Why don't you factor tilt?

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abuss368
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Re: Why don't you factor tilt?

Post by abuss368 »

abc132 wrote: Sun Sep 25, 2022 8:38 pm
Are you suggested paying more taxes is desirable simply because it often comes with more income?
This may not be correct. It is often not a quantity but rather the composition of the income and how that particular income is taxed.

Best.
Tony
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Why don't you factor tilt?

Post by abc132 »

Apathizer wrote: Sun Sep 25, 2022 8:19 pm
abc132 wrote: Sun Sep 25, 2022 7:45 pm
Apathizer wrote: Sun Sep 25, 2022 6:56 pm But the leverage increases risk without the potential increased reward of factors.
Yes, there are separate strategies using leverage with separate risks and rewards.

You have created your own circular argument here without comparing potential risks and rewards.

Apathizer wrote: Sun Sep 25, 2022 6:56 pm Using historical returns, the approximate likelihood of different factors out-performing one month t-bills over a decade is 80% for the market, 85% value, 70% for size, 85% profitability, and 95% for reinvestment. This means there's a 20% chance the cap weight TSM will under-perform on it's own, but only 1.35% a 5-factor portfolio will. Over the same interval, a factor-slanted portfolio (including the TSM) has about an 80% chance of out-performing the cap weight TSM.

I realize this is based on historical data, and we don't know if this will continue, but it's what we have to work with, so to me using this info for portfolio construction makes sense.
Picking the historical winner is not a good way to construct a portfolio.

I prefer individual stocks that won using that methodology.
Stock-picking is likely uncompensated risk whereas factor slants are likely to be compensated with higher returns.
Yes, this is a great example of an uncompensated risk, which is a bad thing. The additional risk can be added with increasing expected returns, and is undesirable. I don't really recommend stock picking but if we backtest there is no risk in what we choose. The same is true with our factor choices - we get to pick the winners.

I would recommend being careful in things that were backtested - with regards to future expectations, and that includes factors which are backtested constructs.
Last edited by abc132 on Sun Sep 25, 2022 9:11 pm, edited 1 time in total.
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Re: Why don't you factor tilt?

Post by abc132 »

abuss368 wrote: Sun Sep 25, 2022 9:04 pm
abc132 wrote: Sun Sep 25, 2022 8:38 pm
Are you suggested paying more taxes is desirable simply because it often comes with more income?
This may not be correct. It is often not a quantity but rather the composition of the income and how that particular income is taxed.

Best.
Tony
We make choices based on the relationship between the two factors but it should be clear that one is desirable, the other is not.

income = desirable
paying taxes = undesirable

That doesn't mean we maximize the thing that is good or minimize the thing that is bad. We find the optimum based on how desirable or undesirable each characteristic is in the combinations that are available to us.


Anyone that adds fixed income to a portfolio reduce the range of outcomes understand this. They are minimizing volatility (more specifically deviation of expected net worth) at the expense of expected returns.

returns = desirable
deviation of outcome = undesirable
Last edited by abc132 on Sun Sep 25, 2022 9:12 pm, edited 1 time in total.
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Re: Why don't you factor tilt?

Post by Apathizer »

abc132 wrote: Sun Sep 25, 2022 9:04 pm
Apathizer wrote: Sun Sep 25, 2022 8:19 pm
abc132 wrote: Sun Sep 25, 2022 7:45 pm
Apathizer wrote: Sun Sep 25, 2022 6:56 pm But the leverage increases risk without the potential increased reward of factors.
Yes, there are separate strategies using leverage with separate risks and rewards.

You have created your own circular argument here without comparing potential risks and rewards.

Apathizer wrote: Sun Sep 25, 2022 6:56 pm Using historical returns, the approximate likelihood of different factors out-performing one month t-bills over a decade is 80% for the market, 85% value, 70% for size, 85% profitability, and 95% for reinvestment. This means there's a 20% chance the cap weight TSM will under-perform on it's own, but only 1.35% a 5-factor portfolio will. Over the same interval, a factor-slanted portfolio (including the TSM) has about an 80% chance of out-performing the cap weight TSM.

I realize this is based on historical data, and we don't know if this will continue, but it's what we have to work with, so to me using this info for portfolio construction makes sense.
Picking the historical winner is not a good way to construct a portfolio.

I prefer individual stocks that won using that methodology.
Stock-picking is likely uncompensated risk whereas factor slants are likely to be compensated with higher returns.
Yes, this is a great example of an uncompensated risk, which is a bad thing. The additional risk can be added with increasing expected returns, and is undesirable. I don't really recommend stock picking but if we backtest there is no risk in what we choose. The same is true with our factor choices - we get to pick the winners.

I would recommend being careful in things that were backtesting with regards to future expectations, and that includes factors which are backtested constructs.
But stock-picking is random whereas factor slants are on systemic understanding of markets. To use a cards analogy, cap weight TSM investing is like betting on all hands whereas factor slanting is like allocating more to hands more likely to win. Both approaches are fine, but there's no reason to bet as much on lousy hands as good ones. While the lousy hands might do as well or better than the good ones, that's improbable.
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Re: Why don't you factor tilt?

Post by abc132 »

Apathizer wrote: Sun Sep 25, 2022 9:15 pm whereas factor slants are based on systemic understanding of markets.
Time will tell, but the past record of such things isn't rosy.

I suspect we haven't solved the markets just yet, and this quote will make a great time capsule.
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Re: Why don't you factor tilt?

Post by rkhusky »

Beensabu wrote: Sat Sep 24, 2022 9:59 pm
rkhusky wrote: Sat Sep 24, 2022 9:38 pm If that corner of the market does well, you gain. If that corner of the market does poorly, you lose.
That's what diversification is.
No it’s not.
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Re: Why don't you factor tilt?

Post by rkhusky »

Random Walker wrote: Sun Sep 25, 2022 9:59 am Yes SV represents a corner of the market in terms of individual stocks, but it has greater net exposure to the known drivers of equity returns.
SV has less diversity and more risk than TSM. Apart from the risk due to being composed of stocks, SV has the additional risks of being entirely composed of small cap stocks and being entirely composed of value stocks.

In order to invest in SV versus TSM, a rational investor should require that SV provide a significant potential for higher returns than TSM.
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Re: Why don't you factor tilt?

Post by rkhusky »

stan1 wrote: Sun Sep 25, 2022 12:50 pm
rkhusky wrote: Sat Sep 24, 2022 9:38 pm Applying factors pares down a portfolio, making it less diverse. The result is a portfolio whose stocks all look the same in regards to the factor components. This increases the risk of the portfolio. If that corner of the market does well, you gain. If that corner of the market does poorly, you lose.
vineviz wrote: Sun Sep 25, 2022 12:05 pm The number of individual holdings isn't a very direct contributor to diversification. Even funds with thousands of stocks can run into diversification issues when a large portion of the capital is allocated to just a handful of stocks. For instance, the five largest companies in the S&P 500 contain over 22% of the weight in that index which is roughly the same as the next 25 stocks combined.

Even if we keep the same 500ish stocks in that index, we can improve the diversification of the index just by adjusting the weights we assign to each stock.
Clearly different definitions of diverse are still being used.
My comment refers to different types of stocks, not number of stocks.
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nedsaid
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Re: Why don't you factor tilt?

Post by nedsaid »

Taylor Larimore wrote: Sun Sep 25, 2022 6:24 pm
nedsaid wrote: Vineviz did study at University of Chicago and sat under Gene Fama himself. He knows as much about the academic research as anyone here.
nedsaid:

I've known for a long time that Vineviz is smarter than I am. Now I know why.

Thank you and best wishes.

Taylor
Jack Bogle's Words of Wisdom: “It’s very difficult for any particular segment of the stock market to sustain superior performance. The watch word for our financial markets is ‘reversion to the mean.’”
Taylor, you are no slouch intellectually. But yes, I have joked about Vineviz being Groucho and Bogleheads matching wits with him as contestants on "You Bet Your Life." I have had a couple of instances of being the hapless contestant but learned something from him in the process.

The thing is, there are varying degrees of understanding related to these topics. Sometimes people talk past each other, sometimes people disagree because they don't quite understand each other's arguments, and sometimes people are in violent agreement. These discussions get to be pretty nuanced. Sometimes a lot of sound and fury over not much.

People are free to either accept or reject the academic research. There are smart people, here and elsewhere, who disagree whether factor premiums exist and if they do, if those factor premiums are investable.

I think Bogle acknowledged what Fama/French found in their research but believed pretty strongly that whatever factor premiums existed in the past were likely not able to be captured in the future. His Telltale Chart speech made the point that in the past there really wasn't a practical way for regular investors to capture the Small Value premium. Indeed, it was difficult for investors to even capture almost 100% of the Market factor because the Index fund wasn't available to retail investor until 1976. You had to rely on the skill of active fund managers to match or beat the market indexes and I suppose that back then most managers failed to achieve that. So pre-1976, investors could not reliably capture the Market factor. So if you couldn't reliably capture the market factor with mutual funds, how could you have captured the premiums from other factors? Dimensional Fund Advisors weren't around back then.

Larry Swedroe disagreed of course and said Bogle was wrong in his Telltail Chart speech, and somewhere I summarized the reasons why some believed Bogle wrong here. To be honest with you, I have forgotten the discussion and I would have to refresh myself on the points made. The old memory banks get to be a bit foggy over time, that old steel trap needs a bit of oil on the hinges!

My conclusion after digesting all of this material and understanding this best I could was that factor tilting was worth a shot. My hope was to squeeze out another 0.50% a year in returns over a 3 fund index approach. Instead, I have trailed the market since 2008, partly because Large Growth has done so well until the last year or two. So I understand why a lot of people here say, why bother?

So it boils down to this, if you believe the academic research, factor tilt your portfolio. If you don't believe the academic research, use the simpler 3-5 fund portfolios recommended by the Bogleheads. Factor tilting is not a hill I am going to die on. I have no quarrel with the simpler index fund portfolios. The Taylor Larimore 3 fund portfolio is perfectly fine. On the other hand, I have never made outrageous claims regarding factor premiums. My expectation of outperformance was 0.50% if things worked right but all along I knew that I could be wrong. I have also said that if you tilt, don't overdo it. I often say here that I was born to be mild.
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Re: Why don't you factor tilt?

Post by Random Walker »

rkhusky wrote: Sun Sep 25, 2022 9:38 pm
Random Walker wrote: Sun Sep 25, 2022 9:59 am Yes SV represents a corner of the market in terms of individual stocks, but it has greater net exposure to the known drivers of equity returns.
SV has less diversity and more risk than TSM. Apart from the risk due to being composed of stocks, SV has the additional risks of being entirely composed of small cap stocks and being entirely composed of value stocks.

In order to invest in SV versus TSM, a rational investor should require that SV provide a significant potential for higher returns than TSM.
Agree SV is more risky than TSM and consequently has higher expected return. TSM has net exposure to one risk factor, market beta. SV has exposure to three risk factors, market beta and betas for size and value as well. So I single SV fund has its risk spread more evenly across unique and independent drivers of equity returns.

Here is the question that interests me. If we start with a TSM fund and then add a SV fund, I believe we create a more efficient portfolio; I would expect the portfolio Sharpe ratio to be higher than TSM alone. If instead I have only a SV fund, would its exposure to three factors result in a higher Sharpe than TSM? I think this logic would say yes. But in an efficient market, we expect all investable assets to have similar Sharpe ratios, and I believe that is about the case. A SV fund has about same Sharpe as TSM. So does that mean that how our portfolio’s collection of factors is packaged affects portfolio efficiency?

In the answering my own question department, I went to Portfolio Visualizer and created 3 portfolios: 100% VTSMX, 100% DFSVX, 50% VTSMX/50%DFSVX. Looked at results as far back as it would go, 1994. Sharpe ratios for all three portfolios were essentially identical. I’m not sure how to interpret this. On the one hand I expect all investable assets to have about the same Sharpes. On the other hand I would at least expect the diversification of adding SV to TSM to improve portfolio Sharpe, but it didn’t. I don’t know what to expect of the 100% SV. It’s a single investable asset, but it is exposed to more independent risk factors.

https://www.portfoliovisualizer.com/bac ... tion2_3=50

Dave
Last edited by Random Walker on Sun Sep 25, 2022 10:55 pm, edited 1 time in total.
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Re: Why don't you factor tilt?

Post by Beensabu »

rkhusky wrote: Sun Sep 25, 2022 9:26 pm
Beensabu wrote: Sat Sep 24, 2022 9:59 pm
rkhusky wrote: Sat Sep 24, 2022 9:38 pm If that corner of the market does well, you gain. If that corner of the market does poorly, you lose.
That's what diversification is.
No it’s not.
Yes, it is.

It wouldn't be my preferred way of stating it, which is why I added the two edits to my original reply, but that's pretty much the concept.

When you spread the risk around, you have more areas subject to different kinds of risks that may arise in different kinds of economic conditions. The idea is that you avoid being over-allocated to a particular area so that if a risk that it is subject to arises, there are other areas that mitigate the damage to the overall portfolio. This also lessens the inclination to market time in the face of changing market conditions. As long as you understand why you are doing what you are doing, which is diversifying in order to manage risk.

Diversification is risk management.

You manage risk by narrowing the range of potential outcomes.

Diversification narrows the range of potential outcomes.

When you diversify away from a single stock, you narrow the range of potential outcomes.

When you diversify away from a single sector, you narrow the range of potential outcomes.

When you diversify away from a single country, you narrow the range of potential outcomes.

When you diversify away from a single capitalization, you narrow the range of potential outcomes.

When you diversify away from a single style, you narrow the range of potential outcomes.

When you diversify away from a single asset class, you narrow the range of potential outcomes.

The more diverse a portfolio becomes, the more you narrow the range of potential outcomes.

You take away the possibility of "winning bigly" while taking away the possibility of "losing bigly".

Instead, you exchange those for the possibilities of "winning moderately" and "losing moderately".

When people refuse to understand this, it makes me wonder if they truly are okay with accepting the average return of the market during their investment lifetime or if they're only okay with it if they get the historical return.
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Re: Why don't you factor tilt?

Post by strummer6969 »

Beensabu wrote: Sun Sep 25, 2022 10:53 pm
rkhusky wrote: Sun Sep 25, 2022 9:26 pm
Beensabu wrote: Sat Sep 24, 2022 9:59 pm
rkhusky wrote: Sat Sep 24, 2022 9:38 pm If that corner of the market does well, you gain. If that corner of the market does poorly, you lose.
That's what diversification is.
No it’s not.
Yes, it is.

It wouldn't be my preferred way of stating it, which is why I added the two edits to my original reply, but that's pretty much the concept.

When you spread the risk around, you have more areas subject to different kinds of risks that may arise in different kinds of economic conditions. The idea is that you avoid being over-allocated to a particular area so that if a risk that it is subject to arises, there are other areas that mitigate the damage to the overall portfolio. This also lessens the inclination to market time in the face of changing market conditions. As long as you understand why you are doing what you are doing, which is diversifying in order to manage risk.

Diversification is risk management.

You manage risk by narrowing the range of potential outcomes.

Diversification narrows the range of potential outcomes.

When you diversify away from a single stock, you narrow the range of potential outcomes.

When you diversify away from a single sector, you narrow the range of potential outcomes.

When you diversify away from a single country, you narrow the range of potential outcomes.

When you diversify away from a single capitalization, you narrow the range of potential outcomes.

When you diversify away from a single style, you narrow the range of potential outcomes.

When you diversify away from a single asset class, you narrow the range of potential outcomes.

The more diverse a portfolio becomes, the more you narrow the range of potential outcomes.

You take away the possibility of "winning bigly" while taking away the possibility of "losing bigly".

Instead, you exchange those for the possibilities of "winning moderately" and "losing moderately".

When people refuse to understand this, it makes me wonder if they truly are okay with accepting the average return of the market during their investment lifetime or if they're only okay with it if they get the historical return.
That was the clearest explanation I've read.
Yet I'm convinced that a large number of people will never intellectually grasp this concept.
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Re: Why don't you factor tilt?

Post by abc132 »

nedsaid wrote: Sun Sep 25, 2022 10:06 pm
The thing is, there are varying degrees of understanding related to these topics. Sometimes people talk past each other, sometimes people disagree because they don't quite understand each other's arguments, and sometimes people are in violent agreement. These discussions get to be pretty nuanced. Sometimes a lot of sound and fury over not much.

People are free to either accept or reject the academic research. There are smart people, here and elsewhere, who disagree whether factor premiums exist and if they do, if those factor premiums are investable.
It frustrating when you get challenged by someone for saying people predicted a 2.6% SWR and within 24 hours that same person posts that they calculated the SWR at 2.7%. It's very difficult to converse and make progress in that context. Sometimes it's more about listening than level of knowledge.
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Re: Why don't you factor tilt?

Post by Random Walker »

Beensabu wrote: Sun Sep 25, 2022 10:53 pm You take away the possibility of "winning bigly" while taking away the possibility of "losing bigly".

Instead, you exchange those for the possibilities of "winning moderately" and "losing moderately".

When people refuse to understand this, it makes me wonder if they truly are okay with accepting the average return of the market during their investment lifetime or if they're only okay with it if they get the historical return.
Completely agree. People talk about “long streaks of underperformance” for size and value as if there is an implicit guarantee that market will give us par, perhaps it’s historical average. And this thinking I believe is likely fueled by the last 10-14 years of historic S&P500 performance in the presence of low overall volatility. When one starts to view market as “just another factor”, he starts to really buy into the proposition of diversifying across factors. Also noteworthy, you mentioned cutting both the good right tail and the bad left tail. If one combines tilt to factors with expected premiums with lower overall equity allocation and increased allocation to safe bonds, he can cut the bad left tail more than the good right tail.

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Re: Why don't you factor tilt?

Post by Apathizer »

abc132 wrote: Sun Sep 25, 2022 9:19 pm
Apathizer wrote: Sun Sep 25, 2022 9:15 pm whereas factor slants are based on systemic understanding of markets.
Time will tell, but the past record of such things isn't rosy.

I suspect we haven't solved the markets just yet, and this quote will make a great time capsule.
As with any complex system we might never 'solve' markets, but we seem to understand most aspects of them. What do you mean 'past record isn't so rosy'? Since factors have historically out-performed the market, it's actually quite rosy.
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Re: Why don't you factor tilt?

Post by Robert T »

.
For simplicity:

Market–rf = 1*equity risk premium
Small Value-rf = 1*equity risk premium + b*size risk premium + c*value risk premium
rf=risk free rate
"b" and "c" are obviously less than 1 as small value is long-only.

Small value, in addition to equity market risk includes size and value risk factors.

As these risk factors have low average correlations with each other, and as they all have time-varying returns (that include long periods of underperformance) there is some [sequence of return] diversifying benefit from exposure to all three risk factors.

For example: here are the annual correlation coefficients: 1929-2021

0.40 = Equity risk premium: size risk premium
0.10 = Equity risk premium: value risk premium
0.09 = Size risk premium: value risk premium

Annualized returns (%): According to Portfolio Visualizer

DFSVX = Dimensional US Small Value fund
VTSMX = Vanguard Total Stock Market fund

DFSVX / VTSMX
14.3 / 20.5 = 1990s (3/1993 – 12/1999)
9.1 / -0.3 = 2000s (1/2000 – 12/2009)
10.7 / 13.3 = 2010s (1/2010 – 12/2019)
11.7 / 8.9 = 2020s so far (1/2020 – 8/2022)
11.1 / 9.7 = Full Period (3/1993 – 8/2022)

The variation in “decade” annualized return of DFSVX (with exposure to all three risk factors) was 9.1% to 14.3% compared VTSMX (with exposure to just one risk factor – market risk) which was -0.3% to 20.5%. The low average correlation of the equity market, size, and value risk factors reduced the overall sequence of return risk (time varying returns) of the equity market factor – providing a diversification benefit (particularly in 2000s).

And as above, ‘just leveraging VTSMX’ will not produce the same sequence of returns as DFSVX – so it is not equivalent.

However, while long-term average correlations tend to be low, correlations among equity market, size, and value risks can increase together – just at the ‘wrong’ time. For example, during the financial crisis the max. drawdowns for DFSVX (-61.2%) was significantly larger than VTSMX (-50.1%). So, in financial crises there tends to be no ‘diversifying benefit’, rather the opposite with an amplification of the downside (i.e. more negative skewness).

June 2007 – February 2009 (cumulative)
DFSVX = -61.2%
VTSMX = -50.1%
FF-Equity risk “premium” = -50.5%
FF-Size risk “premium” = -3.1%
FF-Value risk “premium” = -25.7%

Similarly, during the recent pandemic

January 2020 – March 2021 (cumulative)
DFSVX = -39.0%
VTSMX = -20.9%
FF-Equity risk “premium” = -20.5%
FF-Size risk “premium” = -6.8%
FF-Value risk “premium” = -22.4%

But correlations don’t always go up during equity market declines (as they did in during the financial crisis, and recent pandemic). For example, in the current equity market decline (high inflationary environment), the value premium has been positive, providing a diversification benefit.

2022 YTD
DFSVX = -13.8%
VTSMX = -22.9%

We each have to determine how much exposure our portfolios have to specific “risk” factors. For me, the reduced sequence of return risk (from diversifying across equity market, size, and value risk factors) and the greater relative ‘inflation protection’ (from exposure to the value risk factor) are attractive attributes (particularly during retirement). To provide some downside protection during financial crises (and pandemics), I include an intermediate bond allocation (to US Treasuries).

Obviously, no guarantees.

I know the thread title is "why don't you factor tilt?" and this post doesn't directly address that, but seems to fit with the flow of recent discussion on diversification.
.
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Re: Why don't you factor tilt?

Post by abc132 »

Apathizer wrote: Mon Sep 26, 2022 12:23 am
abc132 wrote: Sun Sep 25, 2022 9:19 pm
Apathizer wrote: Sun Sep 25, 2022 9:15 pm whereas factor slants are based on systemic understanding of markets.
Time will tell, but the past record of such things isn't rosy.

I suspect we haven't solved the markets just yet, and this quote will make a great time capsule.
As with any complex system we might never 'solve' markets, but we seem to understand most aspects of them. What do you mean 'past record isn't so rosy'? Since factors have historically out-performed the market, it's actually quite rosy.
I would refer you to all the quotes about timing the market, or the multitude of past promises that didn't pan out. Everyone thinks they can data mine the past and use anything that won in the past.

I will refer you to arkk which has overperformed while losing money for the average investor.

You are not a winner if you own factor funds and have underperformed on a result or risk-adjusted result basis, regardless of the prior record.

I will refer you to the comments in this thread that risk is good, that we can't separate risk from reward, while at the same time they are constructing a portfolio to lower risk and get the same expected reward. There is not even a basic level of understanding that risk is undesirable, or that multiple factors create an undesirable diversification effect of higher risk. You are simply hoping the rewards are good enough to offset the portfolio with less risky fixed income. It's the fixed income that lowers risk.

I certainly hope factor investing pans out for those involved, but I suspect the true risks of factors not behaving as expected won't be recognized for quite some time. By constructing an argument that can't be proven wrong by future results, one that people buy into, there are going to be a bunch of investors that lose money and do not get what they are promised, regardless of what factors do. They will all believe they got those past results, that they had an advantage, even as they lose out. That's the nature of those that believe in backtesting.
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Re: Why don't you factor tilt?

Post by dcabler »

Robert T wrote: Mon Sep 26, 2022 12:53 am .
For simplicity:

Market–rf = 1*equity risk premium
Small Value-rf = 1*equity risk premium + b*size risk premium + c*value risk premium
rf=risk free rate
"b" and "c" are obviously less than 1 as small value is long-only.

Small value, in addition to equity market risk includes size and value risk factors.

As these risk factors have low average correlations with each other, and as they all have time-varying returns (that include long periods of underperformance) there is some [sequence of return] diversifying benefit from exposure to all three risk factors.

For example: here are the annual correlation coefficients: 1929-2021

0.40 = Equity risk premium: size risk premium
0.10 = Equity risk premium: value risk premium
0.09 = Size risk premium: value risk premium

Annualized returns (%): According to Portfolio Visualizer

DFSVX = Dimensional US Small Value fund
VTSMX = Vanguard Total Stock Market fund

DFSVX / VTSMX
14.3 / 20.5 = 1990s (3/1993 – 12/1999)
9.1 / -0.3 = 2000s (1/2000 – 12/2009)
10.7 / 13.3 = 2010s (1/2010 – 12/2019)
11.7 / 8.9 = 2020s so far (1/2020 – 8/2022)
11.1 / 9.7 = Full Period (3/1993 – 8/2022)

The variation in “decade” annualized return of DFSVX (with exposure to all three risk factors) was 9.1% to 14.3% compared VTSMX (with exposure to just one risk factor – market risk) which was -0.3% to 20.5%. The low average correlation of the equity market, size, and value risk factors reduced the overall sequence of return risk (time varying returns) of the equity market factor – providing a diversification benefit (particularly in 2000s).

And as above, ‘just leveraging VTSMX’ will not produce the same sequence of returns as DFSVX – so it is not equivalent.

However, while long-term average correlations tend to be low, correlations among equity market, size, and value risks can increase together – just at the ‘wrong’ time. For example, during the financial crisis the max. drawdowns for DFSVX (-61.2%) was significantly larger than VTSMX (-50.1%). So, in financial crises there tends to be no ‘diversifying benefit’, rather the opposite with an amplification of the downside (i.e. more negative skewness).

June 2007 – February 2009 (cumulative)
DFSVX = -61.2%
VTSMX = -50.1%
FF-Equity risk “premium” = -50.5%
FF-Size risk “premium” = -3.1%
FF-Value risk “premium” = -25.7%

Similarly, during the recent pandemic

January 2020 – March 2021 (cumulative)
DFSVX = -39.0%
VTSMX = -20.9%
FF-Equity risk “premium” = -20.5%
FF-Size risk “premium” = -6.8%
FF-Value risk “premium” = -22.4%

But correlations don’t always go up during equity market declines (as they did in during the financial crisis, and recent pandemic). For example, in the current equity market decline (high inflationary environment), the value premium has been positive, providing a diversification benefit.

2022 YTD
DFSVX = -13.8%
VTSMX = -22.9%

We each have to determine how much exposure our portfolios have to specific “risk” factors. For me, the reduced sequence of return risk (from diversifying across equity market, size, and value risk factors) and the greater relative ‘inflation protection’ (from exposure to the value risk factor) are attractive attributes (particularly during retirement). To provide some downside protection during financial crises (and pandemics), I include an intermediate bond allocation (to US Treasuries).

Obviously, no guarantees.

I know the thread title is "why don't you factor tilt?" and this post doesn't directly address that, but seems to fit with the flow of recent discussion on diversification.
.
Thank you for this. One reason, I suspect, that many don't (or perhaps even shouldn't) factor tilt is that they might not have the training to understand the math behind factors in the first place. Don't invest in what you don't understand, especially as a DIY'er, would seem to apply. More worrisome would be those who, whether they tilt or not, believe they understand factors when they don't. Hopefully your post will help shed some light.

Also thanks specifically about pointing out how short term correlations among factors can increase together. We also know that short term correlations among any assets can increase together - even stocks vs bonds. Factors aren't uniquely subject to this phenomenon.

My reasons to tilt (albeit mildly) are very similar to yours. And while I no longer think of bonds as "downside protection" in terms of their value as an asset, as somebody who will duration match during retirement, they will some direct downside income protection along with SS.

Cheers.
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Re: Why don't you factor tilt?

Post by vineviz »

abc132 wrote: Sun Sep 25, 2022 8:38 pm Are you suggested paying more taxes is desirable simply because it often comes with more income?
I'm suggesting that the "good/bad" dichotomy is too simplistic a framework to employ in this context.

Systematic risk factors aren't "good" or "bad", and nay attempt to frame risk as one or the other will lead to a muddled discussion.

A portfolio of stocks and bonds is riskier than a portfolio of just bonds. That's not "bad" or "good". It just is what it is.

Anyone wanting to understand the concept of diversification has to be able to hold in their head the notion that it it possible to increase the diversification of a portfolio AND increase the overall riskiness of that portfolio at the same time.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Why don't you factor tilt?

Post by vineviz »

abc132 wrote: Sun Sep 25, 2022 11:06 pm It frustrating when you get challenged by someone for saying people predicted a 2.6% SWR and within 24 hours that same person posts that they calculated the SWR at 2.7%. It's very difficult to converse and make progress in that context. Sometimes it's more about listening than level of knowledge.
You're talking about me, but you're also putting words in my mouth.

But I neither "predicted" not "caclulated" the SWR at 2.7%. I estimated a 90% chance that it would have been expected to be that rate or greater at a particular point in time.

When people represent the lower bound of a confidence interval as the "predicted" outcome it's hard to have an honest discussion on the topic.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Why don't you factor tilt?

Post by rkhusky »

Beensabu wrote: Sun Sep 25, 2022 10:53 pm
rkhusky wrote: Sun Sep 25, 2022 9:26 pm
Beensabu wrote: Sat Sep 24, 2022 9:59 pm
rkhusky wrote: Sat Sep 24, 2022 9:38 pm If that corner of the market does well, you gain. If that corner of the market does poorly, you lose.
That's what diversification is.
No it’s not.
Yes, it is.

It wouldn't be my preferred way of stating it, which is why I added the two edits to my original reply, but that's pretty much the concept.

When you spread the risk around, you have more areas subject to different kinds of risks that may arise in different kinds of economic conditions. The idea is that you avoid being over-allocated to a particular area so that if a risk that it is subject to arises, there are other areas that mitigate the damage to the overall portfolio. This also lessens the inclination to market time in the face of changing market conditions. As long as you understand why you are doing what you are doing, which is diversifying in order to manage risk.

Diversification is risk management.

You manage risk by narrowing the range of potential outcomes.

Diversification narrows the range of potential outcomes.

When you diversify away from a single stock, you narrow the range of potential outcomes.

When you diversify away from a single sector, you narrow the range of potential outcomes.

When you diversify away from a single country, you narrow the range of potential outcomes.

When you diversify away from a single capitalization, you narrow the range of potential outcomes.

When you diversify away from a single style, you narrow the range of potential outcomes.

When you diversify away from a single asset class, you narrow the range of potential outcomes.

The more diverse a portfolio becomes, the more you narrow the range of potential outcomes.

You take away the possibility of "winning bigly" while taking away the possibility of "losing bigly".

Instead, you exchange those for the possibilities of "winning moderately" and "losing moderately".

When people refuse to understand this, it makes me wonder if they truly are okay with accepting the average return of the market during their investment lifetime or if they're only okay with it if they get the historical return.
So, you are agreeing with me that the whole market is more diverse than a small corner of the market?
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Re: Why don't you factor tilt?

Post by rkhusky »

Random Walker wrote: Sun Sep 25, 2022 10:41 pm Agree SV is more risky than TSM and consequently has higher expected return.
That is not necessarily true. 1) You can't calculate the expected return because you don't know the market's statistical distribution, 2) If you try to estimate the future expected return by using past returns, you don't know which past returns to use, because the market is non-stationary. Using a larger sample of returns does not give you a better estimate of the true expected value.

Higher risk does not imply higher return. Rather, a rational investor should require that the higher risk investment provide a significant potential for higher returns.
Random Walker wrote: Sun Sep 25, 2022 10:41 pm TSM has net exposure to one risk factor, market beta. SV has exposure to three risk factors, market beta and betas for size and value as well. So I single SV fund has its risk spread more evenly across unique and independent drivers of equity returns.
But we don't invest in risk factors, we invest in companies. And the companies in an SV fund all have the same size attribute and the same value attribute. The companies in the SV fund are therefore less diverse than the TSM fund, because the TSM fund has companies with a broader range of size attributes and a broader range of value attributes.

Note that SG, LG, and LV funds are also exposed to the same three risk factors as the SV fund.
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Re: Why don't you factor tilt?

Post by DaufuskieNate »

rkhusky wrote: Mon Sep 26, 2022 7:42 am
Random Walker wrote: Sun Sep 25, 2022 10:41 pm Agree SV is more risky than TSM and consequently has higher expected return.
That is not necessarily true. 1) You can't calculate the expected return because you don't know the market's statistical distribution, 2) If you try to estimate the future expected return by using past returns, you don't know which past returns to use, because the market is non-stationary.

Higher risk does not imply higher return. Rather, a rational investor should require that the higher risk investment provide a significant potential for higher returns.
Interesting comment. I do understand it. I'm left wondering how, in your view, does a rational investor convince themselves that the investment provides a significant potential for higher returns? If the investor can't calculate expected returns, or make estimates based on past returns, what criteria do they use? What body of evidence allows them to be "rational" in their decision?
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Re: Why don't you factor tilt?

Post by rkhusky »

DaufuskieNate wrote: Mon Sep 26, 2022 7:53 am
rkhusky wrote: Mon Sep 26, 2022 7:42 am
Random Walker wrote: Sun Sep 25, 2022 10:41 pm Agree SV is more risky than TSM and consequently has higher expected return.
That is not necessarily true. 1) You can't calculate the expected return because you don't know the market's statistical distribution, 2) If you try to estimate the future expected return by using past returns, you don't know which past returns to use, because the market is non-stationary.

Higher risk does not imply higher return. Rather, a rational investor should require that the higher risk investment provide a significant potential for higher returns.
Interesting comment. I do understand it. I'm left wondering how, in your view, does a rational investor convince themselves that the investment provides a significant potential for higher returns? If the investor can't calculate expected returns, or make estimates based on past returns, what criteria do they use? What body of evidence allows them to be "rational" in their decision?
You can never be sure that you have made the right choice. There is no mathematical certainty in investing, which using terms like "expected return" implies. And even if you knew the probability distribution, there is no guarantee that you would get a particular outcome. So, in some sense, the market has double uncertainty because you don't even know the distribution.

You can look at past returns to get a feeling for how the market and segments of the market have performed in the past. You can invest based on the averages, but realize that your estimate of the average might not be accurate, and then hope and pray that things will work out.

There are a range of investments that one could invest in, from very risky (penny stocks) to the very safe (FDIC insured). A rational investor would spend more time analyzing the risk/rewards of the very risk, compared to the very safe. A total market stock fund is somewhere in the middle, where common investors might comfortably assume that the experts have already done due diligence concerning the state of the companies in the fund, to make sure that the prices are in reasonable accordance with the future of the companies.
Last edited by rkhusky on Mon Sep 26, 2022 8:30 am, edited 1 time in total.
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Re: Why don't you factor tilt?

Post by dbr »

rkhusky wrote: Mon Sep 26, 2022 8:18 am
You can never be sure that you have made the right choice. There is no mathematical certainty in investing, which using terms like "expected return" implies. And even if you knew the probability distribution, there is no guarantee that you would get a particular outcome. So, in some sense, the market has double uncertainty because you don't even know the distribution.
Right. You don't know if a model such as Fama-French is valid anymore and giving you valid expected returns, and if the expected returns are valid there is still no guarantee you will get them. That is true with all forecasts that are based on estimated returns and risks but also try to go a step past that and try to tell you what you will actually get. The difficulty in doing the latter makes much of the former moot.
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Re: Why don't you factor tilt?

Post by Random Walker »

rkhusky wrote: Mon Sep 26, 2022 7:42 am But we don't invest in risk factors, we invest in companies. And the companies in an SV fund all have the same size attribute and the same value attribute. The companies in the SV fund are therefore less diverse than the TSM fund, because the TSM fund has companies with a broader range of size attributes and a broader range of value attributes.

Note that SG, LG, and LV funds are also exposed to the same three risk factors as the SV fund.
I’ll address the second point first. No, SG, LG, LV funds do not have net exposure to both the size and value factors; that’s by definition. Your first point I think brings up a potentially very interesting subject. Are we investing in companies? There is a big difference between investing in a company and in the stock of a company. How well a stock does doesn’t really depend as much on the success of the company, it depends more on the company success compared to expectations. Value is especially interesting to me because it has both risk based and behavioral based explanations, and my faith in the behavioral component has increased a lot over time. Conversely, it appears humans love overpaying for growth. Put all that together and next thing you know, you see some of the strongest data supporting momentum. That sort of brings us back to whether we’re investing in companies or stocks.

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Re: Why don't you factor tilt?

Post by Random Walker »

dcabler wrote: Mon Sep 26, 2022 5:09 am
Robert T wrote: Mon Sep 26, 2022 12:53 am .
For simplicity:

Market–rf = 1*equity risk premium
Small Value-rf = 1*equity risk premium + b*size risk premium + c*value risk premium
rf=risk free rate
"b" and "c" are obviously less than 1 as small value is long-only.

Small value, in addition to equity market risk includes size and value risk factors.

As these risk factors have low average correlations with each other, and as they all have time-varying returns (that include long periods of underperformance) there is some [sequence of return] diversifying benefit from exposure to all three risk factors.

For example: here are the annual correlation coefficients: 1929-2021

0.40 = Equity risk premium: size risk premium
0.10 = Equity risk premium: value risk premium
0.09 = Size risk premium: value risk premium

Annualized returns (%): According to Portfolio Visualizer

DFSVX = Dimensional US Small Value fund
VTSMX = Vanguard Total Stock Market fund

DFSVX / VTSMX
14.3 / 20.5 = 1990s (3/1993 – 12/1999)
9.1 / -0.3 = 2000s (1/2000 – 12/2009)
10.7 / 13.3 = 2010s (1/2010 – 12/2019)
11.7 / 8.9 = 2020s so far (1/2020 – 8/2022)
11.1 / 9.7 = Full Period (3/1993 – 8/2022)

The variation in “decade” annualized return of DFSVX (with exposure to all three risk factors) was 9.1% to 14.3% compared VTSMX (with exposure to just one risk factor – market risk) which was -0.3% to 20.5%. The low average correlation of the equity market, size, and value risk factors reduced the overall sequence of return risk (time varying returns) of the equity market factor – providing a diversification benefit (particularly in 2000s).

And as above, ‘just leveraging VTSMX’ will not produce the same sequence of returns as DFSVX – so it is not equivalent.

However, while long-term average correlations tend to be low, correlations among equity market, size, and value risks can increase together – just at the ‘wrong’ time. For example, during the financial crisis the max. drawdowns for DFSVX (-61.2%) was significantly larger than VTSMX (-50.1%). So, in financial crises there tends to be no ‘diversifying benefit’, rather the opposite with an amplification of the downside (i.e. more negative skewness).

June 2007 – February 2009 (cumulative)
DFSVX = -61.2%
VTSMX = -50.1%
FF-Equity risk “premium” = -50.5%
FF-Size risk “premium” = -3.1%
FF-Value risk “premium” = -25.7%

Similarly, during the recent pandemic

January 2020 – March 2021 (cumulative)
DFSVX = -39.0%
VTSMX = -20.9%
FF-Equity risk “premium” = -20.5%
FF-Size risk “premium” = -6.8%
FF-Value risk “premium” = -22.4%

But correlations don’t always go up during equity market declines (as they did in during the financial crisis, and recent pandemic). For example, in the current equity market decline (high inflationary environment), the value premium has been positive, providing a diversification benefit.

2022 YTD
DFSVX = -13.8%
VTSMX = -22.9%

We each have to determine how much exposure our portfolios have to specific “risk” factors. For me, the reduced sequence of return risk (from diversifying across equity market, size, and value risk factors) and the greater relative ‘inflation protection’ (from exposure to the value risk factor) are attractive attributes (particularly during retirement). To provide some downside protection during financial crises (and pandemics), I include an intermediate bond allocation (to US Treasuries).

Obviously, no guarantees.

I know the thread title is "why don't you factor tilt?" and this post doesn't directly address that, but seems to fit with the flow of recent discussion on diversification.
.
Thank you for this. One reason, I suspect, that many don't (or perhaps even shouldn't) factor tilt is that they might not have the training to understand the math behind factors in the first place. Don't invest in what you don't understand, especially as a DIY'er, would seem to apply. More worrisome would be those who, whether they tilt or not, believe they understand factors when they don't. Hopefully your post will help shed some light.

Also thanks specifically about pointing out how short term correlations among factors can increase together. We also know that short term correlations among any assets can increase together - even stocks vs bonds. Factors aren't uniquely subject to this phenomenon.

My reasons to tilt (albeit mildly) are very similar to yours. And while I no longer think of bonds as "downside protection" in terms of their value as an asset, as somebody who will duration match during retirement, they will some direct downside income protection along with SS.

Cheers.
+1!!! Thank you for the effort that went into that post. Super educational and helpful. Really can add to a factor head’s conviction.

Dave
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Re: Why don't you factor tilt?

Post by rkhusky »

Random Walker wrote: Mon Sep 26, 2022 8:30 am I’ll address the second point first. No, SG, LG, LV funds do not have net exposure to both the size and value factors; that’s by definition.
The factors are HmL and SmB. Writing the factor equations in terms of LmH and/or BmS would give equivalent results. The only reason that people have fixated on SV is the assumption/hope that SV will have higher future returns. In terms of the factor equations, SG, LG, and LV are on equal footing with SV.
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Re: Why don't you factor tilt?

Post by Random Walker »

rkhusky wrote: Mon Sep 26, 2022 8:18 am You can never be sure that you have made the right choice. There is no mathematical certainty in investing, which using terms like "expected return" implies. And even if you knew the probability distribution, there is no guarantee that you would get a particular outcome. So, in some sense, the market has double uncertainty because you don't even know the distribution.

You can look at past returns to get a feeling for how the market and segments of the market have performed in the past. You can invest based on the averages, but realize that your estimate of the average might not be accurate, and then hope and pray that things will work out.
In his writings Larry Swedroe has made the distinction between risk (where the odds are known) and uncertainty (where they are not). A flip of a coin or a roll of the dice involves risk. Investing way more involves uncertainty. Is that a reason to avoid factors or diversify across them?

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Re: Why don't you factor tilt?

Post by Random Walker »

rkhusky wrote: Mon Sep 26, 2022 8:37 am
Random Walker wrote: Mon Sep 26, 2022 8:30 am I’ll address the second point first. No, SG, LG, LV funds do not have net exposure to both the size and value factors; that’s by definition.
The factors are HmL and SmB. Writing the factor equations in terms of LmH and/or BmS would give equivalent results. The only reason that people have fixated on SV is the assumption/hope that SV will have higher future returns. In terms of the factor equations, SG, LG, and LV are on equal footing with SV.
Well yes, I suppose so. Factor investors do run with the assumption that smaller companies are riskier than bigger companies and cheaper companies more risky than expensive companies. So we assume SmB and HmL are positive, potentially rewarding additional risks. Even Fama said it’s about preferences. If one prefers less risky companies with lower expected return, he would tilt to LG.

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Re: Why don't you factor tilt?

Post by rkhusky »

Random Walker wrote: Mon Sep 26, 2022 8:30 am
rkhusky wrote: Mon Sep 26, 2022 7:42 am But we don't invest in risk factors, we invest in companies. And the companies in an SV fund all have the same size attribute and the same value attribute. The companies in the SV fund are therefore less diverse than the TSM fund, because the TSM fund has companies with a broader range of size attributes and a broader range of value attributes.

Note that SG, LG, and LV funds are also exposed to the same three risk factors as the SV fund.
Your first point I think brings up a potentially very interesting subject. Are we investing in companies? There is a big difference between investing in a company and in the stock of a company. How well a stock does doesn’t really depend as much on the success of the company, it depends more on the company success compared to expectations. Value is especially interesting to me because it has both risk based and behavioral based explanations, and my faith in the behavioral component has increased a lot over time. Conversely, it appears humans love overpaying for growth. Put all that together and next thing you know, you see some of the strongest data supporting momentum. That sort of brings us back to whether we’re investing in companies or stocks.
Investing in a public company means investing in the stocks and bonds of the company. Since we are talking stocks, the former is what is meant. Agreed that the price movement of stock has to do with how the company performs in relation to expectations. That doesn't change the argument that we invest in companies and not risk factors.
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Re: Why don't you factor tilt?

Post by rkhusky »

Random Walker wrote: Mon Sep 26, 2022 8:46 am Factor investors do run with the assumption that smaller companies are riskier than bigger companies and cheaper companies more risky than expensive companies.
Those assumptions aren't necessarily true. Why should smaller companies be riskier? The companies we are talking about are not mom & pop operations. It seems like smaller companies are more agile and able to handle change better. They might also be more efficient than a bloated mega-corp. Perhaps the advantage to small companies in the past was just a temporary anomaly.

Agreed that some value companies might not have good prospects, but they could have out-sized returns if they turn things around. Other value companies might not have good growth prospects, but have a consistent flow of profits that are paid out in dividends. Perhaps the past out-performance of value companies was also just a temporary anomaly. Or perhaps the out-performance is just cyclical and over a long period of time, there will be no net out-performance.
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Re: Why don't you factor tilt?

Post by stan1 »

rkhusky wrote: Mon Sep 26, 2022 8:56 am
Random Walker wrote: Mon Sep 26, 2022 8:46 am Factor investors do run with the assumption that smaller companies are riskier than bigger companies and cheaper companies more risky than expensive companies.
Those assumptions aren't necessarily true. Why should smaller companies be riskier? The companies we are talking about are not mom & pop operations. It seems like smaller companies are more agile and able to handle change better. They might also be more efficient than a bloated mega-corp. Perhaps the advantage to small companies in the past was just a temporary anomaly.

Agreed that some value companies might not have good prospects, but they could have out-sized returns if they turn things around. Other value companies might not have good growth prospects, but have a consistent flow of profits that are paid out in dividends. Perhaps the past out-performance of value companies was also just a temporary anomaly. Or perhaps the out-performance is just cyclical and over a long period of time, there will be no net out-performance.
You just described risk, so is it more likely to be compensated or uncompensated? If the outcome was known in advance it would be a risk free decision. It's not a risk free decision.
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Re: Why don't you factor tilt?

Post by abc132 »

vineviz wrote: Mon Sep 26, 2022 6:11 am
abc132 wrote: Sun Sep 25, 2022 11:06 pm It frustrating when you get challenged by someone for saying people predicted a 2.6% SWR and within 24 hours that same person posts that they calculated the SWR at 2.7%. It's very difficult to converse and make progress in that context. Sometimes it's more about listening than level of knowledge.
You're talking about me, but you're also putting words in my mouth.

But I neither "predicted" not "caclulated" the SWR at 2.7%. I estimated a 90% chance that it would have been expected to be that rate or greater at a particular point in time.

When people represent the lower bound of a confidence interval as the "predicted" outcome it's hard to have an honest discussion on the topic.
That makes sense to you that you estimated the 90% chance of SWR rate as greater than 2.7% while arguing nobody ever calculated the SWR at 2.6%?

You realize that means the SWR can be below 2.7%?

You realize you also argued in a previous thread that there was only ONE safe withdrawal rate, and now you are contradicting that prior statement. You used to believe SWR had one definition and was not a range of values.

When someone says Wade pfau calculated a SWR of 2.2%, you are going to argue he didn't because of the terminology calculated instead of estimated?

We can see why progress in a discussion is so difficult when I said the SWR was predicted, and not that the SWR was the predicted outcome. Basic reading comprehension helps you understand the difference between the two statements.
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Re: Why don't you factor tilt?

Post by Random Walker »

rkhusky wrote: Mon Sep 26, 2022 8:56 am
Random Walker wrote: Mon Sep 26, 2022 8:46 am Factor investors do run with the assumption that smaller companies are riskier than bigger companies and cheaper companies more risky than expensive companies.
Those assumptions aren't necessarily true. Why should smaller companies be riskier? The companies we are talking about are not mom & pop operations. It seems like smaller companies are more agile and able to handle change better. They might also be more efficient than a bloated mega-corp. Perhaps the advantage to small companies in the past was just a temporary anomaly.

Agreed that some value companies might not have good prospects, but they could have out-sized returns if they turn things around. Other value companies might not have good growth prospects, but have a consistent flow of profits that are paid out in dividends. Perhaps the past out-performance of value companies was also just a temporary anomaly. Or perhaps the out-performance is just cyclical and over a long period of time, there will be no net out-performance.
Pretty much agree with you on all this. Fascinating to see how it plays out over time.

You sort of brought up a dichotomy above in the two value scenarios. The struggling value company that needs a turn around versus the consistent profitable value company with not a lot of growth prospect. Factor investors believe profitability screen helps determine the better stocks for investment in the low P/B realm. I’m a bit confused by the rationale. Larry Swedroe says profitability screen screens out falling knife “value traps”. I think Cliff Asness says profitability screen identifies the low P/B stocks that are truly risky for perhaps not so obvious reasons.

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Re: Why don't you factor tilt?

Post by burritoLover »

I'm not sure how anyone can argue that adding an SCV tilt is less diversified and more concentrated than holding only TSM. The top 20 stocks in TSM make up 30+% of the entire index and the top stock (AAPL) is double that of ALL the SCV stocks in TSM. Adding an SCV tilt reduces your concentration in the mega caps that overwhelm the TSM index even if you don't have a strong conviction with small/value factors.

And we know that anything outside of large caps is practically irrelevant in TSM - a difference in return in the hundredths of a percent over 50 years. So to say you already own SCV in TSM is just nice little meaningless anecdote.
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Re: Why don't you factor tilt?

Post by rkhusky »

Random Walker wrote: Mon Sep 26, 2022 8:39 am
rkhusky wrote: Mon Sep 26, 2022 8:18 am You can never be sure that you have made the right choice. There is no mathematical certainty in investing, which using terms like "expected return" implies. And even if you knew the probability distribution, there is no guarantee that you would get a particular outcome. So, in some sense, the market has double uncertainty because you don't even know the distribution.

You can look at past returns to get a feeling for how the market and segments of the market have performed in the past. You can invest based on the averages, but realize that your estimate of the average might not be accurate, and then hope and pray that things will work out.
In his writings Larry Swedroe has made the distinction between risk (where the odds are known) and uncertainty (where they are not). A flip of a coin or a roll of the dice involves risk. Investing way more involves uncertainty. Is that a reason to avoid factors or diversify across them?

Dave
Investing in SV is not diversifying across risk factors, it is concentrating or compounding risk factors into the same companies. Diversification means the overall risk of the portfolio is somewhere between the risk of the lowest risk component to the risk of the high risk component. With SV, you have only one component, so there is no diversification in regards to the size/value dimensions.
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Re: Why don't you factor tilt?

Post by vineviz »

rkhusky wrote: Mon Sep 26, 2022 9:48 am Investing in SV is not diversifying across risk factors, it is concentrating or compounding risk factors into the same companies. Diversification means the overall risk of the portfolio is somewhere between the risk of the lowest risk component to the risk of the high risk component. With SV, you have only one component, so there is no diversification in regards to the size/value dimensions.
This is not true.

A SCV portfolio has THREE sources of systematic risk: market beta, size beta, and value beta.

That's THREE components, not just one.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Why don't you factor tilt?

Post by abc132 »

rkhusky wrote: Mon Sep 26, 2022 9:48 am
Random Walker wrote: Mon Sep 26, 2022 8:39 am
rkhusky wrote: Mon Sep 26, 2022 8:18 am You can never be sure that you have made the right choice. There is no mathematical certainty in investing, which using terms like "expected return" implies. And even if you knew the probability distribution, there is no guarantee that you would get a particular outcome. So, in some sense, the market has double uncertainty because you don't even know the distribution.

You can look at past returns to get a feeling for how the market and segments of the market have performed in the past. You can invest based on the averages, but realize that your estimate of the average might not be accurate, and then hope and pray that things will work out.
In his writings Larry Swedroe has made the distinction between risk (where the odds are known) and uncertainty (where they are not). A flip of a coin or a roll of the dice involves risk. Investing way more involves uncertainty. Is that a reason to avoid factors or diversify across them?

Dave
Investing in SV is not diversifying across risk factors, it is concentrating or compounding risk factors into the same companies. Diversification means the overall risk of the portfolio is somewhere between the risk of the lowest risk component to the risk of the high risk component. With SV, you have only one component, so there is no diversification in regards to the size/value dimensions.
It is diversifying across factors to compound risk.
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Beensabu
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Re: Why don't you factor tilt?

Post by Beensabu »

rkhusky wrote: Mon Sep 26, 2022 7:30 am
Beensabu wrote: Sun Sep 25, 2022 10:53 pm When you spread the risk around, you have more areas subject to different kinds of risks that may arise in different kinds of economic conditions. The idea is that you avoid being over-allocated to a particular area so that if a risk that it is subject to arises, there are other areas that mitigate the damage to the overall portfolio. This also lessens the inclination to market time in the face of changing market conditions. As long as you understand why you are doing what you are doing, which is diversifying in order to manage risk.
So, you are agreeing with me that the whole market is more diverse than a small corner of the market?
Have you ever read "The Blind Man And The Elephant" by John Godfrey Saxe?
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Re: Why don't you factor tilt?

Post by dcabler »

Beensabu wrote: Mon Sep 26, 2022 10:09 am
Have you ever read "The Blind Man And The Elephant" by John Godfrey Saxe?
The whole thread is starting to remind me of Abbott and Costello's "Who's on First?"
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Re: Why don't you factor tilt?

Post by DaufuskieNate »

rkhusky wrote: Mon Sep 26, 2022 8:18 am
DaufuskieNate wrote: Mon Sep 26, 2022 7:53 am
rkhusky wrote: Mon Sep 26, 2022 7:42 am
Random Walker wrote: Sun Sep 25, 2022 10:41 pm Agree SV is more risky than TSM and consequently has higher expected return.
That is not necessarily true. 1) You can't calculate the expected return because you don't know the market's statistical distribution, 2) If you try to estimate the future expected return by using past returns, you don't know which past returns to use, because the market is non-stationary.

Higher risk does not imply higher return. Rather, a rational investor should require that the higher risk investment provide a significant potential for higher returns.
Interesting comment. I do understand it. I'm left wondering how, in your view, does a rational investor convince themselves that the investment provides a significant potential for higher returns? If the investor can't calculate expected returns, or make estimates based on past returns, what criteria do they use? What body of evidence allows them to be "rational" in their decision?
You can never be sure that you have made the right choice. There is no mathematical certainty in investing, which using terms like "expected return" implies. And even if you knew the probability distribution, there is no guarantee that you would get a particular outcome. So, in some sense, the market has double uncertainty because you don't even know the distribution.

You can look at past returns to get a feeling for how the market and segments of the market have performed in the past. You can invest based on the averages, but realize that your estimate of the average might not be accurate, and then hope and pray that things will work out.

There are a range of investments that one could invest in, from very risky (penny stocks) to the very safe (FDIC insured). A rational investor would spend more time analyzing the risk/rewards of the very risk, compared to the very safe. A total market stock fund is somewhere in the middle, where common investors might comfortably assume that the experts have already done due diligence concerning the state of the companies in the fund, to make sure that the prices are in reasonable accordance with the future of the companies.
Yes, there is uncertainty in any investing decision we make. And yes, sometimes people imply a greater degree of certainty around their decisions than actually exists. Given the degree of uncertainty you are asserting, because of non-stationarity and not knowing anything about the market's statistical distribution, I'm not sure that anything can be gleaned from looking at past returns to get a feel about various market segments as you suggest. I'm also not sure how one could spend more time analyzing the risk/reward of very safe and very risky investments if we cannot reference history due to the lack of any statistical basis to analyze those returns. We may say that something is safe, but how do we know? Bonds generated a negative real return in the 40 years from 1940 to 1980. Does that make them safe? And since we can't reference this historical information with any certainty, how do we know? Yes, we can buy the whole market and hope that so-called experts have done due diligence to make sure that prices are reasonably in line with the fundamentals. But even those experts have to reference information that only exists in history and make inferences as to the future in order to justify things like Tesla having a P/E multiple of 100 and Ford a multiple of 7. And the returns of each of those investments in the future will play out in the totally non-stationary world you have described, but in order to make a decision the experts have to make some assumptions about risk and reward.

And yet, invest we must. Investing decisions will always be made with imperfect information and play out in a world that cannot be predicted with certainty. I just think we are kidding ourselves if we think that investors who decide to tilt to SCV are following a faulty process because it relies on some reference points rooted in history. That same history is being relied upon by experts to decide that valuations are fair relative to the fundamentals of companies. That same history is relied upon by pure index investors to decide the mix of so-called safe and risky assets that will help them achieve their goals. And yes, that same history may even help some decide to go all-in on U.S. stocks. I'm not sure that ANY investing decision can be made without some reference to history, so it probably doesn't make sense to call out any one particular investing decision or style because it relies on history.
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Re: Why don't you factor tilt?

Post by abc132 »

DaufuskieNate wrote: Mon Sep 26, 2022 11:11 am Yes, there is uncertainty in any investing decision we make. And yes, sometimes people imply a greater degree of certainty around their decisions than actually exists. Given the degree of uncertainty you are asserting, because of non-stationarity and not knowing anything about the market's statistical distribution, I'm not sure that anything can be gleaned from looking at past returns to get a feel about various market segments as you suggest. I'm also not sure how one could spend more time analyzing the risk/reward of very safe and very risky investments if we cannot reference history due to the lack of any statistical basis to analyze those returns. We may say that something is safe, but how do we know? Bonds generated a negative real return in the 40 years from 1940 to 1980. Does that make them safe? And since we can't reference this historical information with any certainty, how do we know? Yes, we can buy the whole market and hope that so-called experts have done due diligence to make sure that prices are reasonably in line with the fundamentals. But even those experts have to reference information that only exists in history and make inferences as to the future in order to justify things like Tesla having a P/E multiple of 100 and Ford a multiple of 7. And the returns of each of those investments in the future will play out in the totally non-stationary world you have described, but in order to make a decision the experts have to make some assumptions about risk and reward.

And yet, invest we must. Investing decisions will always be made with imperfect information and play out in a world that cannot be predicted with certainty. I just think we are kidding ourselves if we think that investors who decide to tilt to SCV are following a faulty process because it relies on some reference points rooted in history. That same history is being relied upon by experts to decide that valuations are fair relative to the fundamentals of companies. That same history is relied upon by pure index investors to decide the mix of so-called safe and risky assets that will help them achieve their goals. And yes, that same history may even help some decide to go all-in on U.S. stocks. I'm not sure that ANY investing decision can be made without some reference to history, so it probably doesn't make sense to call out any one particular investing decision or style because it relies on history.
I don't buy the "we've figured out the market" as that ignores the entire history of active investors, regardless of how well X, Y and Z backtested.

Which history is more likely to repeat?
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Re: Why don't you factor tilt?

Post by DaufuskieNate »

abc132 wrote: Mon Sep 26, 2022 11:30 am
DaufuskieNate wrote: Mon Sep 26, 2022 11:11 am Yes, there is uncertainty in any investing decision we make. And yes, sometimes people imply a greater degree of certainty around their decisions than actually exists. Given the degree of uncertainty you are asserting, because of non-stationarity and not knowing anything about the market's statistical distribution, I'm not sure that anything can be gleaned from looking at past returns to get a feel about various market segments as you suggest. I'm also not sure how one could spend more time analyzing the risk/reward of very safe and very risky investments if we cannot reference history due to the lack of any statistical basis to analyze those returns. We may say that something is safe, but how do we know? Bonds generated a negative real return in the 40 years from 1940 to 1980. Does that make them safe? And since we can't reference this historical information with any certainty, how do we know? Yes, we can buy the whole market and hope that so-called experts have done due diligence to make sure that prices are reasonably in line with the fundamentals. But even those experts have to reference information that only exists in history and make inferences as to the future in order to justify things like Tesla having a P/E multiple of 100 and Ford a multiple of 7. And the returns of each of those investments in the future will play out in the totally non-stationary world you have described, but in order to make a decision the experts have to make some assumptions about risk and reward.

And yet, invest we must. Investing decisions will always be made with imperfect information and play out in a world that cannot be predicted with certainty. I just think we are kidding ourselves if we think that investors who decide to tilt to SCV are following a faulty process because it relies on some reference points rooted in history. That same history is being relied upon by experts to decide that valuations are fair relative to the fundamentals of companies. That same history is relied upon by pure index investors to decide the mix of so-called safe and risky assets that will help them achieve their goals. And yes, that same history may even help some decide to go all-in on U.S. stocks. I'm not sure that ANY investing decision can be made without some reference to history, so it probably doesn't make sense to call out any one particular investing decision or style because it relies on history.
I don't buy the "we've figured out the market" as that ignores the entire history of active investors, regardless of how well X, Y and Z backtested.

Which history is more likely to repeat?
I never said that we have figured out the market or that any particular history is more likely to repeat. I DID say that probably all investing decisions are made with some reference to history and that reliance on history is not exclusive to those who choose to factor tilt.
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Re: Why don't you factor tilt?

Post by Apathizer »

abc132 wrote: Mon Sep 26, 2022 2:44 amI certainly hope factor investing pans out for those involved, but I suspect the true risks of factors not behaving as expected won't be recognized for quite some time. By constructing an argument that can't be proven wrong by future results, one that people buy into, there are going to be a bunch of investors that lose money and do not get what they are promised, regardless of what factors do. They will all believe they got those past results, that they had an advantage, even as they lose out. That's the nature of those that believe in backtesting.
It's not just back-testing, but using that data and our understanding for markets to determine a best guesstimate of likely future returns. You're right it might not work out since only relatively simple cyclical occurrences can be precisely predicted. But since we have massive amounts of past return data it makes sense to analyze and understand it as best we can. That's how knowledge progresses.

The cap weight TSM approach is fine, but some of us endeavor to move forward and employ an approach that seems likely more successful. As with almost anything it might not work out; that's how complex reality works.
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Re: Why don't you factor tilt?

Post by pasadena »

People always mention the "potential for extra gains" but not the potential for "extra drag".

So what tells me that this or that "factor" will give me extra gains and not drag my portfolio down? How do I know which one is the right one to choose? In the OP alone, you name several.

So what? Value? Growth? Dividends (for those who like extra taxes)? Which one, and why?
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Re: Why don't you factor tilt?

Post by vineviz »

pasadena wrote: Mon Sep 26, 2022 12:20 pm So what tells me that this or that "factor" will give me extra gains and not drag my portfolio down? How do I know which one is the right one to choose? In the OP alone, you name several.
If you want certainty you'll have to buy bonds.

But anyone who owns stocks can answer the above question: they accept the risk that stocks might underperform bonds in exchange for the expectation that stocks will outperform bonds.

Nothing can "tell you" with certainty that your expectation of higher returns from stocks will be realized, and the same is true with other equity risk factors.
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Re: Why don't you factor tilt?

Post by Enolacs »

All in small cap value.

We will see in 30-50 years whether it was a poor decision.
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Re: Why don't you factor tilt?

Post by rkhusky »

DaufuskieNate wrote: Mon Sep 26, 2022 11:11 am Yes, there is uncertainty in any investing decision we make. And yes, sometimes people imply a greater degree of certainty around their decisions than actually exists. Given the degree of uncertainty you are asserting, because of non-stationarity and not knowing anything about the market's statistical distribution, I'm not sure that anything can be gleaned from looking at past returns to get a feel about various market segments as you suggest. I'm also not sure how one could spend more time analyzing the risk/reward of very safe and very risky investments if we cannot reference history due to the lack of any statistical basis to analyze those returns. We may say that something is safe, but how do we know? Bonds generated a negative real return in the 40 years from 1940 to 1980. Does that make them safe? And since we can't reference this historical information with any certainty, how do we know? Yes, we can buy the whole market and hope that so-called experts have done due diligence to make sure that prices are reasonably in line with the fundamentals. But even those experts have to reference information that only exists in history and make inferences as to the future in order to justify things like Tesla having a P/E multiple of 100 and Ford a multiple of 7. And the returns of each of those investments in the future will play out in the totally non-stationary world you have described, but in order to make a decision the experts have to make some assumptions about risk and reward.

And yet, invest we must. Investing decisions will always be made with imperfect information and play out in a world that cannot be predicted with certainty. I just think we are kidding ourselves if we think that investors who decide to tilt to SCV are following a faulty process because it relies on some reference points rooted in history. That same history is being relied upon by experts to decide that valuations are fair relative to the fundamentals of companies. That same history is relied upon by pure index investors to decide the mix of so-called safe and risky assets that will help them achieve their goals. And yes, that same history may even help some decide to go all-in on U.S. stocks. I'm not sure that ANY investing decision can be made without some reference to history, so it probably doesn't make sense to call out any one particular investing decision or style because it relies on history.
I'm not arguing that one shouldn't look at history. Historical returns can provide bounds to differentiate between what has been seen before and what hasn't. Not that the future can't stray into things not seen before.

I am mainly arguing against the idea that investing in factors is the more sensible choice compared to total market investing. And the idea that one can show mathematically that factor investing is the smarter choice. That by careful selection of uncorrelated components one can generate a portfolio that is nearly certain to out-perform the market. Or that one actually compute the expected return of one's portfolio, as if one can predict the future (better terminology might be: this portfolio had this return from dates A to B).

I believe that factor investing is comparable to choosing your stock/bond ratio. It is a matter of risk sensitivity and personal preference. I don't think that many would argue that an investor is naive if they are not choosing to be 100% in stocks, even though such a portfolio had the greatest return for many past time periods.

We've heard that diversification is the only free lunch in investing. I am opposed to saying that crafting a more risky stock portfolio through factor investing is diversification, as if factor investing is also a free lunch.
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Re: Why don't you factor tilt?

Post by Apathizer »

burritoLover wrote: Mon Sep 26, 2022 9:40 am I'm not sure how anyone can argue that adding an SCV tilt is less diversified and more concentrated than holding only TSM. The top 20 stocks in TSM make up 30+% of the entire index and the top stock (AAPL) is double that of ALL the SCV stocks in TSM. Adding an SCV tilt reduces your concentration in the mega caps that overwhelm the TSM index even if you don't have a strong conviction with small/value factors.

And we know that anything outside of large caps is practically irrelevant in TSM - a difference in return in the hundredths of a percent over 50 years. So to say you already own SCV in TSM is just nice little meaningless anecdote.
I've made this point repeatedly. The cap weight TSM SV allocation is only nominal. A higher SV slant is necessary to provide significant diversification benefit.
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