Factor Investing: The Next-Gen Boglehead frontier

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nedsaid
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by nedsaid »

muffins14 wrote: Sun Mar 26, 2023 9:58 pm
nedsaid wrote: Sun Mar 26, 2023 9:43 pm
nisiprius wrote: Sat Jun 18, 2022 7:49 pm
So people come out with papers where there are 100 factors. Of course, when you put them together, you find out that there really aren't 100...
swilgu1 wrote: Sat Jun 18, 2022 7:15 pm Fama is referring to the momentum factor and newer factor research (e.g. factor 'zoo') as some would call it, not the five factor model that DFA and Avantis funds directly target.
But there's something very very odd about the "five"-factor model, because it too can be criticized on exactly the same grounds. It has an extra factor in there. A Five-Factor Asset Pricing Model itself says:
VI. HML: A Redundant Factor

We note above that the five-factor model never improves the description of average returns from the four-factor model that drops HML. The explanation is interesting. The average HML return is captured by the exposures of HML to other factors. Thus, in the five-factor model, HML seems to be redundant for explaining average returns.
There isn't any "five-factor model!" The paper is saying clearly that you should either be using the value factor or replacing it with the investment and profitability factors.

Yet when I use e.g. the PortfolioVisualizer factor regression tool and select "Fama-French Research Factor" it offers a "Five-factor" model and shows numbers for

Market (Rm-Rf)
Size (SMB)
Value (HML)
Profitability (RMW)
Investment (CMA)

"Value" shouldn't be included if "investment" and "profitability" are!
We note above that the five-factor model never improves the description of average returns from the four-factor model that drops HML.
That is a very strong statement. Why, then, isn't the paper title "A Four-Factor Asset Pricing Model?"

Is the value factor is being retained for no better reason than tradition and old times' sake?
Thank you for this post. I remembered somewhere that there was debate in the academic community regarding whether or not the Value effect could be explained by other factors. Very similar to the debate over REITs, academics say that the behavior of REITs can be replicated by a combination of Small Value/High Yield Bonds or Small Value/Corporate Bonds. So the existence of the Value factor is debated and REITs are no longer a distinct asset class.

My whole world has fallen apart. :wink: Two things that I believed in as an investor are very much in doubt.
Hopefully not fallen apart.
You could view this like we used to think there were atoms, then later we learned atoms are electrons, neutrons, and protons.

Value aka HmL is still a useful thing to measure, but if you wanted to, you could measure the other two factors instead and explain HmL
I am kidding around a bit here. I have been a Value oriented investor for years but I have also had a taste for Aggressive Growth investments as well. I also have not sold my REIT investments.

I see Value mainly in two ways: cheap beats expensive and low expectations are easier to beat than high expectations. I define "cheap" in terms of Price/Earnings, Price/Cash Flow, Price Sales. Price/Book is less meaningful today than 40 years ago. I think of businesses as sets of cash flows much more than I think of them as a mix of assets and liabilities. In other words, I take an Income Statement approach more than a Balance Sheet approach. Cash flows are the primary way, in my view, to value a company; the Balance Sheet is a secondary, though important consideration.

With Value, you take less of a pricing/valuation/expectations risk but earnings of Value companies are more volatile and often Value companies have more leverage.
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nisiprius
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by nisiprius »

Nathan Drake wrote: Sun Mar 26, 2023 8:52 pm...They appear to be performing worse than inflation over time. If you introduced corporate bonds or some foreign bonds you would probably capture better long term inflation protection...
The longest-term currency-hedged foreign bond fund I know of is the PIMCO International Bond (USD hedged) fund, PFORX, and you are correct, it has considerably outperformed a TIPS fund (ACITX), particularly over the last ten years, and the overall growth, inflation-adjusted, has been very steady throughout until 2021.

Source

Image
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BigDGB
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by BigDGB »

nisiprius wrote: Sun Mar 26, 2023 7:51 pm I'm a very conservative investor. I don't say that's objectively right, I'm just saying I am. And yes, I do have a high fixed-income allocation, because a) I'm retired and b) I'm a conservative investor.

I don't see any significant downside to TIPS. The big question is "why not TIPS?" and the "why nots" always seem like technicalities to me. Bonds are for safety, and I don't see the point of taking unnecessary inflation risk in bonds, even if you expect to be rewarded for taking that risk.

I have never liked the idea of relying solely on stocks for inflation protection. That may be true over the long run, but the long run is longer than my personal patience.

In the words of Benjamin Graham, Warren Buffett's mentor:
On this point we can be categorical. There is no close time connection between inflationary (or deflationary) conditions and the movement of common-stock earnings and prices. The obvious example is the recent period 1966-1970. The rise in the cost of living was 22%... but both stock earnings and stock prices have declined since 1965. There are similar contradictions in both directions in the record of previous five-year periods.
Nice succinct answer. I’ve been listening to a few old David Swenson podcasts and podcast reviews on his model portfolio for individual investors ( you are most likely aware of his work) and at a 70% equity allocation, he split the bond portion 50/50 with intermediate nominal treasuries and TIPS . In effect, riding the fence between unexpected inflation and deflation, so a 50/50 compromise at any equity % level is worth strong consideration, given your reasoning that stocks have trailed inflation for long periods in the past.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by Morse Code »

BigDGB wrote: Mon Mar 27, 2023 9:38 am
nisiprius wrote: Sun Mar 26, 2023 7:51 pm I'm a very conservative investor. I don't say that's objectively right, I'm just saying I am. And yes, I do have a high fixed-income allocation, because a) I'm retired and b) I'm a conservative investor.

I don't see any significant downside to TIPS. The big question is "why not TIPS?" and the "why nots" always seem like technicalities to me. Bonds are for safety, and I don't see the point of taking unnecessary inflation risk in bonds, even if you expect to be rewarded for taking that risk.

I have never liked the idea of relying solely on stocks for inflation protection. That may be true over the long run, but the long run is longer than my personal patience.

In the words of Benjamin Graham, Warren Buffett's mentor:
On this point we can be categorical. There is no close time connection between inflationary (or deflationary) conditions and the movement of common-stock earnings and prices. The obvious example is the recent period 1966-1970. The rise in the cost of living was 22%... but both stock earnings and stock prices have declined since 1965. There are similar contradictions in both directions in the record of previous five-year periods.
Nice succinct answer. I’ve been listening to a few old David Swenson podcasts and podcast reviews on his model portfolio for individual investors ( you are most likely aware of his work) and at a 70% equity allocation, he split the bond portion 50/50 with intermediate nominal treasuries and TIPS . In effect, riding the fence between unexpected inflation and deflation, so a 50/50 compromise at any equity % level is worth strong consideration, given your reasoning that stocks have trailed inflation for long periods in the past.
Are there any fund/ETF options that combine nominal treasuries and TIPS? It seems this combination is discussed enough, it would be a popular option.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by BigDGB »

Morse Code wrote: Mon Mar 27, 2023 9:53 am
BigDGB wrote: Mon Mar 27, 2023 9:38 am
nisiprius wrote: Sun Mar 26, 2023 7:51 pm I'm a very conservative investor. I don't say that's objectively right, I'm just saying I am. And yes, I do have a high fixed-income allocation, because a) I'm retired and b) I'm a conservative investor.

I don't see any significant downside to TIPS. The big question is "why not TIPS?" and the "why nots" always seem like technicalities to me. Bonds are for safety, and I don't see the point of taking unnecessary inflation risk in bonds, even if you expect to be rewarded for taking that risk.

I have never liked the idea of relying solely on stocks for inflation protection. That may be true over the long run, but the long run is longer than my personal patience.

In the words of Benjamin Graham, Warren Buffett's mentor:
On this point we can be categorical. There is no close time connection between inflationary (or deflationary) conditions and the movement of common-stock earnings and prices. The obvious example is the recent period 1966-1970. The rise in the cost of living was 22%... but both stock earnings and stock prices have declined since 1965. There are similar contradictions in both directions in the record of previous five-year periods.
Nice succinct answer. I’ve been listening to a few old David Swenson podcasts and podcast reviews on his model portfolio for individual investors ( you are most likely aware of his work) and at a 70% equity allocation, he split the bond portion 50/50 with intermediate nominal treasuries and TIPS . In effect, riding the fence between unexpected inflation and deflation, so a 50/50 compromise at any equity % level is worth strong consideration, given your reasoning that stocks have trailed inflation for long periods in the past.
Are there any fund/ETF options that combine nominal treasuries and TIPS? It seems this combination is discussed enough, it would be a popular option.
I also would be interested in such a fund. I believe that DFA ( Dimensional Fund Advisors ) may have a fund that includes both, but requires an advisor, however due to the different structure of TIPS and how they are priced, it may need to be a fund of funds?

Looking to someone with more knowledge to jump in on any possibilities.
Apathizer
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by Apathizer »

nisiprius wrote: Mon Mar 27, 2023 7:26 am
Nathan Drake wrote: Sun Mar 26, 2023 8:52 pm...They appear to be performing worse than inflation over time. If you introduced corporate bonds or some foreign bonds you would probably capture better long term inflation protection...
The longest-term currency-hedged foreign bond fund I know of is the PIMCO International Bond (USD hedged) fund, PFORX, and you are correct, it has considerably outperformed a TIPS fund (ACITX), particularly over the last ten years, and the overall growth, inflation-adjusted, has been very steady throughout until 2021.

Source

Image
Yup. That's why I prefer to keep it simple and just go with BNDW. Globally diversified bonds hedged to USD.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

Given how many reasonable opinions exist concerning bonds (TIPS or not, corporate bonds or not, high-yield bonds or not, long-term bonds or not) and there is some acceptance of those opinions, it is surprising that stocks do not get the same treatment. Not only there seems to be a great deficiency of threads of when it is appropriate to tilt towards growth or large cap, there is a lack of analyzing the reasons to tilt other than to support a yes or no answer. I am pretty sure you can have two investors with one tilting towards value and one towards growth, and both are designing their portfolio best suited for their needs.

When one realizes that "winning against the market" should not be anyone's objective, tilts are much more interesting.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
Apathizer
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by Apathizer »

secondopinion wrote: Mon Mar 27, 2023 2:02 pm Given how many reasonable opinions exist concerning bonds (TIPS or not, corporate bonds or not, high-yield bonds or not, long-term bonds or not) and there is some acceptance of those opinions, it is surprising that stocks do not get the same treatment. Not only there seems to be a great deficiency of threads of when it is appropriate to tilt towards growth or large cap, there is a lack of analyzing the reasons to tilt other than to support a yes or no answer. I am pretty sure you can have two investors with one tilting towards value and one towards growth, and both are designing their portfolio best suited for their needs.

When one realizes that "winning against the market" should not be anyone's objective, tilts are much more interesting.
The MCW TSM is already tilted towards large growth. I'm hopeful factor tilts will improve total return, but at the very least they should provide more consistent returns by having more diverse sources of risk and potential return.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

Apathizer wrote: Mon Mar 27, 2023 2:08 pm
secondopinion wrote: Mon Mar 27, 2023 2:02 pm Given how many reasonable opinions exist concerning bonds (TIPS or not, corporate bonds or not, high-yield bonds or not, long-term bonds or not) and there is some acceptance of those opinions, it is surprising that stocks do not get the same treatment. Not only there seems to be a great deficiency of threads of when it is appropriate to tilt towards growth or large cap, there is a lack of analyzing the reasons to tilt other than to support a yes or no answer. I am pretty sure you can have two investors with one tilting towards value and one towards growth, and both are designing their portfolio best suited for their needs.

When one realizes that "winning against the market" should not be anyone's objective, tilts are much more interesting.
The MCW TSM is already tilted towards large growth. I'm hopeful factor tilts will improve total return, but at the very least they should provide more consistent returns by having more diverse sources of risk and potential return.
Right. If one considers the global stock market, then the US market is tilted towards large cap growth. However, it is impossible for the US stock market to be tilted against itself.

But how do we really determine whether value is indeed riskier than growth? I would think that value is slightly "safer" than growth in the short-term; this is because even if the future earnings were known, the earnings seen as zero-coupon bonds would place more volatility with growth because of the effective duration being higher. Of course, the actual volatility from the market risk is large enough to make either fairly risky for the short-term.

But as I have said, there is not enough discussion of this kind to speak as to whether a tilt, no tilt, or an anti-tilt is the better choice.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

secondopinion wrote: Mon Mar 27, 2023 2:42 pm But how do we really determine whether value is indeed riskier than growth? I would think that value is slightly "safer" than growth in the short-term; this is because even if the future earnings were known, the earnings seen as zero-coupon bonds would place more volatility with growth because of the effective duration being higher. Of course, the actual volatility from the market risk is large enough to make either fairly risky for the short-term.

But as I have said, there is not enough discussion of this kind.
If we believe modern portfolio theory which tells us that risk and return are fundamentally linked, we just need to look at the long term outperformance of value over growth, then from modern portfolio theory we can say in order to have earned a higher return it must be riskier. The truth is that we probably can't ever know for certain what the actual risks underlying the factors are. Factor models like FF-5 tell use where in the market to look to find priced risks with positive premiums. But Fama and French didn't attempt to explain why the premiums exist, just that there's strong empirical evidence to suggest that they do. Some of the research in behavioral finance suggests that some of the factors may be perceived risks that arise from investor biases, if this were the case the factors wouldn't increase actual risk in the portfolio at all. My guess is that the factors are probably a combination of real economic risks and investor misperception
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by Gaston »

secondopinion wrote: Mon Mar 27, 2023 2:02 pm Not only there seems to be a great deficiency of threads of when it is appropriate to tilt towards growth or large cap, there is a lack of analyzing the reasons to tilt other than to support a yes or no answer.
Tilting isn't a core component of the Boglehead philosophy. That doesn't mean you can't do it, but as this is the Boglehead forum, most threads likely will focus on buying the whole market.

I check the Rational Reminder forum every couple of months. There's a large-ish group there that talks about factors and factor investing strategies. The hosts of the Rational Reminder podcast also back the idea of factor investing. So that forum / podcast might have what you are looking for.

If interested, you can see their (the host's) model portfolio in the link below. They are Canadian, so they emphasize products available in Canada. But the portfolio would be easy to replicate in the USA (if that's where you are).

You might also want to listen to any podcast that has Cliff Asness as a guest. He seems to be one of the gurus of factor investing. He comes across as a bright, balanced individual, championing the use of factors while at the same time deriding their misuse.

One last thing (and my apologies if you already know this): I highlighted the word "when" in your original post. As far as I can tell, with factor investing, you select the handful of factors you believe in, then select an investment product that maximizes those factors. You then hold that product for decades. I've not heard factor investing referred to as a market timing strategy.

https://static1.squarespace.com/static/ ... P-1222.pdf
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

Gaston wrote: Mon Mar 27, 2023 3:14 pm Tilting isn't a core component of the Boglehead philosophy. That doesn't mean you can't do it, but as this is the Boglehead forum, most threads likely will focus on buying the whole market.

I check the Rational Reminder forum every couple of months. There's a large-ish group there that talks about factors and factor investing strategies. The hosts of the Rational Reminder podcast also back the idea of factor investing. So that forum / podcast might have what you are looking for.

If interested, you can see their (the host's) model portfolio in the link below. They are Canadian, so they emphasize products available in Canada. But the portfolio would be easy to replicate in the USA (if that's where you are).

You might also want to listen to any podcast that has Cliff Asness as a guest. He seems to be one of the gurus of factor investing. He comes across as a bright, balanced individual, championing the use of factors while at the same time deriding their misuse.

https://static1.squarespace.com/static/ ... P-1222.pdf
I will look into that.
Gaston wrote: Mon Mar 27, 2023 3:14 pm
secondopinion wrote: Mon Mar 27, 2023 2:02 pm Not only there seems to be a great deficiency of threads of when it is appropriate to tilt towards growth or large cap, there is a lack of analyzing the reasons to tilt other than to support a yes or no answer.
One last thing (and my apologies if you already know this): I highlighted the word "when" in your original post. As far as I can tell, with factor investing, you select the handful of factors you believe in, then select an investment product that maximizes those factors. You then hold that product for decades. I've not heard factor investing referred to as a market timing strategy.[/b]
My use of "when" is not a market timing statement but about portfolio design. It is more like the question "when should I have more bonds?" rather than "when should I buy more bonds?"
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
Apathizer
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by Apathizer »

km91 wrote: Mon Mar 27, 2023 3:11 pm
secondopinion wrote: Mon Mar 27, 2023 2:42 pm But how do we really determine whether value is indeed riskier than growth? I would think that value is slightly "safer" than growth in the short-term; this is because even if the future earnings were known, the earnings seen as zero-coupon bonds would place more volatility with growth because of the effective duration being higher. Of course, the actual volatility from the market risk is large enough to make either fairly risky for the short-term.

But as I have said, there is not enough discussion of this kind.
If we believe modern portfolio theory which tells us that risk and return are fundamentally linked, we just need to look at the long term outperformance of value over growth, then from modern portfolio theory we can say in order to have earned a higher return it must be riskier. The truth is that we probably can't ever know for certain what the actual risks underlying the factors are. Factor models like FF-5 tell use where in the market to look to find priced risks with positive premiums. But Fama and French didn't attempt to explain why the premiums exist, just that there's strong empirical evidence to suggest that they do. Some of the research in behavioral finance suggests that some of the factors may be perceived risks that arise from investor biases, if this were the case the factors wouldn't increase actual risk in the portfolio at all. My guess is that the factors are probably a combination of real economic risks and investor misperception.
I tend to agree. There could be a number of reasons why value stocks would out-perform. Growth stocks are generally less volatile and most investors are willing to pay more for this. Investors generally have high, perhaps unrealistically high, expectations for growth stocks and more modest expectations for value stocks. It's generally easier to reach or exceed modest expectations than lofty ones.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

km91 wrote: Mon Mar 27, 2023 3:11 pm
secondopinion wrote: Mon Mar 27, 2023 2:42 pm But how do we really determine whether value is indeed riskier than growth? I would think that value is slightly "safer" than growth in the short-term; this is because even if the future earnings were known, the earnings seen as zero-coupon bonds would place more volatility with growth because of the effective duration being higher. Of course, the actual volatility from the market risk is large enough to make either fairly risky for the short-term.

But as I have said, there is not enough discussion of this kind.
If we believe modern portfolio theory which tells us that risk and return are fundamentally linked, we just need to look at the long term outperformance of value over growth, then from modern portfolio theory we can say in order to have earned a higher return it must be riskier. The truth is that we probably can't ever know for certain what the actual risks underlying the factors are. Factor models like FF-5 tell use where in the market to look to find priced risks with positive premiums. But Fama and French didn't attempt to explain why the premiums exist, just that there's strong empirical evidence to suggest that they do. Some of the research in behavioral finance suggests that some of the factors may be perceived risks that arise from investor biases, if this were the case the factors wouldn't increase actual risk in the portfolio at all. My guess is that the factors are probably a combination of real economic risks and investor misperception
This is not valid logic:
  • For there to be risk, there must be a means to underperform/outperform. All we have concluded is that value has outperformed.
  • If we consider the other statistical moments besides the first two (return and volatility), higher negative skew will produce a higher probability of observing outperformance given equal return and volatility.
  • If we consider the volatility of volatility, then how does that stack into the framework?
  • There are multiple risk-free interest rates across the entire yield curve. In arbitrage, we would use the bond that matches the investment timeframe exactly rather than hoping the shortest-term risk-free rate to remain constant. However, then which one is the true risk-free rate? Which one has a premium? I think a lot of investing in general will be tied to this yield curve.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

Apathizer wrote: Mon Mar 27, 2023 3:48 pm
km91 wrote: Mon Mar 27, 2023 3:11 pm
secondopinion wrote: Mon Mar 27, 2023 2:42 pm But how do we really determine whether value is indeed riskier than growth? I would think that value is slightly "safer" than growth in the short-term; this is because even if the future earnings were known, the earnings seen as zero-coupon bonds would place more volatility with growth because of the effective duration being higher. Of course, the actual volatility from the market risk is large enough to make either fairly risky for the short-term.

But as I have said, there is not enough discussion of this kind.
If we believe modern portfolio theory which tells us that risk and return are fundamentally linked, we just need to look at the long term outperformance of value over growth, then from modern portfolio theory we can say in order to have earned a higher return it must be riskier. The truth is that we probably can't ever know for certain what the actual risks underlying the factors are. Factor models like FF-5 tell use where in the market to look to find priced risks with positive premiums. But Fama and French didn't attempt to explain why the premiums exist, just that there's strong empirical evidence to suggest that they do. Some of the research in behavioral finance suggests that some of the factors may be perceived risks that arise from investor biases, if this were the case the factors wouldn't increase actual risk in the portfolio at all. My guess is that the factors are probably a combination of real economic risks and investor misperception.
I tend to agree. There could be a number of reasons why value stocks would out-perform. Growth stocks are generally less volatile and most investors are willing to pay more for this. Investors generally have high, perhaps unrealistically high, expectations for growth stocks and more modest expectations for value stocks. It's generally easier to reach or exceed modest expectations than lofty ones.
Do we have proof that they are actually less volatile? They pay more per dollar of present earnings because it is expected that the future earnings will be greater later, not that they less risky. Using a short-term metric of risk and higher effective duration of the earning payout of growth stocks, they should not be safer under such a metric unless something else is confounding the results.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
Apathizer
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by Apathizer »

secondopinion wrote: Mon Mar 27, 2023 4:05 pm
Apathizer wrote: Mon Mar 27, 2023 3:48 pm
km91 wrote: Mon Mar 27, 2023 3:11 pm
secondopinion wrote: Mon Mar 27, 2023 2:42 pm But how do we really determine whether value is indeed riskier than growth? I would think that value is slightly "safer" than growth in the short-term; this is because even if the future earnings were known, the earnings seen as zero-coupon bonds would place more volatility with growth because of the effective duration being higher. Of course, the actual volatility from the market risk is large enough to make either fairly risky for the short-term.

But as I have said, there is not enough discussion of this kind.
If we believe modern portfolio theory which tells us that risk and return are fundamentally linked, we just need to look at the long term outperformance of value over growth, then from modern portfolio theory we can say in order to have earned a higher return it must be riskier. The truth is that we probably can't ever know for certain what the actual risks underlying the factors are. Factor models like FF-5 tell use where in the market to look to find priced risks with positive premiums. But Fama and French didn't attempt to explain why the premiums exist, just that there's strong empirical evidence to suggest that they do. Some of the research in behavioral finance suggests that some of the factors may be perceived risks that arise from investor biases, if this were the case the factors wouldn't increase actual risk in the portfolio at all. My guess is that the factors are probably a combination of real economic risks and investor misperception.
I tend to agree. There could be a number of reasons why value stocks would out-perform. Growth stocks are generally less volatile and most investors are willing to pay more for this. Investors generally have high, perhaps unrealistically high, expectations for growth stocks and more modest expectations for value stocks. It's generally easier to reach or exceed modest expectations than lofty ones.
Do we have proof that they are actually less volatile? They pay more per dollar of present earnings because it is expected that the future earnings will be greater later, not that they less risky. Using a short-term metric of risk and higher effective duration of the earning payout of growth stocks, they should not be safer under such a metric.
Value stocks, esp small value, tend to be more reactive to adversity than large growth, though much depends on the type of adversity. In 2020 with the Covid scare the entire market dropped, but large growth didn't fall nearly as much as small value. Small value recovered in about a year and has since out-performed growth.

Eventually growth companies reach maturity and their future prospects are more modest. This seems to be happening now. Many big IT companies like FB/Meta and Microsoft seemed to have matured to the extent they aren't expected to have massive future growth. Consequently their prices have dropped and they're laying people off.
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km91
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

secondopinion wrote: Mon Mar 27, 2023 4:01 pm This is not valid logic:
  • For there to be risk, there must be a means to underperform/outperform. All we have concluded is that value has outperformed.
  • If we consider the other statistical moments besides the first two (return and volatility), higher negative skew will produce a higher probability of observing outperformance given equal return and volatility.
  • If we consider the volatility of volatility, then how does that stack into the framework?
  • There are multiple risk-free interest rates across the entire yield curve. In arbitrage, we would use the bond that matches the investment timeframe exactly rather than hoping the shortest-term risk-free rate to remain constant. However, then which one is the true risk-free rate? Which one has a premium? I think a lot of investing in general will be tied to this yield curve.
If modern portfolio theory is correct, the long term performance difference between two portfolios should mostly be explained by the amount of risk in the portfolio. Every qualitative and quantitative risk is priced into the market and investors earn a return in line with the amount of risk they take. I assume the market has already priced in the statistical moments of risk and vol of vol, I certainly don't know how to. The 3mo t bill rate as the risk free rate is a pretty good universal heuristic. It is useful to be able to compare the expected risk premium to the rate of return on cash, and it's a simple reference point that makes comparing investment decisions easy. A retirement saver is probably better off using a longer duration bond as their risk free rate, yet good luck convincing many that a 30yr treasury actually less risky than a t bill
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

Apathizer wrote: Mon Mar 27, 2023 4:19 pm
secondopinion wrote: Mon Mar 27, 2023 4:05 pm
Apathizer wrote: Mon Mar 27, 2023 3:48 pm
km91 wrote: Mon Mar 27, 2023 3:11 pm
secondopinion wrote: Mon Mar 27, 2023 2:42 pm But how do we really determine whether value is indeed riskier than growth? I would think that value is slightly "safer" than growth in the short-term; this is because even if the future earnings were known, the earnings seen as zero-coupon bonds would place more volatility with growth because of the effective duration being higher. Of course, the actual volatility from the market risk is large enough to make either fairly risky for the short-term.

But as I have said, there is not enough discussion of this kind.
If we believe modern portfolio theory which tells us that risk and return are fundamentally linked, we just need to look at the long term outperformance of value over growth, then from modern portfolio theory we can say in order to have earned a higher return it must be riskier. The truth is that we probably can't ever know for certain what the actual risks underlying the factors are. Factor models like FF-5 tell use where in the market to look to find priced risks with positive premiums. But Fama and French didn't attempt to explain why the premiums exist, just that there's strong empirical evidence to suggest that they do. Some of the research in behavioral finance suggests that some of the factors may be perceived risks that arise from investor biases, if this were the case the factors wouldn't increase actual risk in the portfolio at all. My guess is that the factors are probably a combination of real economic risks and investor misperception.
I tend to agree. There could be a number of reasons why value stocks would out-perform. Growth stocks are generally less volatile and most investors are willing to pay more for this. Investors generally have high, perhaps unrealistically high, expectations for growth stocks and more modest expectations for value stocks. It's generally easier to reach or exceed modest expectations than lofty ones.
Do we have proof that they are actually less volatile? They pay more per dollar of present earnings because it is expected that the future earnings will be greater later, not that they less risky. Using a short-term metric of risk and higher effective duration of the earning payout of growth stocks, they should not be safer under such a metric.
Value stocks, esp small value, tend to be more reactive to adversity than large growth, though much depends on the type of adversity. In 2020 with the Covid scare the entire market dropped, but large growth didn't fall nearly as much as small value. Small value recovered in about a year and has since out-performed growth.

Eventually growth companies reach maturity and their future prospects are more modest. This seems to be happening now. Many big IT companies like FB/Meta and Microsoft seemed to have matured to the extent they aren't expected to have massive future growth. Consequently their prices have dropped and they're laying people off.
Well, two things:
  • 2020 was a bear with reduced yields. Under those conditions, growth should outperform given all other things equal if one considers effective duration.
  • 2022 was a bear with increased yields. Under those conditions, value should outperform given all other things equal if one considers effective duration.
It has not shown that value is more risky in the short-term sense unless one assumes that decreasing yields and bear markets are positively correlated. If we do that, then sure I can agree with the notion.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

km91 wrote: Mon Mar 27, 2023 4:28 pm
secondopinion wrote: Mon Mar 27, 2023 4:01 pm This is not valid logic:
  • For there to be risk, there must be a means to underperform/outperform. All we have concluded is that value has outperformed.
  • If we consider the other statistical moments besides the first two (return and volatility), higher negative skew will produce a higher probability of observing outperformance given equal return and volatility.
  • If we consider the volatility of volatility, then how does that stack into the framework?
  • There are multiple risk-free interest rates across the entire yield curve. In arbitrage, we would use the bond that matches the investment timeframe exactly rather than hoping the shortest-term risk-free rate to remain constant. However, then which one is the true risk-free rate? Which one has a premium? I think a lot of investing in general will be tied to this yield curve.
If modern portfolio theory is correct, the long term performance difference between two portfolios should mostly be explained by the amount of risk in the portfolio. Every qualitative and quantitative risk is priced into the market and investors earn a return in line with the amount of risk they take. I assume the market has already priced in the statistical moments of risk and vol of vol, I certainly don't know how to. The 3mo t bill rate as the risk free rate is a pretty good universal heuristic. It is useful to be able to compare the expected risk premium to the rate of return on cash, and it's a simple reference point that makes comparing investment decisions easy. A retirement saver is probably better off using a longer duration bond as their risk free rate, yet good luck convincing many that a 30yr treasury actually less risky than a t bill
But there can be still sizable amount of difference after, say, 30 years anyway. There might be a term premium for bonds, for example; but we can obviously find extended periods (like 30+ years) where this clearly does not surface.

As a result, value does not convince me as something being neither riskier than growth; nor as something that should have a premium (but neither on the side that it should be paying a premium). I think the dynamics are more complex that a simple claim on risk.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

secondopinion wrote: Mon Mar 27, 2023 4:47 pm But there can be still sizable amount of difference after, say, 30 years anyway. There might be a term premium for bonds, for example; but we can obviously find extended periods (like 30+ years) where this clearly does not surface.

As a result, value does not convince me as something being neither riskier than growth; nor as something that should have a premium (but neither on the side that it should be paying a premium). I think the dynamics are more complex that a simple claim on risk.
Yes, this is the risk. There's other things we can do to test the robustness of the factor though. Rolling return periods, testing on out of sample data, testing on other equity markets, use anecdotal evidence, economic theory, and intuition. The back test only tells us that a relationship existed in the data in the past, but if we rely on other evidence there is a good case to be made that value or quality or size deliver a positive expected premium over the long term and probably do represent real underlying economic risks as perceived by investors. Personally, I find that the strongest evidence in favor of value is simple intuition, buying diversified portfolios of assets at relatively cheap prices is probably better than buying diversified portfolios with more expensive prices. When I go to the store I typically don't buy the most expensive product, it seems to make sense to tilt my portfolio away from the most expensive stocks in the market
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by rkhusky »

km91 wrote: Mon Mar 27, 2023 5:41 pm Personally, I find that the strongest evidence in favor of value is simple intuition, buying diversified portfolios of assets at relatively cheap prices is probably better than buying diversified portfolios with more expensive prices. When I go to the store I typically don't buy the most expensive product, it seems to make sense to tilt my portfolio away from the most expensive stocks in the market
It’s interesting that there are millions of people scouring the stock market for cheap stocks that will increase in price and make them money. Yet there are simple metrics right under their noses, like P/E and P/B, that will do the job for them for a fraction of the effort.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

rkhusky wrote: Mon Mar 27, 2023 6:13 pm It’s interesting that there are millions of people scouring the stock market for cheap stocks that will increase in price and make them money. Yet there are simple metrics right under their noses, like P/E and P/B, that will do the job for them for a fraction of the effort.
I'm saving for retirement. I want to buy a portfolio of assets that will deliver a stream of earnings in the future. It doesn't take a Phd from University of Chicago to guess that spending less per $1 of earnings is probably better than spending more. The stock market is exactly that, a market, it offers us many prices to choose from. For almost any item I buy on a monthly basis, I would never even consider buying the most expensive version. I'm sure my grocery store sells a $15 bottle of ketchup for a reason, and I'm sure the stock market sells 50x p/e stocks for a reason, all I know is both sound expensive
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by rkhusky »

km91 wrote: Mon Mar 27, 2023 6:52 pm
rkhusky wrote: Mon Mar 27, 2023 6:13 pm It’s interesting that there are millions of people scouring the stock market for cheap stocks that will increase in price and make them money. Yet there are simple metrics right under their noses, like P/E and P/B, that will do the job for them for a fraction of the effort.
I'm saving for retirement. I want to buy a portfolio of assets that will deliver a stream of earnings in the future. It doesn't take a Phd from University of Chicago to guess that spending less per $1 of earnings is probably better than spending more. The stock market is exactly that, a market, it offers us many prices to choose from. For almost any item I buy on a monthly basis, I would never even consider buying the most expensive version. I'm sure my grocery store sells a $15 bottle of ketchup for a reason, and I'm sure the stock market sells 50x p/e stocks for a reason, all I know is both sound expensive
For stocks, you don’t know whether something is cheap or expensive until after the fact. I remember when Apple’s stock was $30/sh. Was that cheap or expensive? How about Amazon’s price before they started dominating the online market and weren’t making any money? Was SVB’s share price in January cheap or expensive?

Edit: Another way to look at it is everything is appropriately priced at every instant in time. After all, things are only worth what someone is willing to pay for them.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

rkhusky wrote: Mon Mar 27, 2023 8:26 pm For stocks, you don’t know whether something is cheap or expensive until after the fact. I remember when Apple’s stock was $30/sh. Was that cheap or expensive? How about Amazon’s price before they started dominating the online market and weren’t making any money? Was SVB’s share price in January cheap or expensive?
Sure we do. You're just framing it as cheap or expensive relative to the future price, which is unknowable. We can easily look at a stock's price history or valuation metrics and decide if the stock is cheap or expensive relative to other stocks currently for sale in the market, or relative to it's historical price. TSLA trades at 50 p/e. Is it expensive compared to it's future price? Who knows. We do know it's more expensive than the market as a whole, and more expensive then most other times in it's own history. When I am in the grocery store, I decide whether something is cheap or expensive relative to the other versions offered on the shelf and it's own price history. I don't try to measure cheapness or expensiveness against what I think the price will be in the future
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by rkhusky »

km91 wrote: Mon Mar 27, 2023 8:58 pm
rkhusky wrote: Mon Mar 27, 2023 8:26 pm For stocks, you don’t know whether something is cheap or expensive until after the fact. I remember when Apple’s stock was $30/sh. Was that cheap or expensive? How about Amazon’s price before they started dominating the online market and weren’t making any money? Was SVB’s share price in January cheap or expensive?
Sure we do. You're just framing it as cheap or expensive relative to the future price, which is unknowable. We can easily look at a stock's price history or valuation metrics and decide if the stock is cheap or expensive relative to other stocks currently for sale in the market, or relative to it's historical price. TSLA trades at 50 p/e. Is it expensive compared to it's future price? Who knows. We do know it's more expensive than the market as a whole, and more expensive then most other times in it's own history. When I am in the grocery store, I decide whether something is cheap or expensive relative to the other versions offered on the shelf and it's own price history. I don't try to measure cheapness or expensiveness against what I think the price will be in the future
When I buy goods, price is not the only metric I use. Quality is also important. I suspect most people combine the two in a subjective way when buying stuff. I don’t buy soft brown bananas at 20c/lb, when I can get firm yellow bananas at 49c/lb. Others may pay 69c/lb for organic.

And stock value metrics don’t use price history, just a current comparison to other stocks.

The current price of stocks is based on the market’s projections about future earnings.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by BrooklynInvest »

scout1 wrote: Sun Jun 12, 2022 12:11 pm I used to work for a factor investor like AQR years ago as it was dying. They died because they did some backtests until they found what worked. They then devised theories on why these factors persist.
Same story with me. Same conclusion. And I work in marketing so I know nonsense when I read it.. 'cause I may have written it ;-)

I'd no more factor tilt than I would sector tilt or actively pick stocks. Boglehead-ism isn't just for beginners.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by beezlebub »

BrooklynInvest wrote: Tue Mar 28, 2023 8:38 am
scout1 wrote: Sun Jun 12, 2022 12:11 pm I used to work for a factor investor like AQR years ago as it was dying. They died because they did some backtests until they found what worked. They then devised theories on why these factors persist.
Same story with me. Same conclusion. And I work in marketing so I know nonsense when I read it.. 'cause I may have written it ;-)

I'd no more factor tilt than I would sector tilt or actively pick stocks. Boglehead-ism isn't just for beginners.
That's my take on it too. I recently comments on a thread here about Avantis about how the whole "financial science" marketing scheme they run is nothing more than speculating based on backtests with an attempt to legitimize it with PhDs and various financial "experts" working for the company. It naturally didn't go over with the Avantis/factor investing crowd too well. It baffles me that here on Bogleheads how many people try to justify market speculation and gambling with a goal of beating the market when the base principle of index investing is that you likely are not going to beat the market.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

rkhusky wrote: Tue Mar 28, 2023 8:09 am When I buy goods, price is not the only metric I use. Quality is also important. I suspect most people combine the two in a subjective way when buying stuff. I don’t buy soft brown bananas at 20c/lb, when I can get firm yellow bananas at 49c/lb. Others may pay 69c/lb for organic.

And stock value metrics don’t use price history, just a current comparison to other stocks.

The current price of stocks is based on the market’s projections about future earnings.
Good point, there are many "factors" that are important to us beyond price. "Value" and "quality" are also important. Perhaps some people prefer "trend"-y products. Luckily for us, competitive markets cater to many different preferences

A stock's price is based on it's future earnings, which are unknowable. It's also based on many other factors, most of which are unknowable as well. Value is the the price of current earnings, this is something we can easily calculate. Quality/profitability is also easily observable. I'd rather make investment decisions based on what I know, not what I don't know. Experience tells me that the most expensive product on the shelf usually isn't worth the money, I have a feeling the same is true for the stock market as well
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

beezlebub wrote: Tue Mar 28, 2023 9:51 am It baffles me that here on Bogleheads how many people try to justify market speculation and gambling with a goal of beating the market when the base principle of index investing is that you likely are not going to beat the market.
There is no speculation with factor investing. When we buy value, we're making no prediction about the future, we're buying it because the price today is cheap. Same with profitability, we aren't predicting whether the company will be profitable in the future, we are observing if it's profitable today. I want to build a portfolio of profitable, productive companies. I know for certain that companies with cheap earnings and high profits fit this bill. Will expensive and unprofitable companies become cheap and profitable in the future? Some probably will, but that's just speculation
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by drumboy256 »

km91 wrote: Tue Mar 28, 2023 10:10 am
beezlebub wrote: Tue Mar 28, 2023 9:51 am It baffles me that here on Bogleheads how many people try to justify market speculation and gambling with a goal of beating the market when the base principle of index investing is that you likely are not going to beat the market.
There is no speculation with factor investing. When we buy value, we're making no prediction about the future, we're buying it because the price today is cheap. Same with profitability, we aren't predicting whether the company will be profitable in the future, we are observing if it's profitable today. I want to build a portfolio of profitable, productive companies. I know for certain that companies with cheap earnings and high profits fit this bill. Will expensive and unprofitable companies become cheap and profitable in the future? Some probably will, but that's just speculation
This is something I've personally battled against since the inception of this thread. Performance chasing is a stock pickers fallacy, full stop. If Factor nuts were including ARKK in their funds, I would say that ain't factor investing, that's just pure gambling. To km91's point, the goal is factor risk against personal risk and goals/objectives of investing.

Someone just the other day posted a thread about "When to stop investing in stocks...." and I was like---- never? Risk factors or market factors that include risk will always be around and while your goals/objectives may change over time, market risk will always be persistent. I'm getting ready to post a 1 year update on the journey and it's been an interesting one. With funds like AVGE and soon to be AVGV coming out, I don't see any reason a "traditional" Boglehead could not add in either of those funds to their portfolio (tilt, slant, etc.) and sleep well at night. In fact, I'm concerned about the Bogleheads that just invest in VTI.... but that's a topic for another day.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by beezlebub »

km91 wrote: Tue Mar 28, 2023 10:10 am
beezlebub wrote: Tue Mar 28, 2023 9:51 am It baffles me that here on Bogleheads how many people try to justify market speculation and gambling with a goal of beating the market when the base principle of index investing is that you likely are not going to beat the market.
There is no speculation with factor investing. When we buy value, we're making no prediction about the future, we're buying it because the price today is cheap. Same with profitability, we aren't predicting whether the company will be profitable in the future, we are observing if it's profitable today. I want to build a portfolio of profitable, productive companies. I know for certain that companies with cheap earnings and high profits fit this bill. Will expensive and unprofitable companies become cheap and profitable in the future? Some probably will, but that's just speculation
That sounds like speculation to me. You are making a prediction for the future based on what has historically worked. You are making the assumption the past will repeat itself in your prediction. It's market speculation.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

beezlebub wrote: Tue Mar 28, 2023 10:42 am That sounds like speculation to me. You are making a prediction for the future based on what has historically worked. You are making the assumption the past will repeat itself in your prediction. It's market speculation.
I want to build a portfolio of profitable and productive companies. I buy companies that are profitable and productive today. I'm making no prediction about the future
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by drumboy256 »

beezlebub wrote: Tue Mar 28, 2023 10:42 am
km91 wrote: Tue Mar 28, 2023 10:10 am
beezlebub wrote: Tue Mar 28, 2023 9:51 am It baffles me that here on Bogleheads how many people try to justify market speculation and gambling with a goal of beating the market when the base principle of index investing is that you likely are not going to beat the market.
There is no speculation with factor investing. When we buy value, we're making no prediction about the future, we're buying it because the price today is cheap. Same with profitability, we aren't predicting whether the company will be profitable in the future, we are observing if it's profitable today. I want to build a portfolio of profitable, productive companies. I know for certain that companies with cheap earnings and high profits fit this bill. Will expensive and unprofitable companies become cheap and profitable in the future? Some probably will, but that's just speculation
That sounds like speculation to me. You are making a prediction for the future based on what has historically worked. You are making the assumption the past will repeat itself in your prediction. It's market speculation.
Not to be blunt--- but the phrase "Past returns don't guarantee future performance...." applies to everything, not just factors. So by virtue, indexes by that definition are also beholden to speculation because an index may or may not be around in the future? By that logic, it would be mean that either A) An index will change and/or re-scope their stock assets covered or B) cease to exist.

My point here is that any "bet" on the future, index or factor can be viewed as a speculation.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by beezlebub »

km91 wrote: Tue Mar 28, 2023 10:47 am
beezlebub wrote: Tue Mar 28, 2023 10:42 am That sounds like speculation to me. You are making a prediction for the future based on what has historically worked. You are making the assumption the past will repeat itself in your prediction. It's market speculation.
I want to build a portfolio of profitable and productive companies. I buy companies that are profitable and productive today. I'm making no prediction about the future
That is the very definition of stock picking and is the opposite of index investing.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by beezlebub »

drumboy256 wrote: Tue Mar 28, 2023 10:47 am
beezlebub wrote: Tue Mar 28, 2023 10:42 am
km91 wrote: Tue Mar 28, 2023 10:10 am
beezlebub wrote: Tue Mar 28, 2023 9:51 am It baffles me that here on Bogleheads how many people try to justify market speculation and gambling with a goal of beating the market when the base principle of index investing is that you likely are not going to beat the market.
There is no speculation with factor investing. When we buy value, we're making no prediction about the future, we're buying it because the price today is cheap. Same with profitability, we aren't predicting whether the company will be profitable in the future, we are observing if it's profitable today. I want to build a portfolio of profitable, productive companies. I know for certain that companies with cheap earnings and high profits fit this bill. Will expensive and unprofitable companies become cheap and profitable in the future? Some probably will, but that's just speculation
That sounds like speculation to me. You are making a prediction for the future based on what has historically worked. You are making the assumption the past will repeat itself in your prediction. It's market speculation.
Not to be blunt--- but the phrase "Past returns don't guarantee future performance...." applies to everything, not just factors. So by virtue, indexes by that definition are also beholden to speculation because an index may or may not be around in the future? By that logic, it would be mean that either A) An index will change and/or re-scope their stock assets covered or B) cease to exist.

My point here is that any "bet" on the future, index or factor can be viewed as a speculation.
A total market index is not static, so it inherently changes over time. That's not making a bet, that is simply investing in the total market and letting the market determine the appropriate weightings and inclusions.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

beezlebub wrote: Tue Mar 28, 2023 10:48 am That is the very definition of stock picking and is the opposite of index investing.
Yes, with index investing you are buying some companies that are expensive and unprofitable. You are speculating that they will become profitable and more expensive in the future. It's the index investor who is making a gamble, I know the companies I am buying are profitable and productive today
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by beezlebub »

km91 wrote: Tue Mar 28, 2023 10:53 am
beezlebub wrote: Tue Mar 28, 2023 10:48 am That is the very definition of stock picking and is the opposite of index investing.
Yes, with index investing you are buying some companies that are expensive and unprofitable. You are speculating that they will become profitable and more expensive in the future. It's the index investor who is making a gamble, I know the companies I am buying are profitable and productive today
You are making a gamble that those companies will continue to be profitable and productive in the future, while missing out on the companies that may not be profitable today but could be the frontrunners of tomorrow. I call that stock picking, and it doesn't really fit with the Boglehead approach and is more of the WallStreetBets type of approach. But to each his own.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

beezlebub wrote: Tue Mar 28, 2023 10:56 am You are making a gamble that those companies will continue to be profitable and productive in the future, while missing out on the companies that may not be profitable today but could be the frontrunners of tomorrow. I call that stock picking, and it doesn't really fit with the Boglehead approach and is more of the WallStreetBets type of approach. But to each his own.
No, you keep reframing my decision in terms of a future outcome but I keep saying I did not look to the future to make my decision. I want a portfolio of profitable and productive companies today. I buy profitable and productive companies today. In the future I will also probably want a portfolio of profitable and productive companies. I will probably buy profitable and productive companies in the future
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by rkhusky »

km91 wrote: Tue Mar 28, 2023 9:52 am A stock's price is based on it's future earnings, which are unknowable. It's also based on many other factors, most of which are unknowable as well. Value is the the price of current earnings, this is something we can easily calculate.
Interestingly, price for a cap weighted fund is irrelevant. Prices can go up and down and the cap weighted index is agnostic. Instead the fund buys shares in proportion to the shares each company has issued in relation to the total shares in the market.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by rkhusky »

km91 wrote: Tue Mar 28, 2023 11:05 am
beezlebub wrote: Tue Mar 28, 2023 10:56 am You are making a gamble that those companies will continue to be profitable and productive in the future, while missing out on the companies that may not be profitable today but could be the frontrunners of tomorrow. I call that stock picking, and it doesn't really fit with the Boglehead approach and is more of the WallStreetBets type of approach. But to each his own.
No, you keep reframing my decision in terms of a future outcome but I keep saying I did not look to the future to make my decision. I want a portfolio of profitable and productive companies today. I buy profitable and productive companies today. In the future I will also probably want a portfolio of profitable and productive companies. I will probably buy profitable and productive companies in the future
A value company would be something like SVB in January. It looks profitable now, but if analysts can look at the details, they see future problems and lower the current price. Hence you get a seemingly cheap stock - low P/E. If you invest in value, you are hoping stocks like SVB can turn things around and then you make money. If too many go bankrupt, you lose money.

If a company is profitable and looks to be profitable in the future, it’s not going to have a low price.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

beezlebub wrote: Tue Mar 28, 2023 10:56 am
km91 wrote: Tue Mar 28, 2023 10:53 am
beezlebub wrote: Tue Mar 28, 2023 10:48 am That is the very definition of stock picking and is the opposite of index investing.
Yes, with index investing you are buying some companies that are expensive and unprofitable. You are speculating that they will become profitable and more expensive in the future. It's the index investor who is making a gamble, I know the companies I am buying are profitable and productive today
You are making a gamble that those companies will continue to be profitable and productive in the future, while missing out on the companies that may not be profitable today but could be the frontrunners of tomorrow. I call that stock picking, and it doesn't really fit with the Boglehead approach and is more of the WallStreetBets type of approach. But to each his own.
Let me ask these questions: What bonds should a pension hold? What bonds should this year's vacation money be held in? What bonds should a retiree hold? What bonds should a 20 year old hold? I doubt all of these would have the answer of "100% of the total bond market".

Likewise, is it not possible that the best choice of stocks for certain investors might not be "100% of the total stock market"? That is the only assertion I make for factor investing. And aside from bold words saying it is gambling or speculation, there is nothing to deny this assertion.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
km91
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

rkhusky wrote: Tue Mar 28, 2023 11:17 am A value company would be something like SVB in January. It looks profitable now, but if analysts can look at the details, they see future problems and lower the current price. Hence you get a seemingly cheap stock - low P/E. If you invest in value, you are hoping stocks like SVB can turn things around and then you make money. If too many go bankrupt, you lose money.

If a company is profitable and looks to be profitable in the future, it’s not going to have a low price.
Notice how both these points refer to some future unknowable event. I want to build a portfolio of productive and profitable companies. The only way I know how to do that is to buy companies that are profitable and productive today. Anything else is just speculation
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BrooklynInvest
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by BrooklynInvest »

km91 wrote: Tue Mar 28, 2023 10:10 am
beezlebub wrote: Tue Mar 28, 2023 9:51 am It baffles me that here on Bogleheads how many people try to justify market speculation and gambling with a goal of beating the market when the base principle of index investing is that you likely are not going to beat the market.
There is no speculation with factor investing. When we buy value, we're making no prediction about the future, we're buying it because the price today is cheap. Same with profitability, we aren't predicting whether the company will be profitable in the future, we are observing if it's profitable today. I want to build a portfolio of profitable, productive companies. I know for certain that companies with cheap earnings and high profits fit this bill. Will expensive and unprofitable companies become cheap and profitable in the future? Some probably will, but that's just speculation
There's no speculation with factor investing?

Is not the point of your value tilt to outperform market holders like me in the future? If not, why bother? It's your prediction and speculation for outperformance by definition, no? I mean, you might be right of course.

How do you know your stocks are cheap and the market isn't accurately pricing them?

Me I let the market do the work. I can't identify mispriced factors, stocks, sectors or regions. So I don't.
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burritoLover
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Re: Factor Investing: The Next-Gen Boglehead frontier

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You might want to ask yourself why do high yield junk bond funds tend to outperform treasuries or investment grade corporates of the same duration over longer periods? These junk bond funds would consist of more distressed companies with a higher chance of bankruptcy just like small companies with lower price-to-something metrics. They are riskier and they tend to be more volatile and have bigger drawdowns in both cases. A well-diversified SCV fund has caps on sector and country weightings and these funds are riskier than the broad market. It isn't rocket science - it is rules based stock selection. It isn't ARKK stock picking where the reason for picking the stock can be literally anything, no matter how subjective.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

BrooklynInvest wrote: Tue Mar 28, 2023 12:03 pm There's no speculation with factor investing?

Is not the point of your value tilt to outperform market holders like me in the future? If not, why bother? It's your prediction and speculation for outperformance by definition, no? I mean, you might be right of course.

How do you know your stocks are cheap and the market isn't accurately pricing them?

Me I let the market do the work. I can't identify mispriced factors, stocks, sectors or regions. So I don't.
This is such bizarre framing. When I buy a different brand of toothpaste than you is it because I'm trying to beat you? Is one of us right or wrong? Should I buy every brand of toothpaste on the shelf because there's no way for me to know which is the "right" price? It can be simultaneously true that Target is pricing the "cheap" brand of toothpaste and the "expensive" brand correctly

I keep repeating this, I want a portfolio of profitable and productive companies, so I buy companies that are profitable and productive today. I know nothing about the future, I'm not making any claim that my portfolio will outperform or beat your portfolio, or the market portfolio, or anyone else's portfolio. I just want to own companies that make profits and aren't too expensive. Sure, cheap stocks could get cheaper in the future, expensive stocks might get more expensive, but to know that we'd have to know the future
Last edited by km91 on Tue Mar 28, 2023 1:07 pm, edited 2 times in total.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

rkhusky wrote: Tue Mar 28, 2023 11:17 am
km91 wrote: Tue Mar 28, 2023 11:05 am
beezlebub wrote: Tue Mar 28, 2023 10:56 am You are making a gamble that those companies will continue to be profitable and productive in the future, while missing out on the companies that may not be profitable today but could be the frontrunners of tomorrow. I call that stock picking, and it doesn't really fit with the Boglehead approach and is more of the WallStreetBets type of approach. But to each his own.
No, you keep reframing my decision in terms of a future outcome but I keep saying I did not look to the future to make my decision. I want a portfolio of profitable and productive companies today. I buy profitable and productive companies today. In the future I will also probably want a portfolio of profitable and productive companies. I will probably buy profitable and productive companies in the future
A value company would be something like SVB in January. It looks profitable now, but if analysts can look at the details, they see future problems and lower the current price. Hence you get a seemingly cheap stock - low P/E. If you invest in value, you are hoping stocks like SVB can turn things around and then you make money. If too many go bankrupt, you lose money.

If a company is profitable and looks to be profitable in the future, it’s not going to have a low price.
Well, not a very low price. You can still have considerable variation in the price depending if one is discussing toothpaste or technology; one will probably never be super profitable and carries a lower price, the other could be and carries a higher price. That is why profitability and value factors are often seen as different.

As one who has done bottom fishing, it is entirely correct that very low P/E means a likely earnings cut. The stock price includes the entire stream of expected earnings (discounted as needed for risk and future value). Value/Growth funds do not trim out their junk by default. The question is what kind of trash and treasures does the investor want to hold?
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by secondopinion »

BrooklynInvest wrote: Tue Mar 28, 2023 12:03 pm
km91 wrote: Tue Mar 28, 2023 10:10 am
beezlebub wrote: Tue Mar 28, 2023 9:51 am It baffles me that here on Bogleheads how many people try to justify market speculation and gambling with a goal of beating the market when the base principle of index investing is that you likely are not going to beat the market.
There is no speculation with factor investing. When we buy value, we're making no prediction about the future, we're buying it because the price today is cheap. Same with profitability, we aren't predicting whether the company will be profitable in the future, we are observing if it's profitable today. I want to build a portfolio of profitable, productive companies. I know for certain that companies with cheap earnings and high profits fit this bill. Will expensive and unprofitable companies become cheap and profitable in the future? Some probably will, but that's just speculation
There's no speculation with factor investing?

Is not the point of your value tilt to outperform market holders like me in the future? If not, why bother? It's your prediction and speculation for outperformance by definition, no? I mean, you might be right of course.

How do you know your stocks are cheap and the market isn't accurately pricing them?


Me I let the market do the work. I can't identify mispriced factors, stocks, sectors or regions. So I don't.
The stream of earnings (note I did not say dividend) is what one is buying from a stock. If the stream of greater present earnings is more valuable to the portfolio needs of the investor versus possibly greater earnings later, then a value tilt is entirely appropriate. That is precisely why retirees seem to prefer value-ish stocks; they might not live to reap all the earnings of the growth stock, so rather put the earnings forward and let the future earnings be the risky part of the stock performance. If the market is accurately pricing them, then it is not going to be harmful to tilt provided enough diversification happens.

Trying to argue that value/growth tilts are bad is like trying to argue that bond duration tilts are bad; there are sound reasons to tilt that do not need general outperformance, for all of investing needs only selective outperformance. That is, it should outperform when outperformance is needed the most and underperforms when outperformance is needed the least.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by rkhusky »

km91 wrote: Tue Mar 28, 2023 12:00 pm
rkhusky wrote: Tue Mar 28, 2023 11:17 am A value company would be something like SVB in January. It looks profitable now, but if analysts can look at the details, they see future problems and lower the current price. Hence you get a seemingly cheap stock - low P/E. If you invest in value, you are hoping stocks like SVB can turn things around and then you make money. If too many go bankrupt, you lose money.

If a company is profitable and looks to be profitable in the future, it’s not going to have a low price.
Notice how both these points refer to some future unknowable event. I want to build a portfolio of productive and profitable companies. The only way I know how to do that is to buy companies that are profitable and productive today. Anything else is just speculation
If a competitor has just developed and announced a product that is twice as effective and costs half as much as your company’s product, it’s a good bet that your company is going to make a lot less money in the future, even if they are making money now. The price for your company will quickly drop, even if the earnings don’t immediately drop. That’s a classic value company.
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by km91 »

rkhusky wrote: Tue Mar 28, 2023 1:09 pm If a competitor has just developed and announced a product that is twice as effective and costs half as much as your company’s product, it’s a good bet that your company is going to make a lot less money in the future, even if they are making money now. The price for your company will quickly drop, even if the earnings don’t immediately drop. That’s a classic value company.
Again, why are we making bets and predictions about the future? If you want to take this bet, go ahead, but I'm explicitly saying that I am not making a prediction about the future. I want productive and profitable companies in my portfolio and I want to spend less money compared to more money, so I buy the stocks that the market currently has on offer that meet these criteria. I assume the market has a very good reason for selling expensive stocks or unprofitable stocks and assume they're priced correctly, I just don't need to buy everything that has a price tag
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Re: Factor Investing: The Next-Gen Boglehead frontier

Post by Beensabu »

rkhusky wrote: Tue Mar 28, 2023 11:11 am
km91 wrote: Tue Mar 28, 2023 9:52 am A stock's price is based on it's future earnings, which are unknowable. It's also based on many other factors, most of which are unknowable as well. Value is the the price of current earnings, this is something we can easily calculate.
Interestingly, price for a cap weighted fund is irrelevant. Prices can go up and down and the cap weighted index is agnostic. Instead the fund buys shares in proportion to the shares each company has issued in relation to the total shares in the market.
That's not true.

Market cap is outstanding shares multiplied by share price, not just number of shares. Price is completely relevant.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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