Tag Archives: nasdaqqqq

How Long Can You Stick With Failing Factor Investing?

Someone asked me the other day why I reject factor investing. My answer was simple. I said that factor investing is usually just a good marketing pitch to charge higher fees for something that will give you most of the correlation of a market cap weighted portfolio. For the uninitiated, factor investing is one of the hot buzz words in portfolio construction these days. Researchers found that “risk” doesn’t properly describe what drives returns over the long-term and several other factors were discovered that explain some of these outperforming anomalies. For instance, value stocks tend to outperform and momentum stocks often outperform. But this isn’t always the case. This is simply the case inside of the rather small data set that researchers have mined so far. And that brings us to a rather gigantic problem with factor investing: these factors can go through extremely long periods of underperformance. Eddy Elfenbein does the legwork over at Crossing Wall Street where he shows that value has underperformed the S&P 500 for 8 years. That’s an entire market cycle! I’m not sure there’s a single investor who would put up with that type of underperformance. And yet factor investing is more popular than ever. In fact, we keep coming up with new factors by the day. And when one fails we move on to some other fancier and more intricate sounding sales pitch. But here’s the really big problem for me. When you buy stocks you shouldn’t look for the absolute best portfolio. There are no holy grails. You are just looking for an adequate portfolio that reflects a very broadly diversified set of equity instruments. You don’t need the best return. You want most of the return. But most factor portfolios just increase tax and fee frictions while giving you a substantial amount of the equity correlation that you’re looking for in a portfolio. But what we find with all of these factor funds is that they’re still very highly correlated with their benchmark. If you can decide when that correlation shifts a tiny bit to give you some slice of outperformance then you’re much smarter than me and everyone else in this business. Here’s a simple example of what I mean here. If we look at growth relative to the market cap weighted portfolio we find that the two portfolios have a 96% correlation over the last 15 years: In the early 2000’s growth looked terrible relative to market cap weighting. And then it has dramatically outperformed since the financial crisis. But over the course of the entire cycle there’s no telling where you would have gotten on and off that roller coaster ride. All we know is that you got 96% of the equity market correlation. And if you jumped on the growth roller coaster you paid a higher fee and you MAYBE outperformed. So, when you start looking for that holy grail in the factor pool you really start doing two things that are cardinal sins in the world of indexing: You’re relying on being able to time when a factor will or won’t outperform. You’re increasing your fees in the pursuit of beating the market. Breaking those rules just don’t make a lot of sense to me. I prefer to keep things simple. So, maybe I am too hard on the factor investing crowd, but I just don’t see why we should pay extra for something that might give you better performance, will definitely give you most of the correlation and will definitely increase your fees. Share this article with a colleague

4 (Or Is It 6?) Years In The Making

Volatility is back – there’s no getting around it, and we’ve got ourselves a nice little 10% correction from earlier this year. Last week, we saw big intra-day swings in the markets across the globe, and yesterday, we saw more of the same, with the S&P 500 (NYSEARCA: SPY ) off nearly 3% at the end of the day and the international markets off further. (Of course, the US market was actually up last week, but who’s counting?) The past few weeks have struck many as a bit of a shock, in large part because it has been some time since we’ve had really any volatility in the markets at all. The VIX (S&P 500 volatility) has spiked back to levels we haven’t seen since late 2011: (click to enlarge) But we still pale in comparison to the huge swings in 2008 and 2009: (click to enlarge) The primary issue is that we got comfortable. Really comfortable. I talked about this earlier – when we were fat and happy and too cozy in our calm markets to be bothered to remember what markets do on a regular basis. I see the irony in my post: “I don’t know what the catalyst will be. More aggressive Fed tapering? Global unrest? An unseen recession? Political turmoil? War? Most likely it will be something none of us saw coming – that is how these things usually work out.” Last year, not too many people said that we’d be getting a correction because of fears of a Chinese economic slowdown or because the anticipated-for-five-years-now Fed rate hike was finally (maybe) coming around the corner. I certainly didn’t. The only thing you should be thinking with these kind of short-term corrections is “This is what stocks do.” Put it on a post-it on the bathroom mirror or on the back of your phone or the side of your monitor or wherever you need the reminder. Stocks go down! Sometimes they do it quickly (see November 2008-March 2009), and sometimes it takes quite a while (see 2000-2002). Sometimes they go down a little (do you even remember the decline in 2011?), and sometimes they go down a lot. Sometimes it’s because of a recession, and sometimes it’s not. Every time someone you’ve never heard of will get credit for “predicting it,” and every time someone who has been bearish for the last 20 years will revel in their brief vindication. Each and every time, you will have an opportunity to decide how you will respond. Are you going to stare at the market every day? Are you going to anchor on what your account value was three months ago and bemoan your “losses?” Are you going to find some market commentator who told you he saw this coming and now know exactly what you should do next? Here’s what you should probably do when stocks go down: Nothing. Boring advice, I know. But usually, you should do nothing. Sometimes there’s an opportunity to take some tax losses. Sometimes it will warrant rebalancing (though rarely upon a 10% correction, depending on your rebalancing rules). Most of the time, you’re going to do nothing. We’re not good at doing nothing (more on that later), but give it a try. Go outside or read a good book and tell yourself “This is what stocks do,” and do nothing.

Wild Week In The Market And How Investing Is Like Buying Groceries

Last week, along with some sharp turns in the market, came some interesting comments on Federal Reserve policy and markets from Ray Dalio, the investment guru and world’s largest hedge fund manager. Dalio, the founder of Bridgewater Associates feels that the Federal Reserve, while they may raise interest rates soon, will be forced to enact another round of Quantitative Easing (QE). QE is the purchase of assets by the Federal Reserve to stimulate the economy. It increases the size of the Fed’s balance sheet and provides support to equity prices. Much like in 1936, the Fed finds themselves painted into a corner and addicted to quantitative easing. In 1936 the Fed raised rates for the first time since the 1929 stock market crash and that tighter monetary policy caused a recession which sent equity prices tumbling. Will the Fed do that again? They are certainly trying to avoid that but must get interest rates above zero. Dalio expects a major easing from the Fed. Could we see rising interest rates courtesy of the Federal Reserve AND QE? We are contingency planners and must provide for all outcomes. On Monday of last week the S&P 500 was over 4 standard deviations away from its 50 Day Moving Average (DMA). That is a level that would denote an extreme move in a short amount of time. The last time that this occurred was in August of 2011 when the United States sovereign debt was downgraded. The following week the S&P 500 rallied over 7%. We felt that Monday was an appropriate time to put cash to work for our more aggressive clients. By the end of the week we had seen a 6.3% rally in the S&P 500 from its lows and we felt that taking some profits in a tax efficient manner was appropriate. History has shown that sharp selloffs like this tend to have reflex rallies that are prone to failure. Having seen sharp declines investors are likely to scale back risk exposure and that produces overhead resistance to stock prices. We would not be shocked and are quite prepared for the downside in prices to resume this week. Now is a very good time to reassess one’s appetite for risk and whether that is commensurate with one’s risk exposure. If you didn’t sleep well last week you need to have less risk in your portfolio. If the market selloff didn’t interfere with your zzzz’s or you felt like buying on the dip then your risk is either okay or could be increased. Take some time and think about how you reacted last week. It is going to be another fun filled week. These are the times that we thrive on and live for. Dislocations in markets provide opportunity. You can see things as problems or opportunities. If you are prepared then it is an opportunity. We are prepared with an underweight in equities and quite happy with market moves lower and dislocations. We are shopping for groceries and want to see lower prices. As Warren Buffett has often said, “Why would anyone want higher stock prices”? Know that we have room in our basket and are looking for groceries in the discount aisle. Share this article with a colleague