Why don't you factor tilt?

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JohnFromPNW
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Re: Why don't you factor tilt?

Post by JohnFromPNW »

Random Walker wrote: Wed Sep 28, 2022 7:53 am
JohnFromPNW wrote: Tue Sep 27, 2022 11:28 pm I guess one of the reasons I don’t have a tilt as of this moment is the practical implementation of a tilt. Sure you could add small, value, or small value. But how much small, how much value? I could pick a percent but is that the right amount?

And what about profitability, investment, momentum, and volatility? Do I need those too? And how much? And how to organize those within the traditional domestic/foreign/emerging framework? One fund for each factor both domestic and international? One fund for each factor for each cap size both domestic and international?

And if I actually buy all of them will they all just offset each other and I end up back at the total market fund?
A couple thoughts. First, makes sense to invest in each factor proportionate to your belief in each. Second, you don’t want to own an individual fund for each factor; you don’t want one fund buying a stock and another one selling the same stock. So it’s better to buy integrated funds that incorporate multiple factors. For example there are SV funds that have profitability and momentum screens and buy/hold ranges to screen out negative momentum and take a little advantage of positive momentum.

Dave
I see how adding AVUV could provide exposure to some of that. But, what if the value premium shows up only in large caps next time, or only in emerging markets? Or what if AVUV’s popularity has pumped enough money into its selection of securities it negates the potential premium? Or what if quality is actually the only factor that matters and AVUV’s superior profitability to VIOV is actually causing its relative outperformance so far?

I know (or don’t think) there are answers to those questions and adding small cap value is the most accepted means of capturing factors. Adding additional small cap to market cap weighted fund does conceptually seem more diversified, but so does adding utilities or so does equal weighting large, mid and small.
rkhusky
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Re: Why don't you factor tilt?

Post by rkhusky »

JohnFromPNW wrote: Tue Sep 27, 2022 11:28 pm I guess one of the reasons I don’t have a tilt as of this moment is the practical implementation of a tilt. Sure you could add small, value, or small value. But how much small, how much value? I could pick a percent but is that the right amount?

And what about profitability, investment, momentum, and volatility? Do I need those too? And how much? And how to organize those within the traditional domestic/foreign/emerging framework? One fund for each factor both domestic and international? One fund for each factor for each cap size both domestic and international?

And if I actually buy all of them will they all just offset each other and I end up back at the total market fund?
I think it is helpful to view factor investing like choosing your stock/bond ratio. There is no right answer, just personal preference and risk sensitivity. It might seem like a 100% stock portfolio is the rational choice, based on historical returns, but going with a 60/40 or 40/60 portfolio is perfectly fine too. Likewise a 100% factor stock sub-portfolio might seem the logical choice too, based on historical returns, but 50/50 or 0/100 (factor/TSM) are perfectly fine too.
dcabler
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Re: Why don't you factor tilt?

Post by dcabler »

rkhusky wrote: Wed Sep 28, 2022 8:17 am
I think it is helpful to view factor investing like choosing your stock/bond ratio. There is no right answer, just personal preference and risk sensitivity. It might seem like a 100% stock portfolio is the rational choice, based on historical returns, but going with a 60/40 or 40/60 portfolio is perfectly fine too. Likewise a 100% factor stock sub-portfolio might seem the logical choice too, based on historical returns, but 50/50 or 0/100 (factor/TSM) are perfectly fine too.
In a thread that is almost a case study in different types cognitive biases by the very nature of the question being asked, this is one of the most sensible posts I've seen, IMO.

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

Post by jmk »

Larry Swedroe wrote in one of his early books something that stuck with me: the market is the average, and (paraphrasing) you might consider tilting strategically in so far as are in a unique situation relative to the average.
Poe22
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Re: Why don't you factor tilt?

Post by Poe22 »

Imho, the greatest fallacy of SCV/factor-proponents is implicitly believing that the guys selling their stocks to them are less smart than they are.

Me, I don't know nothin'
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vineviz
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Re: Why don't you factor tilt?

Post by vineviz »

Poe22 wrote: Sat Oct 01, 2022 5:53 am Imho, the greatest fallacy of SCV/factor-proponents is implicitly believing that the guys selling their stocks to them are less smart than they are.
The greatest fallacy of factor opponents is espousing unfounded beliefs about factor proponents.
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dbr
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Re: Why don't you factor tilt?

Post by dbr »

vineviz wrote: Sat Oct 01, 2022 8:51 am
Poe22 wrote: Sat Oct 01, 2022 5:53 am Imho, the greatest fallacy of SCV/factor-proponents is implicitly believing that the guys selling their stocks to them are less smart than they are.
The greatest fallacy of factor opponents is espousing unfounded beliefs about factor proponents.
I don't understand how one can be a proponent or an opponent of factor investing. Aren't we all just trying to see how things work and then match what best suits what we are trying to do. But it would not be of any concern to me what someone else decides to do.

I do agree it can be hard to see exactly how things do work and people have different understandings of what they think they see and sometimes even differences of how to frame an approach to it. That is why discussion should be helpful.
Poe22
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Re: Why don't you factor tilt?

Post by Poe22 »

dbr wrote: Sat Oct 01, 2022 9:19 am
vineviz wrote: Sat Oct 01, 2022 8:51 am
Poe22 wrote: Sat Oct 01, 2022 5:53 am Imho, the greatest fallacy of SCV/factor-proponents is implicitly believing that the guys selling their stocks to them are less smart than they are.
The greatest fallacy of factor opponents is espousing unfounded beliefs about factor proponents.
I don't understand how one can be a proponent or an opponent of factor investing. Aren't we all just trying to see how things work and then match what best suits what we are trying to do. But it would not be of any concern to me what someone else decides to do.

I do agree it can be hard to see exactly how things do work and people have different understandings of what they think they see and sometimes even differences of how to frame an approach to it. That is why discussion should be helpful.
I agree. I just don't like fortune telling.

If some guys are telling me that some factor (or any other asset, for that matter) is likely to have a premium to the total stock market and to increase the reliability of outcomes (whatever that means) in the future: To me, that's mere crystal ball talk about outsmarting the market.

Not my thing. Thanks, but no thanks.
DaufuskieNate
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Re: Why don't you factor tilt?

Post by DaufuskieNate »

Poe22 wrote: Sat Oct 01, 2022 5:53 am Imho, the greatest fallacy of SCV/factor-proponents is implicitly believing that the guys selling their stocks to them are less smart than they are.

Me, I don't know nothin'
Or, one could implicitly believe that they are buying their SCV stocks at a fair price and earning a premium for taking more risk. Kind of like buying stocks instead of fixed income.
Poe22
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Re: Why don't you factor tilt?

Post by Poe22 »

DaufuskieNate wrote: Sat Oct 01, 2022 9:38 am
Poe22 wrote: Sat Oct 01, 2022 5:53 am Imho, the greatest fallacy of SCV/factor-proponents is implicitly believing that the guys selling their stocks to them are less smart than they are.

Me, I don't know nothin'
Or, one could implicitly believe that they are buying their SCV stocks at a fair price and earning a premium for taking more risk. Kind of like buying stocks instead of fixed income.
You see, that's why you're smarter than me: I don't know what the "fair price" for any asset is, and much less which factors will earn me a premium to the market in the future.
DaufuskieNate
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Re: Why don't you factor tilt?

Post by DaufuskieNate »

Poe22 wrote: Sat Oct 01, 2022 9:53 am
DaufuskieNate wrote: Sat Oct 01, 2022 9:38 am
Poe22 wrote: Sat Oct 01, 2022 5:53 am Imho, the greatest fallacy of SCV/factor-proponents is implicitly believing that the guys selling their stocks to them are less smart than they are.

Me, I don't know nothin'
Or, one could implicitly believe that they are buying their SCV stocks at a fair price and earning a premium for taking more risk. Kind of like buying stocks instead of fixed income.
You see, that's why you're smarter than me: I don't know what the "fair price" for any asset is, and much less which factors will earn me a premium to the market in the future.
If markets are largely efficient (they are) you can assume you are paying a fair price. If you invest in stocks at all, you are already making an assumption that a factor (the market factor) will earn you a premium.
Poe22
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Re: Why don't you factor tilt?

Post by Poe22 »

DaufuskieNate wrote: Sat Oct 01, 2022 9:58 am If you invest in stocks at all, you are already making an assumption that a factor (the market factor) will earn you a premium.
I'm truly baffled by the idea of the market being "a factor". The market is the sum of all factors, the whole universe of publicly traded stocks, not just "a factor".

To me, calling the market just a factor is an ingenious PR-stunt luring you into buying more funds than you actually need. OMG, I cannot rely on just this one factor, "the market", I need more than that, something shinier. At a higher price than a simple 3-fund portfolio, of course.

Soon, I'm gonna advertise my new low vol-quality-large cap fund (0.3 TER, because 3 factors, you know). And I'm working on my secret masterpiece, the "total all factor fund": It's basically VT, but its got a shinier design, so that's 2 and 20 fees. You're welcome
Last edited by Poe22 on Sat Oct 01, 2022 4:00 pm, edited 2 times in total.
DaufuskieNate
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Re: Why don't you factor tilt?

Post by DaufuskieNate »

Poe22 wrote: Sat Oct 01, 2022 3:50 pm
DaufuskieNate wrote: Sat Oct 01, 2022 9:58 am If you invest in stocks at all, you are already making an assumption that a factor (the market factor) will earn you a premium.
I'm truly baffled by the idea of the market being "a factor". The market is the sum of all factors, the whole universe of publicly traded stocks, not just "a factor".

To me, calling the market just a factor is an ingenious PR-stunt luring you into buying more funds than you actually need. OMG, I cannot rely on just this one factor, "the market", I need more than that, something shinier. At a higher price than a simple 3-fund portfolio, of course.
What we are talking about is earning a premium for taking more risk. It's really as simple as that. The market prices risk. Do you always earn the premium? No. There's risk. But you certainly invest with the expectation of earning a premium over the long term for taking more risk. You do this when you invest in TSM and expect to earn a premium over a bank savings account.
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Beensabu
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Re: Why don't you factor tilt?

Post by Beensabu »

Poe22 wrote: Sat Oct 01, 2022 3:50 pm
DaufuskieNate wrote: Sat Oct 01, 2022 9:58 am If you invest in stocks at all, you are already making an assumption that a factor (the market factor) will earn you a premium.
I'm truly baffled by the idea of the market being "a factor". The market is the sum of all factors, the whole universe of publicly traded stocks, not just "a factor".
You could read this stuff, if you wanted to:

https://www.bogleheads.org/wiki/Factors_(finance)

https://www.bogleheads.org/wiki/CAPM_-_ ... cing_Model

https://www.bogleheads.org/wiki/Fama_an ... ctor_model

You don't have to do anything about it. It's just interesting is all.
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Logan Roy
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Re: Why don't you factor tilt?

Post by Logan Roy »

DaufuskieNate wrote: Sat Oct 01, 2022 3:56 pm
Poe22 wrote: Sat Oct 01, 2022 3:50 pm
DaufuskieNate wrote: Sat Oct 01, 2022 9:58 am If you invest in stocks at all, you are already making an assumption that a factor (the market factor) will earn you a premium.
I'm truly baffled by the idea of the market being "a factor". The market is the sum of all factors, the whole universe of publicly traded stocks, not just "a factor".

To me, calling the market just a factor is an ingenious PR-stunt luring you into buying more funds than you actually need. OMG, I cannot rely on just this one factor, "the market", I need more than that, something shinier. At a higher price than a simple 3-fund portfolio, of course.
What we are talking about is earning a premium for taking more risk. It's really as simple as that. The market prices risk. Do you always earn the premium? No. There's risk. But you certainly invest with the expectation of earning a premium over the long term for taking more risk. You do this when you invest in TSM and expect to earn a premium over a bank savings account.
It's very difficult to prove. Stocks and bonds returned the same for most of the 19th century. Jack Bogle believed, given long enough, stock and bond market returns would likely mean revert again, as the risks that get factored into pricing eventually play out. And a lot of the older data that seemed to support stocks (and small-caps) outperforming over longer periods seems now to be flawed. (Asness demonstrated that there's probably never been any real small-cap premium.)

The outperformance of stocks through much of the 20th century could have more to do with the rapid global adoption of free markets. Other factors, like Quality, while also debated by the likes of Arnott, don't appear to be 'risk' factors. In fact the two best performing stocks sectors over the 20th century were Consumer Staples and Healthcare (two of the lowest risk sectors – among the least sensitive to rates and recession).

I think at very least we can say the tenets of factor investing are highly debatable, and certainly not anything like clear cut.
rkhusky
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Re: Why don't you factor tilt?

Post by rkhusky »

Beensabu wrote: Sat Oct 01, 2022 4:34 pm
Poe22 wrote: Sat Oct 01, 2022 3:50 pm
DaufuskieNate wrote: Sat Oct 01, 2022 9:58 am If you invest in stocks at all, you are already making an assumption that a factor (the market factor) will earn you a premium.
I'm truly baffled by the idea of the market being "a factor". The market is the sum of all factors, the whole universe of publicly traded stocks, not just "a factor".
You could read this stuff, if you wanted to:

https://www.bogleheads.org/wiki/Factors_(finance)

https://www.bogleheads.org/wiki/CAPM_-_ ... cing_Model

https://www.bogleheads.org/wiki/Fama_an ... ctor_model

You don't have to do anything about it. It's just interesting is all.
But note that the returns of most, if not all, stocks are not well fit by any of these models. The models only have reasonable fits to certain largish groups of stocks.
Fallible
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Re: Why don't you factor tilt?

Post by Fallible »

Cannibly wrote: Fri Sep 16, 2022 4:04 pm This is to those Bogleheads who stick pretty closely to a globally diversified portfolio of stocks and bonds (indexed) and have decided not to factor tilt - no extra value, no extra growth, REITs, commodities, high-yield bonds, and no managed funds either. After reading many posts since joining a few months ago, the primary reasons I have seen for avoiding any factoring and managed funds and sticking with some version of a Bogleheads 3-fund or 4-fund include:

-- Simplicity
-- To avoid tinkering
-- The potential for extra return is just not worth it (I like the "the extra juice is not worth the squeeze" analogy)
-- Easier to stick to it and maintain discipline
-- The market return is just fine with you

Is there something I missed - your personal reasons - that's not covered in some way by what I listed?
...
Simplicity includes the rest on your list: it's simpler if I don't tinker, if I don't seek elusive potential, if I'm to have the discipline to stick to it, and am OK with a return that is "enough." And simplicity adds an invaluable benefit for me: Time for other or more important things in my life.
"Yes, investing is simple. But it is not easy, for it requires discipline, patience, steadfastness, and that most uncommon of all gifts, common sense." ~Jack Bogle
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Beensabu
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Re: Why don't you factor tilt?

Post by Beensabu »

rkhusky wrote: Sat Oct 01, 2022 6:15 pm
Beensabu wrote: Sat Oct 01, 2022 4:34 pm
Poe22 wrote: Sat Oct 01, 2022 3:50 pm
DaufuskieNate wrote: Sat Oct 01, 2022 9:58 am If you invest in stocks at all, you are already making an assumption that a factor (the market factor) will earn you a premium.
I'm truly baffled by the idea of the market being "a factor". The market is the sum of all factors, the whole universe of publicly traded stocks, not just "a factor".
You could read this stuff, if you wanted to:

https://www.bogleheads.org/wiki/Factors_(finance)

https://www.bogleheads.org/wiki/CAPM_-_ ... cing_Model

https://www.bogleheads.org/wiki/Fama_an ... ctor_model

You don't have to do anything about it. It's just interesting is all.
But note that the returns of most, if not all, stocks are not well fit by any of these models. The models only have reasonable fits to certain largish groups of stocks.
I don't think I understand what you're saying. Could you please expand on that?
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Re: Why don't you factor tilt?

Post by Alex Frakt »

I've removed several posts bickering about nothing of substance. Let's keep this to market theory please.
rkhusky
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Re: Why don't you factor tilt?

Post by rkhusky »

Beensabu wrote: Sat Oct 01, 2022 7:02 pm
rkhusky wrote: Sat Oct 01, 2022 6:15 pm But note that the returns of most, if not all, stocks are not well fit by any of these models. The models only have reasonable fits to certain largish groups of stocks.
I don't think I understand what you're saying. Could you please expand on that?
If you apply a factor model to an individual stock's returns, you do not get a good fit. For example, for AAPL (Apple) the FF 3-factor model has an R^2 of 28%, for XOM (Exxon-Mobil) it is 33%, for BRK-A (Berkshire Hathaway) it is 35%. The FF 3-factor model does not explain these stock returns very well. On the other hand, the FF 3-factor model has an R^2 of 92.3% for VISGX (Vanguard Small Cap Growth). But the model has an R^2 of 28% for VUIAX (Vanguard Utilities). So, not even the returns of all index mutual funds are well explained by the model.
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Beensabu
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Re: Why don't you factor tilt?

Post by Beensabu »

rkhusky wrote: Sat Oct 01, 2022 8:46 pm
Beensabu wrote: Sat Oct 01, 2022 7:02 pm
rkhusky wrote: Sat Oct 01, 2022 6:15 pm But note that the returns of most, if not all, stocks are not well fit by any of these models. The models only have reasonable fits to certain largish groups of stocks.
I don't think I understand what you're saying. Could you please expand on that?
If you apply a factor model to an individual stock's returns, you do not get a good fit. For example, for AAPL (Apple) the FF 3-factor model has an R^2 of 28%, for XOM (Exxon-Mobil) it is 33%, for BRK-A (Berkshire Hathaway) it is 35%. The FF 3-factor model does not explain these stock returns very well. On the other hand, the FF 3-factor model has an R^2 of 92.3% for VISGX (Vanguard Small Cap Growth). But the model has an R^2 of 28% for VUIAX (Vanguard Utilities). So, not even the returns of all index mutual funds are well explained by the model.
Okay. Why would you apply a factor model to an individual stock's returns?
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tvubpwcisla
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Re: Why don't you factor tilt?

Post by tvubpwcisla »

Mostly because I do not have good balance.
rkhusky
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Re: Why don't you factor tilt?

Post by rkhusky »

Beensabu wrote: Sat Oct 01, 2022 8:57 pm
rkhusky wrote: Sat Oct 01, 2022 8:46 pm
Beensabu wrote: Sat Oct 01, 2022 7:02 pm
rkhusky wrote: Sat Oct 01, 2022 6:15 pm But note that the returns of most, if not all, stocks are not well fit by any of these models. The models only have reasonable fits to certain largish groups of stocks.
I don't think I understand what you're saying. Could you please expand on that?
If you apply a factor model to an individual stock's returns, you do not get a good fit. For example, for AAPL (Apple) the FF 3-factor model has an R^2 of 28%, for XOM (Exxon-Mobil) it is 33%, for BRK-A (Berkshire Hathaway) it is 35%. The FF 3-factor model does not explain these stock returns very well. On the other hand, the FF 3-factor model has an R^2 of 92.3% for VISGX (Vanguard Small Cap Growth). But the model has an R^2 of 28% for VUIAX (Vanguard Utilities). So, not even the returns of all index mutual funds are well explained by the model.
Okay. Why would you apply a factor model to an individual stock's returns?
The point being, just because you buy stocks does not mean that you are buying the market factor.
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Beensabu
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Re: Why don't you factor tilt?

Post by Beensabu »

rkhusky wrote: Sat Oct 01, 2022 9:01 pm
Beensabu wrote: Sat Oct 01, 2022 8:57 pm
rkhusky wrote: Sat Oct 01, 2022 8:46 pm
Beensabu wrote: Sat Oct 01, 2022 7:02 pm
rkhusky wrote: Sat Oct 01, 2022 6:15 pm But note that the returns of most, if not all, stocks are not well fit by any of these models. The models only have reasonable fits to certain largish groups of stocks.
I don't think I understand what you're saying. Could you please expand on that?
If you apply a factor model to an individual stock's returns, you do not get a good fit. For example, for AAPL (Apple) the FF 3-factor model has an R^2 of 28%, for XOM (Exxon-Mobil) it is 33%, for BRK-A (Berkshire Hathaway) it is 35%. The FF 3-factor model does not explain these stock returns very well. On the other hand, the FF 3-factor model has an R^2 of 92.3% for VISGX (Vanguard Small Cap Growth). But the model has an R^2 of 28% for VUIAX (Vanguard Utilities). So, not even the returns of all index mutual funds are well explained by the model.
Okay. Why would you apply a factor model to an individual stock's returns?
The point being, just because you buy stocks does not mean that you are buying the market factor.
...

And therefore you cannot buy the HmL and SmB factors by buying certain stocks? Is that what you're saying?
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Re: Why don't you factor tilt?

Post by rkhusky »

Beensabu wrote: Sat Oct 01, 2022 9:16 pm
rkhusky wrote: Sat Oct 01, 2022 9:01 pm
Beensabu wrote: Sat Oct 01, 2022 8:57 pm
rkhusky wrote: Sat Oct 01, 2022 8:46 pm
Beensabu wrote: Sat Oct 01, 2022 7:02 pm
I don't think I understand what you're saying. Could you please expand on that?
If you apply a factor model to an individual stock's returns, you do not get a good fit. For example, for AAPL (Apple) the FF 3-factor model has an R^2 of 28%, for XOM (Exxon-Mobil) it is 33%, for BRK-A (Berkshire Hathaway) it is 35%. The FF 3-factor model does not explain these stock returns very well. On the other hand, the FF 3-factor model has an R^2 of 92.3% for VISGX (Vanguard Small Cap Growth). But the model has an R^2 of 28% for VUIAX (Vanguard Utilities). So, not even the returns of all index mutual funds are well explained by the model.
Okay. Why would you apply a factor model to an individual stock's returns?
The point being, just because you buy stocks does not mean that you are buying the market factor.
...

And therefore you cannot buy the HmL and SmB factors by buying certain stocks? Is that what you're saying?
No, not if the stocks or funds are not explained by the model.
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Beensabu
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Re: Why don't you factor tilt?

Post by Beensabu »

rkhusky wrote: Sat Oct 01, 2022 9:48 pm
Beensabu wrote: Sat Oct 01, 2022 9:16 pm
rkhusky wrote: Sat Oct 01, 2022 9:01 pm
Beensabu wrote: Sat Oct 01, 2022 8:57 pm
rkhusky wrote: Sat Oct 01, 2022 8:46 pm
If you apply a factor model to an individual stock's returns, you do not get a good fit. For example, for AAPL (Apple) the FF 3-factor model has an R^2 of 28%, for XOM (Exxon-Mobil) it is 33%, for BRK-A (Berkshire Hathaway) it is 35%. The FF 3-factor model does not explain these stock returns very well. On the other hand, the FF 3-factor model has an R^2 of 92.3% for VISGX (Vanguard Small Cap Growth). But the model has an R^2 of 28% for VUIAX (Vanguard Utilities). So, not even the returns of all index mutual funds are well explained by the model.
Okay. Why would you apply a factor model to an individual stock's returns?
The point being, just because you buy stocks does not mean that you are buying the market factor.
...

And therefore you cannot buy the HmL and SmB factors by buying certain stocks? Is that what you're saying?
No, not if the stocks or funds are not explained by the model.
Just to be clear, you are saying that because you cannot buy the market factor by buying individual stocks, you cannot buy the HmL and SmB factors by buying stocks that meet those characteristics (or funds that hold stocks that meet those characteristics), and thus factors are un-buyable? So is the market also un-buyable? Are we unable to buy a fund that buys the market factor?
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Re: Why don't you factor tilt?

Post by Alex Frakt »

Beensabu wrote: Sat Oct 01, 2022 9:55 pmJust to be clear, you are saying that because you cannot buy the market factor by buying individual stocks, you cannot buy the HmL and SmB factors by buying stocks that meet those characteristics (or funds that hold stocks that meet those characteristics), and thus factors are un-buyable? So is the market also un-buyable? Are we unable to buy a fund that buys the market factor?
Buying individual stocks means accepting a dispersion of returns that will dwarf any contribution from any market factors. Indexing that segment of the market removes that risk. Thus your the leap from being unable to buy market factors by "buying [individual] stocks that meet those characteristics" to buying "funds that hold stocks that meet those characteristics" is unwarranted.

Edit. I assigned the "leap" to the wrong person. Beensabu was responding to:
rkhusky wrote: Sat Oct 01, 2022 8:46 pm If you apply a factor model to an individual stock's returns, you do not get a good fit. For example, for AAPL (Apple) the FF 3-factor model has an R^2 of 28%, for XOM (Exxon-Mobil) it is 33%, for BRK-A (Berkshire Hathaway) it is 35%. The FF 3-factor model does not explain these stock returns very well.
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Re: Why don't you factor tilt?

Post by Beensabu »

Alex Frakt wrote: Sat Oct 01, 2022 11:18 pm
Beensabu wrote: Sat Oct 01, 2022 9:55 pmJust to be clear, you are saying that because you cannot buy the market factor by buying individual stocks, you cannot buy the HmL and SmB factors by buying stocks that meet those characteristics (or funds that hold stocks that meet those characteristics), and thus factors are un-buyable? So is the market also un-buyable? Are we unable to buy a fund that buys the market factor?
Buying individual stocks means accepting a dispersion of returns that will dwarf any contribution from any market factors. Indexing that segment of the market removes that risk. Thus your leap from being unable to buy market factors by "buying [individual] stocks that meet those characteristics" to buying "funds that hold stocks that meet those characteristics" is unwarranted.
I agree. It wasn't my leap.
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Re: Why don't you factor tilt?

Post by Alex Frakt »

Oops. I'll add to my previous post to make that clear.
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Re: Why don't you factor tilt?

Post by fisher0815 »

Apathizer wrote: Tue Sep 27, 2022 3:13 am
A cap weight TSM index is generally fine, but it's dominated by large growth. Factor slants are based on similar fundamentals; they're just diversifying into other aspects of the market: value, size, profitability, and reinvestment.
In my view this abstract thinking of the stock market on a non-company level is a big mistake. Large successful companies are not a bad thing. They are not your enemy to fight. Large companies are already well diversified across many customers, products and/or countries.

Theoretically, everyone with a factor portfolio gets good grades from Eugene Fama. But the stock market will not reward you this way. All this academic research about the stock market is just based on past data and any math genius can conjure up some really great studies and tables with it. But in practice for the future, in my opinion, these findings make no sense, since the stock market is a complex adaptive system. It will take away any easy-to-replicate advantage.
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Re: Why don't you factor tilt?

Post by Poe22 »

fisher0815 wrote: Sun Oct 02, 2022 2:06 am In my view this abstract thinking of the stock market on a non-company level is a big mistake. Large successful companies are not a bad thing. They are not your enemy to fight. Large companies are already well diversified across many customers, products and/or countries.

Theoretically, everyone with a factor portfolio gets good grades from Eugene Fama. But the stock market will not reward you this way. All this academic research about the stock market is just based on past data and any math genius can conjure up some really great studies and tables with it. But in practice for the future, in my opinion, these findings make no sense, since the stock market is a complex adaptive system. It will take away any easy-to-replicate advantage.
+1, fully agree. Dismissing market capitalization as not good enough due to perceived "growth"/"large cap"-heaviness is flawed thinking to me. That reminds me of the old "smart money" vs. "dumb money" argument active managers are using while underperforming the "dumb" market since decades.
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Re: Why don't you factor tilt?

Post by vineviz »

fisher0815 wrote: Sun Oct 02, 2022 2:06 am Theoretically, everyone with a factor portfolio gets good grades from Eugene Fama. But the stock market will not reward you this way. All this academic research about the stock market is just based on past data and any math genius can conjure up some really great studies and tables with it. But in practice for the future, in my opinion, these findings make no sense, since the stock market is a complex adaptive system. It will take away any easy-to-replicate advantage.
I think the error in this argument is the implicit assumption that factors other than market beta must represent "easy-to-replicate" mispricings, an assumption that is completely incompatible with empirical evidence.

It is almost certainly true that if factor returns actually did some sort of risk-free misplacing that they would be arbitraged away quickly and completely after "discovery".

That they have NOT been arbitraged away many decade post-discovery tells you that any attempt to frame them as naive data mining is probably on shaky ground.
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Re: Why don't you factor tilt?

Post by Taylor Larimore »

Bogleheads:

One of the reasons that I avoid "tilting" is because it is "inefficient". Another is the value of "simplicity".

This article by John Norstad, a friend and Northwestern University mathematician, explains:

Three Proofs that TSM is Efficient

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Re: Why don't you factor tilt?

Post by Apathizer »

fisher0815 wrote: Sun Oct 02, 2022 2:06 am
Apathizer wrote: Tue Sep 27, 2022 3:13 am
A cap weight TSM index is generally fine, but it's dominated by large growth. Factor slants are based on similar fundamentals; they're just diversifying into other aspects of the market: value, size, profitability, and reinvestment.
In my view this abstract thinking of the stock market on a non-company level is a big mistake. Large successful companies are not a bad thing. They are not your enemy to fight. Large companies are already well diversified across many customers, products and/or countries.

Theoretically, everyone with a factor portfolio gets good grades from Eugene Fama. But the stock market will not reward you this way. All this academic research about the stock market is just based on past data and any math genius can conjure up some really great studies and tables with it. But in practice for the future, in my opinion, these findings make no sense, since the stock market is a complex adaptive system. It will take away any easy-to-replicate advantage.
It's not just abstract; it's practical. The future returns of high-share price large growth companies is likely to be relatively low compared to smaller, highly profitable, lower-priced companies. Remember, the basis of returns isn't just expected future profits but also the price that is paid today for those expected future profits. Large growth companies have higher share-prices since their share-price is expected to be less volatile, but also lower. These companies have already generated the lion's share of their returns and future returns will likely be significantly lower.

It's not necessarily an 'easy-to-replicate' advantage; it's diversifying to other potential return sources (and risk) other than the market. While the market is more efficient on average than individual investors, not all individual investors are necessarily rational and efficient. Many have unrealistically high expectations for flashy growth stocks which can irrationally inflate share-prices. Factor slants are a hedge against this risk.
Taylor Larimore wrote: Sun Oct 02, 2022 11:10 am Bogleheads:

One of the reasons that I avoid "tilting" is because it is "inefficient". Another is the value of "simplicity".

This article by John Norstad, a friend and Northwestern University mathematician, explains:

Three Proofs that TSM is Efficient
An argument from authority is among the weakest. I can just as easily provide you articles by someone just as prestigious articulating an argument for factor slants. As I said above, markets are only as efficient as the collective efforts of individual investors many of whom aren't necessarily rational and efficient.
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Re: Why don't you factor tilt?

Post by Taylor Larimore »

Apathaser wrote: An argument from authority is among the weakest. I can just as easily provide you articles by someone just as prestigious articulating an argument for factor slants. As I said above, markets are only as efficient as the collective efforts of individual investors many of whom aren't necessarily rational and efficient.
Apathaser:

I agree with you that unsupported "authority" is often a weak argument.

The article by John Norstad showing "3 Proofs that TSM (U.S. Total Stock Market) is efficient" is based entirely on mathematics--not "prestigious articulating".

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Re: Why don't you factor tilt?

Post by rkhusky »

Beensabu wrote: Sat Oct 01, 2022 9:55 pm
rkhusky wrote: Sat Oct 01, 2022 9:48 pm
Beensabu wrote: Sat Oct 01, 2022 9:16 pm
rkhusky wrote: Sat Oct 01, 2022 9:01 pm
Beensabu wrote: Sat Oct 01, 2022 8:57 pm

Okay. Why would you apply a factor model to an individual stock's returns?
The point being, just because you buy stocks does not mean that you are buying the market factor.
...

And therefore you cannot buy the HmL and SmB factors by buying certain stocks? Is that what you're saying?
No, not if the stocks or funds are not explained by the model.
Just to be clear, you are saying that because you cannot buy the market factor by buying individual stocks, you cannot buy the HmL and SmB factors by buying stocks that meet those characteristics (or funds that hold stocks that meet those characteristics), and thus factors are un-buyable? So is the market also un-buyable? Are we unable to buy a fund that buys the market factor?
You can if you find a fund whose returns are well explained by a factor model, like VISGX.
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Re: Why don't you factor tilt?

Post by vineviz »

Taylor Larimore wrote: Sun Oct 02, 2022 6:37 pm
Apathaser wrote: An argument from authority is among the weakest. I can just as easily provide you articles by someone just as prestigious articulating an argument for factor slants. As I said above, markets are only as efficient as the collective efforts of individual investors many of whom aren't necessarily rational and efficient.
Apathaser:

I agree with you that unsupported "authority" is often a weak argument.

The article by John Norstad showing "3 Proofs that TSM (U.S. Total Stock Market) is efficient" is based entirely on mathematics--not "prestigious articulating".
Unfortunately, mathematics couldn’t save Norstad from being incorrect.
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Re: Why don't you factor tilt?

Post by Apathizer »

Taylor Larimore wrote: Sun Oct 02, 2022 6:37 pm The article by John Norstad showing "3 Proofs that TSM (U.S. Total Stock Market) is efficient" is based entirely on mathematics--not "prestigious articulating".
That article doesn't discredit factors at all. The argument for factors doesn't refute the idea markets are generally efficient. Factor-slants are a systematic extension of market efficiency. Again, it's based on the reasoning and evidence that some types of stocks are likely to have higher returns. By increasing weights to these stocks, factor slants are just a logical extension of and perfectly compatible with index investing.
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Re: Why don't you factor tilt?

Post by rkhusky »

Apathizer wrote: Sun Oct 02, 2022 7:59 pm Again, it's based on the reasoning and evidence that some types of stocks are likely to have higher returns.
Actually, it’s based on the hope that certain stocks, which had higher returns in the past, will have higher returns in the future.

The future probability distribution is unknown.
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Re: Why don't you factor tilt?

Post by Apathizer »

rkhusky wrote: Sun Oct 02, 2022 9:21 pm
Apathizer wrote: Sun Oct 02, 2022 7:59 pm Again, it's based on the reasoning and evidence that some types of stocks are likely to have higher returns.
Actually, it’s based on the hope that certain stocks, which had higher returns in the past, will have higher returns in the future.

The future probability distribution is unknown.
It's also based on our admittedly imperfect understanding of how markets seem to work. Based on this understanding, and the information we have showing certain types of stocks have had consistently higher long-term returns, this seems likely to continue. We can't predict this with certainty, but that's true of everything except purely cyclical processes. The evidence factors will likely improve overall and consistency of returns seems strong enough to me I'm willing to integrate them into a total market portfolio. A cap weight TSM portfolio is fine for those skeptical of factors.
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Re: Why don't you factor tilt?

Post by markus75 »

vineviz wrote: Sun Oct 02, 2022 10:38 am It is almost certainly true that if factor returns actually did some sort of risk-free misplacing that they would be arbitraged away quickly and completely after "discovery".

That they have NOT been arbitraged away many decade post-discovery tells you that any attempt to frame them as naive data mining is probably on shaky ground.
For me your post-discovery evidence is a just random pattern, which creates the illusion that it still works.
Apathizer wrote: Sun Oct 02, 2022 3:33 pm
It's not just abstract; it's practical. The future returns of high-share price large growth companies is likely to be relatively low compared to smaller, highly profitable, lower-priced companies. Remember, the basis of returns isn't just expected future profits but also the price that is paid today for those expected future profits. Large growth companies have higher share-prices since their share-price is expected to be less volatile, but also lower. These companies have already generated the lion's share of their returns and future returns will likely be significantly lower.

It's not necessarily an 'easy-to-replicate' advantage; it's diversifying to other potential return sources (and risk) other than the market. While the market is more efficient on average than individual investors, not all individual investors are necessarily rational and efficient. Many have unrealistically high expectations for flashy growth stocks which can irrationally inflate share-prices. Factor slants are a hedge against this risk.
Knowing which stocks have a higher likelihood of performing worse or better is the same mindset that stock pickers and active investors have.
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Re: Why don't you factor tilt?

Post by vineviz »

markus75 wrote: Mon Oct 03, 2022 3:28 am
For me your post-discovery evidence is a just random pattern, which creates the illusion that it still works.
The evidence is what it is, whether you like it (or even understand it) or not.
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Re: Why don't you factor tilt?

Post by markus75 »

vineviz wrote: Mon Oct 03, 2022 6:02 am
markus75 wrote: Mon Oct 03, 2022 3:28 am
For me your post-discovery evidence is a just random pattern, which creates the illusion that it still works.
The evidence is what it is, whether you like it (or even understand it) or not.
Random patterns are what they are, whether you like it (or even understand it) or not.
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Re: Why don't you factor tilt?

Post by vineviz »

markus75 wrote: Mon Oct 03, 2022 6:50 am
vineviz wrote: Mon Oct 03, 2022 6:02 am
markus75 wrote: Mon Oct 03, 2022 3:28 am
For me your post-discovery evidence is a just random pattern, which creates the illusion that it still works.
The evidence is what it is, whether you like it (or even understand it) or not.
Random patterns are what they are, whether you like it (or even understand it) or not.
We have statistical tools that allow us to separate random data from non-random data.

Asset prices aren’t random.
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Re: Why don't you factor tilt?

Post by markus75 »

vineviz wrote: Mon Oct 03, 2022 6:56 am
markus75 wrote: Mon Oct 03, 2022 6:50 am
vineviz wrote: Mon Oct 03, 2022 6:02 am
markus75 wrote: Mon Oct 03, 2022 3:28 am
For me your post-discovery evidence is a just random pattern, which creates the illusion that it still works.
The evidence is what it is, whether you like it (or even understand it) or not.
Random patterns are what they are, whether you like it (or even understand it) or not.
We have statistical tools that allow us to separate random data from non-random data.

Asset prices aren’t random.
I would not trust your statistical tools. In my humble opinion, the stock market is not the right playground for statistical tools.

CAPM uses the past to make determinations about the future. You're evaluating the past to determine the future, when it's a well known fact that securities are susceptible to extreme deviations from their historic behavior.
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Re: Why don't you factor tilt?

Post by vineviz »

markus75 wrote: Mon Oct 03, 2022 7:22 am
I would not trust your statistical tools. In my humble opinion, the stock market is not the right playground for statistical tools.
They aren't my tools.

You're entitled to your opinion, obviously, but unless it is informed by evidence or reasoned argument I'm not sure what we can learn from it.
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Re: Why don't you factor tilt?

Post by burritoLover »

Have you all checked out the latest podcast from Rational Reminder? Couple of academic guests that present an argument that only CAPM matters and that factors are not a risk story:
https://rationalreminder.ca/podcast/220
Jules Van Binsbergen wrote:To summarize it very simply, we just ask the question, do investors view Fama-French factors as outperformance or as risk? And the answer is they view it as outperformance, not as risk. And so it's an alpha. They view it ... They count it as alpha, not as a risk premium that you can ... Because ... Another way of saying it is a risk ... You shouldn't reward a manager with more money if all they did was take more risk according to that risk premium. You should only reward them if it was outperformance. And so clearly they count it as outperformance.

Now, in the beginning there was some criticism, and people said, "Oh, but this is just because it's unsophisticated investors." But then there were some people that did it for hedge funds. Where I think people generally agreed that the investors are quite more sophisticated and they found the same result there. And then there were even some people that tried to do it for real investment decisions inside firms to figure out what firms themselves uses the risk model. And again, the same ... No, I say that quite incorrectly. How firms decide to repurchase their stock or issue more stock. And so that's also an investment decision that's made inside the firm by managers. And again, the same result shows up. It's again going to be the CAPM. CAPM seems to be quite a dominant model that seems to be showing up all over the place.
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Re: Why don't you factor tilt?

Post by rkhusky »

Apathizer wrote: Sun Oct 02, 2022 9:43 pm
rkhusky wrote: Sun Oct 02, 2022 9:21 pm
Apathizer wrote: Sun Oct 02, 2022 7:59 pm Again, it's based on the reasoning and evidence that some types of stocks are likely to have higher returns.
Actually, it’s based on the hope that certain stocks, which had higher returns in the past, will have higher returns in the future.

The future probability distribution is unknown.
It's also based on our admittedly imperfect understanding of how markets seem to work. Based on this understanding, and the information we have showing certain types of stocks have had consistently higher long-term returns, this seems likely to continue. We can't predict this with certainty, but that's true of everything except purely cyclical processes. The evidence factors will likely improve overall and consistency of returns seems strong enough to me I'm willing to integrate them into a total market portfolio. A cap weight TSM portfolio is fine for those skeptical of factors.
Higher returns for certain types of stocks have not been consistent, especially in the modern age of data mining with high-speed computers and communication.
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Re: Why don't you factor tilt?

Post by Apathizer »

markus75 wrote: Mon Oct 03, 2022 3:28 am Knowing which stocks have a higher likelihood of performing worse or better is the same mindset that stock pickers and active investors have.
While stock-pickers might use factors as part of their selection, it also involves personal judgement and guesswork. An actively managed fund typically selects only about 50-200 stocks. That's not how factor-slants work. Factor-slants are mathematical. They use the TSM as a basis, but shift allocation somewhat away from market cap weights. It's a fairly minor variation of index-investing.
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Re: Why don't you factor tilt?

Post by Apathizer »

rkhusky wrote: Mon Oct 03, 2022 7:54 am
Apathizer wrote: Sun Oct 02, 2022 9:43 pm
rkhusky wrote: Sun Oct 02, 2022 9:21 pm
Apathizer wrote: Sun Oct 02, 2022 7:59 pm Again, it's based on the reasoning and evidence that some types of stocks are likely to have higher returns.
Actually, it’s based on the hope that certain stocks, which had higher returns in the past, will have higher returns in the future.

The future probability distribution is unknown.
It's also based on our admittedly imperfect understanding of how markets seem to work. Based on this understanding, and the information we have showing certain types of stocks have had consistently higher long-term returns, this seems likely to continue. We can't predict this with certainty, but that's true of everything except purely cyclical processes. The evidence factors will likely improve overall and consistency of returns seems strong enough to me I'm willing to integrate them into a total market portfolio. A cap weight TSM portfolio is fine for those skeptical of factors.
Higher returns for certain types of stocks have not been consistent, especially in the modern age of data mining with high-speed computers and communication.
Based on the data available the higher returns of the 4 non-market factors have occurred about 70-80% of the time. That seems pretty consistent. Rigorous analysis by multiple sources reduces the likely these results are attributable to data mining or random chance. It could be, but it's unlikely. Remember, we're talking about probability not certainty.
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