Factor Investing – Tilting at Windmills
Great quote from Sagan! I take it to heart. 🙂
From what I’ve seen of factor investing funds so far, the returns promise a marginal improvement over buy and hold. But on the other hand, at least in the ETF wrapper, the fees haven’t been too bad… around .50%-.75%, not counting Goldman’s earth shattering .35% or so. Is this all on the level of “high fees”? ‘cuz its all pretty darn low compared to business as usual in mutual funds. We’re playing in like a 1% sandbox here… Schwab at the bottom, whoever it is at the high end. Any factor or factor composite would have to produce at least a fraction under 1% to be at break-even. It doesn’t seem like a very high bar to me?
OTOH, you always like to say that the evidence is “pretty compelling” that this or that doesn’t work, but you’re just basing that on a simple (super) majority of funds not outperforming their benchmark indexes in SPV reports. You ignore the minority that clearly do beat their benchmark indexes, which in this case, would have been from 22% to 1%. That’s clearly a significant gap that would make me hesitant to ever say “pretty compelling”. So I assume you keep saying that because you’re advocating for the lowest cost, most passive approach to investing targeted at the “dumb money” and not “smart money”. Correct?
My hypothesis about why funds (including factor-based) may suck is it all comes down to the liquidity issue. After all, only the best performing 25% of all stocks since 1983 accounted for all of the stock market’s gains (there’s a more recent paper with even worse stats going back farther but I can’t find it again). But because this is a fund being used as an investment vehicle, you have to do something about the cash continuously flowing in from me-to FOMO investors, hence you’re forced to mission creep or the fund was designed not to be narrowband from the outset which certainly looks like the case in the traditional three factors at the moment. The Vanguard “small cap value” is gawd awful bad.
Do we have the same limitations as individual investors? No way, Jose! If you can develop a method to cull that 25% winners from the other 75% garbage that you are not forced to buy, you will earn above average returns. This is why Buffett says he’d make 50% a year if he didn’t have the size problem… the same logic holds true for funds. I will go on the record here and declare that any fund that does NOT ever close to new money to stay true to its narrowband mission is a scam. How do you tell a Ponzi from a legitimate investment opportunity? The former never closes.
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