for a very good reason, like a dying company in a dying industry.

Management is another consideration. I think of Peter Lynch making a big investment in Chrysler when he managed the Fidelity Magellan Fund. Chrysler had horrible products, awful financials, and needed a government loan to tide them over until things could be turned around. Lynch was impressed with Lee Iacocca, Bob Lutz who was very passionate about cars, and a crack design team with some excellent products in the pipeline. Awful company with great new people with a passion for the business and a plan to turn things around.

So Value investing is more than running the numbers. There are intangible qualities that need to be considered and Peter Lynch's Chrysler story is the most dramatic example of that.

The analogy that I often use here is that I want to buy fine Cuban cigars when they go on sale and not just pick up discarded cigar butts for the last few puffs. Quality makes a big difference.
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

JoMoney wrote: Sat Jan 15, 2022 11:53 am
nisiprius wrote: Sat Jan 15, 2022 11:44 am...
Forty years after launch, despite a great start for the first three years, DFSCX hasn't made a penny more than an S&P 500 index fund...
And that doesn't even account for the fact that for the longest time, the only way to get access to DFA's secret-sauce index like non-index funds was to pay an advisor half a percent (or more) annually.

If one had looked to Vanguard's low cost small-cap index fund results would have been lower. Some people would discount the index fund as being poorly represented by the Russell 2000 over early years (despite the Russell 2000 + Russell 1000 perfectly representing the 'Total Market' Russell 3000) :?
Avantis has solved the problem you discuss above, they offer an excellent suite of ETFs that offer an updated factors approach very similar to DFA. Avantis will soon launch a Small Cap ETF that will invest in Micro-Caps. No need for an Advisor to access.
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Re: Fama and French: The Five-Factor Model Revisited

Post by Schlabba »

muffins14 wrote: Sat Jan 15, 2022 8:17 pm This is a pretty weak article. Why are people so engrossed in it?

They choose some data since 1920 and some since 1960s. They don’t really explain their method at all, for how they create the baskets of stocks they say track the factors, and they claim to address the question “so how well has Fama and French’s five-factor model explained returns over the decades?“ but none of the analysis even addresses that, they just look wt what cumulative returns are highest. They don’t talk at all about explaining returns.

This article isn’t helpful for any decision making I think, unless you wanted to know what had the highest cumulative return from arbitrary and different start dates. That’s not a good way to build a portfolio
They also forgot all the international stockmarkets where the factors showed up.
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Re: Fama and French: The Five-Factor Model Revisited

Post by jason2459 »

nedsaid wrote: Sat Jan 15, 2022 9:14 pm
JoMoney wrote: Sat Jan 15, 2022 11:53 am
nisiprius wrote: Sat Jan 15, 2022 11:44 am...
Forty years after launch, despite a great start for the first three years, DFSCX hasn't made a penny more than an S&P 500 index fund...
And that doesn't even account for the fact that for the longest time, the only way to get access to DFA's secret-sauce index like non-index funds was to pay an advisor half a percent (or more) annually.

If one had looked to Vanguard's low cost small-cap index fund results would have been lower. Some people would discount the index fund as being poorly represented by the Russell 2000 over early years (despite the Russell 2000 + Russell 1000 perfectly representing the 'Total Market' Russell 3000) :?
Avantis has solved the problem you discuss above, they offer an excellent suite of ETFs that offer an updated factors approach very similar to DFA. Avantis will soon launch a Small Cap ETF that will invest in Micro-Caps. No need for an Advisor to access.
Even before Avantis, DFA used profitablity as well. And for passive index funds the S&P indices have a set of quality like qualification to get on and stay in the listings. So even though the SP600 value index mentions three specific methods to determine value there's also the initial quality screen to get into the SP 600 universe. I know of three funds that use that index VIOV, SLYV, and IJS.

AVSC Avantis' smaller approach was released this past week. It's avg market cap is 1.62B right now

AVUS avg market cap 2.71B

VIOV avg market cap 1.96B

Just interesting stats.

Because then there's the SP600 pure value index like the RZV ETF with a market cap avg of 1.08B

So is going down into the microcaps really worth it? Is SmB to the extreme going to to pull something out of the hat? I don't think so

SP600 value vs pure value since at least 2006
https://www.portfoliovisualizer.com/bac ... ion2_2=100

Don't know where I'm really going with this. Just something fun to look up.
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Re: Fama and French: The Five-Factor Model Revisited

Post by Nathan Drake »

nisiprius wrote: Sat Jan 15, 2022 11:44 am I have a huge problem with factor advocates, or anyone, saying a) that you have to be prepared to commit for decades to some strategy, while b) changing the strategy a couple of times a decade.

First, "Quality" is not one of the five Fama-French factors, which are "market," "size," "value," "profitability," and "investment."
A) is no different than investing in a bog standard total stock market fund. If you expect a premium from the market over bonds, you have to potentially be willing to commit for decades to this strategy, seeing how the US stock market and individual foriegn stock markets have gone through periods of significant underperformance for decades.

The good thing with taking on more risk with SCV funds is that their underperformance is relative to the market and tends to still do quite well without comparing their returns to the total market (ex: 10% annualized from 2010 - 2021 was still a great outcome). By taking on this additional risk, and diversifying across a wider spectrum of risk premiums, SCV funds have far less start date sensitivity compared to TSM funds - less likelihood of poor outcomes over 5 or 10 year periods.

B) This is not consistent with what the academic factors studied. There are multiple measures of "Value" that all work, even though they may have a certain dispersion of returns due to their own "secret sauce" by including various quality screens. A bog standard SCV index fund, RUT 2000 Value, has shown a premium without any significant screens compared to, say, Avantis. And this includes many of the "junk stocks" that Avantis tries to weed out.

And, as mentioned, even very popular index funds (S&P 500) have quality screens, so this is not uncommon for even "TSM" funds.
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Re: Fama and French: The Five-Factor Model Revisited

Post by Random Walker »

rkhusky wrote: Sat Jan 15, 2022 7:31 pm
The methodology for computing value/growth appears fairly complex. It uses Price-to-Projected Earnings, Price-to-Book, Price-to-Sales, Price-to-Cash Flow and Dividend Yield to compute a value score. And Long-Term Projected Earnings Growth , Book Value Growth, Sales Growth, Cash Flow Growth, and Historical Earnings Growth to compute a growth score.

Most of their 39-page document is explaining the value/growth calculations.

With something this complex, can you really trust that their definition of value/growth matches up with your expectations? And it's not clear what the sensitivity of the model is to various parameters choices.

They say they started using this methodology for US stocks in 2002.
I take a different view. I take the view that “Price/Anything” is effectively a measure of relative value. The fact that there are so many potential value screens attests to the robustness of value overall. That being said, I understand that multiple metrics are probably better than a single metric.

Dave
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Re: Fama and French: The Five-Factor Model Revisited

Post by Seasonal »

nedsaid wrote: Sat Jan 15, 2022 12:51 pm
Seasonal wrote: Sat Jan 15, 2022 12:42 pm
nedsaid wrote: Sat Jan 15, 2022 12:17 pm The Size effect was real, it stopped working when too many people knew about it.
By the time any of us know about a factor, especially if we wait until it seems reliable, too many people know about it. Information disseminates very rapidly these days.
nedsaid wrote: Sat Jan 15, 2022 12:17 pm So you probably need to combine factors a bit, the precise combination is a trade secret or proprietary information, but I don't believe the factors are dead. Eventually, even the professionals who ought to know better will make the behavioral errors that created the factor premiums in the first place.
The market portfolio is a combination of all factors in a way that the market "regards" as appropriate.
The Market Portfolio by definition is the Market Factor. A market portfolio contains Value stocks, contains Small stocks, contains Quality stocks, and so on but does not contain the factors themselves except for the Market factor.

The thing is, if the Market portfolio contains all of the factors, then CAPM would explain 100% of the variances in return of stock portfolios, it only explains about 2/3 of the variances. If the Market Portfolio contains all of the factors, then all stock portfolios should perform about the same, adjusted for risk. We know that isn't true. This all started when researchers found that high volatility stocks performed less well than predicted and that low volatility stocks performed better than the CAPM model predicted. Clearly something else was at work here.
Why should the that be the case? CAPM is a simplistic model relying solely on mean and variance.
jatwell
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Re: Fama and French: The Five-Factor Model Revisited

Post by jatwell »

nisiprius wrote: Sat Jan 15, 2022 11:44 am I have a huge problem with factor advocates, or anyone, saying a) that you have to be prepared to commit for decades to some strategy, while b) changing the strategy a couple of times a decade.

First, "Quality" is not one of the five Fama-French factors, which are "market," "size," "value," "profitability," and "investment."

Second, the constant changes in the story tell us is that financial researchers do not know when they have enough data to make actionable predictions.

This is accompanied by rhetorical maneuvers that walk back claims in subtle ways. And, of course, to be fair, it is not exactly the same people making the initial claims as the people saying later "we never said that."

As Robin Wigglesworth's book, Trillions, confirms, Dimensional Fund Advisors was founded on the size factor. The pure, unadorned size factor and nothing else, and a fund, DFSCX, now known as the DFA US Micro Cap Fund, to allow investors to reap the supposed benefits.

The size factor has been walked back progressively--it's important, just not quite as big as Banz thought; it's important, just not as strong as some others; it's important, but only in raw return, not risk-adjusted return; it's not important even in raw return, but we can "resurrect" it as a flavor enhancer for other factors.

And yet people still constantly post asking how to add small-caps (not small-cap value, just small-caps) to an S&P 500 fund.

Forty years after launch, despite a great start for the first three years,* DFSCX hasn't made a penny more than an S&P 500 index fund,

Image

and instead of saying "fund companies and advisors misapplied research and misled you," they say "O, the size factor? That old thing? Nobody ever really advocated that. Quit looking over there, look at this shiny new factor, hot off the press, this one is the real thing, commit to sticking to it for forty years, and see how that goes.

*I intentionally created my own chart to make sure I was crediting DFSCX with those first three good years, which PortfolioVisualizer doesn't include.
What if you did half of each and rebalanced with 5/25 bands?
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nedsaid
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Re: Fama and French: The Five-Factor Model Revisited

Post by nedsaid »

jason2459 wrote: Sat Jan 15, 2022 10:28 pm
nedsaid wrote: Sat Jan 15, 2022 9:14 pm
JoMoney wrote: Sat Jan 15, 2022 11:53 am
nisiprius wrote: Sat Jan 15, 2022 11:44 am...
Forty years after launch, despite a great start for the first three years, DFSCX hasn't made a penny more than an S&P 500 index fund...
And that doesn't even account for the fact that for the longest time, the only way to get access to DFA's secret-sauce index like non-index funds was to pay an advisor half a percent (or more) annually.

If one had looked to Vanguard's low cost small-cap index fund results would have been lower. Some people would discount the index fund as being poorly represented by the Russell 2000 over early years (despite the Russell 2000 + Russell 1000 perfectly representing the 'Total Market' Russell 3000) :?
Avantis has solved the problem you discuss above, they offer an excellent suite of ETFs that offer an updated factors approach very similar to DFA. Avantis will soon launch a Small Cap ETF that will invest in Micro-Caps. No need for an Advisor to access.
Even before Avantis, DFA used profitablity as well. And for passive index funds the S&P indices have a set of quality like qualification to get on and stay in the listings. So even though the SP600 value index mentions three specific methods to determine value there's also the initial quality screen to get into the SP 600 universe. I know of three funds that use that index VIOV, SLYV, and IJS.

AVSC Avantis' smaller approach was released this past week. It's avg market cap is 1.62B right now

AVUS avg market cap 2.71B

VIOV avg market cap 1.96B

Just interesting stats.

Because then there's the SP600 pure value index like the RZV ETF with a market cap avg of 1.08B

So is going down into the microcaps really worth it? Is SmB to the extreme going to to pull something out of the hat? I don't think so

SP600 value vs pure value since at least 2006
https://www.portfoliovisualizer.com/bac ... ion2_2=100

Don't know where I'm really going with this. Just something fun to look up.
Right after I bought a Micro-Cap Index ETF, I read a Morningstar article that said investors were better off in a Small-Cap Index. Oh well. I still own the ETF, never sold.
A fool and his money are good for business.
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