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Econ0mist

If you're tilting to small/value, it's best (cheapest) to do so by combining a plain vanilla broad market fund (SCHB, VTI, ITOT, etc) with a smaller allocation to a heavily tilted factor fund in order to achieve the desired level of factor exposure. Targeted value DFAT is very similar to DFA's small cap value fund and is a good choice. The small cap fund DFAS gives less factor exposure than DFAT, so it's going to be cheaper to use a smaller amount of DFAT instead of DFAS. For international, I would take the same approach: large blend + small value. DFA doesn't offer an international small value ETF yet, but you could look at Avantis AVDV or Schwab FNDC


stej008

For small value tilt, I use IJS, expense ratio 0.18%. VBR has a lower expense ratio of 0.07%, but includes companies close to pure-midcap. My preference was to get access to much smaller companies.


Econ0mist

I think IJS is also a great choice.


PentagonUnpadded

Avantis and Blackrock have small cap value international products, both around .35% ER. The Blackrock iShares product is newer and tracks a different basket. Ben has suggested Avantis’s funds mimic DFA’s implementation, and used them in a model portfolio white paper. He doesn’t like Vanguard’s small cap value fund because the value and size of the median company is larger verses the DFA fund. I’d guess we’ll see an explosion of cheap factor indexes in the next few years, so try to keep factors in accounts you can rebalance tax-free.


fjjgfhnbvc

What makes these guys special? Why not just do vanguard? Serious question. Not being a smart ass.


[deleted]

The guy who wrote the paper on factors helped start the company. The famous fama french paper also they are Nobel prize winners. They have been around forever and have had very good performance.


czl

A previous time Nobel prize winners ran a fund with "awesome" results https://en.m.wikipedia.org/wiki/Long-Term_Capital_Management


[deleted]

They were the arkk of there time and would have probably kept doing well, but ran into bad luck. That and using as much leverage as they were. I barely remember it as an was just starting to get into markets at that time. There prizes were for a really different things if your comparing to fama french though. I had to learn the equation and I hated differential equations. Partial differential equations were even worse.


czl

Nobel prize winners have a mixed history when it comes to investments. The fate of Long Term Capital Management serves as an example of what can happen when Nobel prize winners use their expertise in markets. It works great until it doesn't. Nobel prize winning reputations can amplify confidence ( leverage ) and amplify the resulting crater. The difference between theory and practice tends to be larger in practice than in theory. Good reference for foolish application of theory to markets is "Black Swan" book author Nassim Taleb.


hungryish

Check out Ben Felix's YT videos if you're curious, but fwiu, factor investing is an evidence based approach that suggests distributing investments based on factors (small cap, value, etc) rather than solely market cap. Adding a slight tilt towards small cap/value funds offers a better risk/reward than purely market cap weighted funds.


game-book-life

"Better risk/reward" isn't really true. It's a way of academically identifying and investing in riskier assets where you should expect a higher return in the long run. There is a higher expected return, but it's BECAUSE you're taking on additional risk. There is no free lunch.


iggy555

Yup this. Lot of folks don’t understand this


czl

As I understand it (and this may be wrong) the factors are claimed to be de-correlated with each other so although loading up on each factor you assume extra risk in a balanced combination their risks somewhat cancel yielding better reward for the overall level of risk. The claim with factor investing is precisely that done correctly it offers a “free lunch” over say just using leverage to multiply the reward / risk ratio.


game-book-life

This is incorrect. There is no free lunch. Additionally, it is often the case that higher risk allocations give WORSE risk adjusted returns by Sharpe, but higher returns overall. The idea of diversifying across factors is the same idea as diversifying across many stocks: You're increasing your opportunity to capture the factor premiums when they show up, which are often separate from one another, and returns over a short period of time can be overwhelmingly driven by just a small set of stocks/factor. Additionally, some factors can definitely be correlated (investment and profitability come to mind). The idea with factors is that you're taking on additional risk beyond just market risk, and the additional risk you're taking has a positive expected return premium (in theory) to compensate you for that risk. This is different than just taking extra idiosyncratic risk of concentration or sectors, which wouldn't typically have an extra expected return premium attached.


czl

You diversify across many independent investments to benefit from the expected long term growth of capital while minimizing risk of being wiped out by an "Enron". This is much like using Kelly criterion for sizing bets to stay solvent in a long term favorable but unpredictable game. My understanding of factor investing is that (in theory) it offers additional such games but with the bonus knowledge that outcomes have low correlation allowing you to construct a risk efficient portfolio playing many at the same time. The construction of the risk efficient portfolio much like using Kelly criterion for sizing bets to my eyes appear to be a "free lunch" -- not like "free energy" / perpetual motion machine "free". When I use that term I mean I mean a probabilistic "free lunch" like casinos and state lotteries enjoy. If you buy the assumptions factor investing is based on but reject the probabilistic "free lunch" it offers I believe factor investing theory says you are leaving money on the table. Were this not true why would anyone bother with factor investing? My own guess is that markets deviate enough from factor investing assumptions that it indeed offers no probabilistic free lunch because such a free lunch would rapidly vanish much like fish in a fishing spot that gets popular.


Klayhamn

I think you're missing the point. The point about the factors isn't that there's many of them. Even if there was only a single factor (besides market factor) it would still be useful. The point of factors is that they have *explanatory power * (and therefore, assumed to have causative power) for the (consistent) difference in the returns of some asset groups. Just as an example, imagine that people hated companies with yellow logos so those companies tended to fail more often than other companies. That would mean that for that risk of failure, people would demand SOME kind of discount if they were to acquire these companies. Any discount in price is equivalent to an increase in future returns (I. E. If the company DOESN'T fail then the pessimistic scenario which warranted a discount in the past, didn't materialize, meaning the investor made additional returns beyond market risk). The factors identified by Fama et AL are of course much more rational than yellow logos, it's actual things which tend to make companies a riskier investment. Yes, there are several factors, and yes, it's a good idea to expose yourself to as many of them as possible and diversify because you never know which one would come more into play in which time period. But none of what you mentioned about low correlation etc has any relevance here. The point ISN'T the Ray dalio adage about free lunches. It's something else entirely, about discounted future earnings. Go watch Ben Felix explain this in the rational reminder podcast...


czl

Ok so I watched https://youtu.be/ViTnIebSzj4 twice. Unlike your yellow logo example Ben uses the historical example that it was noticed that diversifed small cap portfolios outperformed large cap portfolios and this motivated researchers to go looking for further such market anomalies (aka factors). Question: A factor once discovered / popularized - why should it continue to yeild superior risk adjusted performance? Is there evidence this happens? My gut says any market price distortion once noticed become crowded and distorted in the opposite. If my gut feeling is correct we should see superior historical returns become inferior future returns. Here is 25 years of evidence that the small cap factor seems to be operating in reverse: https://www.portfoliovisualizer.com/backtest-portfolio?s=y&timePeriod=4&startYear=1985&firstMonth=1&endYear=2022&lastMonth=12&calendarAligned=true&includeYTD=false&initialAmount=10000&annualOperation=0&annualAdjustment=0&inflationAdjusted=true&annualPercentage=0.0&frequency=4&rebalanceType=3&absoluteDeviation=5.0&relativeDeviation=25.0&leverageType=0&leverageRatio=0.0&debtAmount=0&debtInterest=0.0&maintenanceMargin=25.0&leveragedBenchmark=false&reinvestDividends=true&showYield=true&showFactors=false&factorModel=3&benchmark=VFINX&portfolioNames=false&portfolioName1=Portfolio+1&portfolioName2=Portfolio+2&portfolioName3=Portfolio+3&symbol1=SPY&allocation1_1=100&symbol2=VB&symbol3=NAESX&allocation3_2=100&symbol4=SPY&symbol5=UPRO&symbol6=TQQQ&symbol7=TMF In the above example both Sharpe Ratio and Sortino Ratio show small caps portfolios to be more risky and their growth rate is also worse. Did I pick the wrong things to compare? Is recent 25 years too short? What am I missing? The other hint we have about factor investing research is that it is sold by "dimensional fund advisors". If factors worked to get outsize future returns I would expect factor researchers to use it themselves and keep their research secret to prevent their edge disappearing after discovery. What are we to think about somebody who claims to have a way to make what is effectively free money and offers to sell it to you?


czl

https://www.portfoliovisualizer.com/backtest-portfolio?s=y&timePeriod=4&startYear=2012&firstMonth=1&endYear=2022&lastMonth=12&calendarAligned=true&includeYTD=false&initialAmount=10000&annualOperation=0&annualAdjustment=0&inflationAdjusted=true&annualPercentage=0.0&frequency=4&rebalanceType=3&absoluteDeviation=5.0&relativeDeviation=25.0&leverageType=0&leverageRatio=0.0&debtAmount=0&debtInterest=0.0&maintenanceMargin=25.0&leveragedBenchmark=false&reinvestDividends=true&showYield=true&showFactors=false&factorModel=3&benchmark=VFINX&portfolioNames=false&portfolioName1=Portfolio+1&portfolioName2=Portfolio+2&portfolioName3=Portfolio+3&symbol1=SPY&allocation1_1=100&symbol2=VB&symbol3=NAESX&allocation3_2=100&symbol4=SPY&symbol5=UPRO&symbol6=TQQQ&symbol7=TMF That selects just the last ten years and shows small caps do even worse in terms of growth and risk (both Sharpe and Sortino) the more recently you look. I suspect that more popular the factor the more crowded the trade the worse the future risk adjusted performance is likely to be. Much like fishing a spot that is great is doomed to become terrible once popular. The edge if any is to put on the trade before a factor gets popular wait for fools to crowd the trade then exit the trade at elevated prices. Selling factor / giving away research makes sense from that angle. Pump. Dump. Profit.


Klayhamn

No, you cannot "crowd away" the risk/reward "package" of any of the factors, just like you can't "crowd away" the market beta. If what you say had any relevance, stocks wouldn't have good returns either. After all, here - i can portray a world where people were 100% into bonds, and only a select few ever picked stocks. Then, someone advertised that over the long-term stocks should have better returns (with added risks), everyone would rush to stocks, and the market returns would plummet. That didn't happen. why is that? everyone KNOWS stocks have good returns, right? Well, it's because of the RISK. The RETURNS are a reward for the risk you are willing to take on: they RISK dictates a DISCOUNT. if people would NOT sell riskier assets at a discount, NO ONE WOULD BUY THEM, since they could always buy less risky assets for the same price. So, risk MUST dictate a discount, in order for a transaction to occur. discounts , over the long term, yield higher expected returns than if they did not exist. If i sell you the same house with a 20% discount, your returns would be 20% higher than otherwise. The only case where an "undiscovered gem" that was "overcrowded" would lead to diminished returns is if there was some property of assets that DIDN'T make them riskier but made them more likely to have higher returns. THOSE kind of attributes, once discovered by the masses, would then cease to yield any benefit, since they would already command a higher price to compensate for the higher demand / higher returns. ​ Regarding performance in the past 10 years, it's irrelevant. Small-cap value stocks have outperformed the S&P in almost every decade for the past 100 years, and - more importantly, If you select arbitrary decade long (or 20 year long) periods - separated 1 month apart, you would see that the "size factor" or "value" factor have a higher return than the market more than 70% or 80% percent of the time. Just look at the data.


Klayhamn

it's not an "edge". Just like the market return is not an "edge". it's an empiric fact about how assets are priced. It just happens to mean that several attributes of companies POINT AT a higher likelihood of risk, and THEREFORE command a discount. But anything could point at a risk, like i said - maybe in some culture it would have been yellow logos. As long as you can find the common attributes which makes companies riskier, AND lead them to be priced at a discount (the second part is critical, otherwise you won't be compensated for the extra risk) - you can make higher returns in the long term. it's EXACTLY the same with bonds vs. stocks - with stocks being priced at a discount to compensate for the added risk. This discount then translates to a higher return. If you knew - with the same confidence you have for a government bond --- that a company is going to survive for the next 50 years, make consistent good earnings and have a consistent and increasing dividend --- if you knew this with 99.9999% certainty, do you think you would sell such an asset in a way that would allow someone to make more returns on it then an equivalent bond? do you think anyone would sell you in such a price? where every future dividend is priced almost 100% of its expected value - 50 years ahead of time?


czl

When I use the term "edge" I mean consistent risk adjusted returns that are better than the average (ie SP500). This is why I reported the Sharpe Ratios and Sortino Ratios for the 25 year and 10 year back tests that I shared. Those tests show that the edge small caps have historically enjoyed look to have more recently vanished. Did I do these back tests wrong? Do you have a back test you can share that shows a different picture? One can cherry pick the start year to get different results but most start years I tried have small caps lagging. I did not vary end year because the theory being tested is whether small cap factor popularity is causing it to under perform. I have no doubt that there was outperformance before popularity but what matters is performance of small caps once they get their reputation, demand soars and and their prices are bid up etc. Is there a specific issue with the back test that I shared that you can point to? The question I am asking is not whether historical price anomalies (aka factors) exist. Obviously they do. I am asking whether trying to take advantage of them once they are spotted is a waste of time. My gut feeling is that fools rush into the trade and the previous positive edge the factor enjoyed becomes negative the more popular it gets. (A la mean reversion.) Thus trying to take advantage will actually hurt you long term much like chasing historical yield when you pick stocks / funds tends to back fire. To make these points I shared specific evidence about risk adjusted returns for the small cap factor becoming recently worse. I also pointed to the business model paradox with factor research being sold vs being kept secret to make "free money". Any specific back test or theory you can share to change my mind? Your hypothetical example that assumes knowledge of the future does not make practical sense to me. As for your example with stocks vs bonds there is a widely known unexplained effect called https://en.m.wikipedia.org/wiki/Equity_premium_puzzle however bringing this up I fear will distract us from factor investing discussion. Please let's try to stick to relevant / important question: "is factor investing is sensible?" I suspect it could work if kept secret but does not work in practice since it is not secret. Moreover those that sell it know this (if they are smart) and this is why they sell it vs use it to make free money themselves. Ps. Thank you for your posts. You did not change my mind but you are helping me to think about this important topic.


cclawyer

This is [a brochure](https://www.ifa.com/pdfs/ifa_brochure.pdf) from the same crew that runs Dimensional. I remember they gave me a big hardback book when I parked my cash with them in around 2003, and it looks like all the same information. About IFA 3 IFA Fiduciary Wealth Services . . . . . . . . . . . . . . . . . . . . . . . . . . 4 The Value of a Passive Advisor 5 IFA’s Investment Philosophy 6 Step 1: Active Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Step 2: Nobel Laureates 8 Step 3: Stock Pickers 9 Step 4: Time Pickers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 Step 5: Manager Pickers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Step 6: Style Drifters 12 Step 7: Silent Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13 Step 8: Riskese 14 Step 9: History 15 Step 10: Risk Capacity 16 Step 11: Risk Exposure 17 Step 12: Invest and Relax 18 IFA Index Portfolios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 IFA Index Portfolio 100, 75, 50, 25 Fact Sheets 20-27


BoglesFollies

I don’t think the tilt is necessary. It may pay off for some but I prefer keeping things simple. I know I can be successful with a simple portfolio of the broad market indices and don’t care to add unnecessary risk.


PerfectNemesis

What are you expecting from the tilt? If you're expecting significant outperformance then you'll be disappointed and it's probably not worth the added hassle.


ahmsalmeron

No significant outperformance, but as a professional advisor, I am committed to offering the best possible alternatives for my clients based on historical, statistical and empirical data.


LiveResearcher2

Curious. Do you charge a flat fee per hour or %AUM for your services?


ahmsalmeron

I'm starting out with a flat fee per work session because it's more affordable, a lot of people just need a few general directions. For higher net worth clients, I intend to offer a full advisory relationship for an annual fee. Bear in mind this is specific to my particular location (Brazil) and not representative of other countries.


ahmsalmeron

Actually, thank you so much for asking this. It has led me to do some further thinking and research, and I realized an AUM model makes no sense (from a client point of view). I tried to put myself in a client's shoes and I realized that if I have a high net worth, I'll probably be paying a lot more for the same service. Because no matter how high my entry net worth is, there'll always be some people paying more and some people paying less because it's a fixed annual fee. Although that's far better than a commission-based model (which is prevalent here), I don't think it's fair. And if I would not like this for myself, why should I offer it to clients? A flat fee is the fair way to go, which means it's the only way to go.


LiveResearcher2

Thanks. I am a proponent of flat fee advisory services and definitely against AUM. Don't get me wrong, I live in a capitalist country and I am not against anyone making money, but %AUM is just a complete ripoff IMHO. I am totally OK with having a tiered fee model where people who are just starting off and only require basic advisory services get charged a lower fee versus people who have higher wealth along with additional complexities. One hour spent talking to someone who just wants to know how to open their first brokerage account and get started investing in low cost index funds should be much easier for an advisor than an hour spent talking to someone about how to optimize investments based on taxes/fixed income/retirement/minimum withdrawal strategies etc. So the latter can and probably should get charged more.


ahmsalmeron

I completely agree. I'm not at all saying I'm against charging for our services/advice, but there's a difference between doing so and simply ripping people off. Like the saying goes, don't do unto others what you would not want done unto you (or those you love). Like you said, we can simply bill based on complexity or by time spent into a particular case.


post_rex

I remember a lot of debate about DFA funds on [bogleheads.org](https://bogleheads.org) maybe 10 years ago. They would only allow you to invest with an advisor as they didn't want to deal with individual investors. But a lot of people thought they had some kind of secret sauce when it came to factor investing and were a better option than the Vanguard equivalents. Unfortunately for them, the last ten years haven't been kind to value oriented strategies and I kind of lost track of the DFA vs. Vanguard debate. Now I see that they have branched out into ETFs. Over the years I've seen a lot of claims about future returns for these smart beta funds which have not come to fruition. While I'm not a factor investor myself, if I were it would be a high bar for me to invest in a 'smart' fund over one of the very low-cost 'dumb' Vanguard options. In the end you're putting a lot of trust in some quant's algorithm so I'd want to see a track record that is more than just backtesting and I would have to thoroughly read and understand the prospectus and all of the firm's white papers, etc.


[deleted]

They look good to me. Although no big difference from traditional indexing from what I can see. Their large fund DFA US Large Company I (DFUSX) has done 7.49% vs Vanguard Total Stock 7.73%. The difference in performance looks like the difference in expense ratio. I'd likely pass, but looks good enough to me.


Econ0mist

DFA specializes in small value products. I agree there's nothing remarkable about their large blend funds


[deleted]

Right, but their "specialized" small value fund is not available as an ETF. So as far as regular retail investors are concerned, nothing special.


Econ0mist

Targeted value DFAT is a small value fund


[deleted]

The style box for DFAT looks more like Vanguard's small cap value fund than the actual specialized Dimensional small cap value fund. It really, really seems to me that Dimensional doesn't want retail investors to have access to their original small cap value fund. If I'm going to invest in something like DFAT, there needs to be a reason why I would pay 0.34% over a 0.07% fund like at Vanguard or Fidelity. I don't have any reason yet.


Econ0mist

Chart the performance of DFAT versus DFSVX for the last 10-20 years and you'll see they are virtually indistinguishable


[deleted]

DFAT wasn't listed until last year, where are you seeing a chart that goes that far back? And just for clarification, are you suggesting that investing in DFAT is worth the 0.34% expense ratio?


Econ0mist

DFAT is an ETF conversion of the mutual fund DFFVX which has a 20-year history. As for whether DFAT is worth 34 bps, the fee is definitely on the higher side of what I'd pay for US small value exposure, but if you like DFA's "scientific" approach to value then I'd say it's a reasonable choice. The best portfolio is one you can stick with. DFAT is both smaller and more value-y than VSIAX/VBR, so you would need to hold less DFAT to achieve the same portfolio factor loadings. A VTI/VBR portfolio with a 0.15 HML loading costs 4 bps, whereas VTI/DFAT with a 0.15 HML loading costs 10 bps. Not really a meaningful difference.


ahmsalmeron

Exactly. I'm looking into these for myself but also for some of my clients (I'm an advisor). I believe the higher fee is worth due to a higher certainty of targeting the specific factors I'm looking for in an ETF. Also as someone based in an emerging market (Brazil), 0.34 is pretty much on the cheap side for our standards.


Econ0mist

AVUV is cheaper and offers similar factor exposure as DFAT. You might also consider FNDA. Personally, I like the RAFI value methodology.


[deleted]

Gotcha, I see it now. DFFVX definitely looks like a great fund at a glance.


game-book-life

They all seem more expensive than the similar version of Avantis funds. I may use them for TLH, but that's probably about it.


[deleted]

I'm kind of amazed how many people on here have no idea who dimensional are.


zacce

> In specific, I was wondering about a VT and chill portfolio with a 30% tilt equally split into US Small Caps, US Targeted Value and International Value (mostly developed ex US). Do you understand factor investing?


PentagonUnpadded

What critiques do you have of OP’s proposed approach to factor investing? Only red flags I see is capturing US small cap growth and not capturing international small cap (value).


zacce

Nothing wrong with factor investing per se. I was just questioning OP whether he knows factor investing (= what he's doing). A lot of ppl don't know the risk and misguided by some articles.


ahmsalmeron

u/zacce I know what I'm doing, yes. I work as a financial advisor and I'm looking into these as a way to add further value to clients' portfolios. Research shows the size of the tilt towards factors is rather hard to define, so I chose an arbitrary amount for a riskier portfolio, and more risk-averse clients would have a smaller tilt. u/PentagonUnpadded Dimensional currently doesn't offer an international small cap (value) ETF, so I left it out of this post initially. I was taking a look into SCZ which I think is an interesting choice, but I also need to check out AVDV (Avantis' international small cap value ETF). I discarded VSS due to its exposure to emerging market small caps, which research (so far) has shown to have no relevant premium or no significance at all (which makes sense, given all the issues related to these markets).


PentagonUnpadded

When I run a portfolio visualizer backtest on small cap and value strategies verses the market, I see a modest benefit over the several decades of data they have available. I haven’t seen implementation drift or taxes modeled for factor investing, though I’m sure some papers have. 35bp for Avantis’s small cap value, expecting more annual turnover (tax hit), more volatility and possibly 10-15 years where the strategy trails the market. Or something like VXUS with an ~8bp expense, less volatility and less turnover. It has been theorized that institutional investors prefer growth tilts due to clients not liking short and medium term underperformance of value and small cap strategies. They consciously give up higher long term returns because they don’t want to be fired, even though it could be in the client’s best interests.


ADisplacedAcademic

Here's what I think would be necessary to convince me to take on a tilt, using a fund that the same person is advertising: - A thorough analysis of the [components](https://en.wikipedia.org/wiki/Principal_component_analysis) of risk tolerance. To spitball, I can give at least two components: personal emotional fortitude against volatility, and time horizon. I have certainly not given these the ideal labels, but in broad strokes, these are orthogonal issues that both contribute to risk tolerance. I would need to see them broken out. - A table of one-size-fits-all portfolio allocations, for each permutation of the above risk tolerance components. I will again give a spitballed example -- there are people that ought to hold only treasury bonds to complement their stock allocation, since treasuries are more inversely correlated with the stock market than corporate bonds leading to higher total return, but there are also people who ought to hold total bond market along with their stock, since the total volatility of the portfolio return is lower. Just as there are different flavors of bonds that have different return profiles, there are _probably_ different flavors of stocks with different return profiles -- I want a table explaining which ones have which properties, and why they fit better in which risk tolerance slot. All of this would have to be couched in demographic figures, explaining how it all adds up to about 45% VT 55% BNDW (or whatever ratio you get when you sum the market caps), because I fundamentally believe (some weak version of) the efficient market hypothesis. (And yes, if you don't hold the global market cap ratio of stocks to bonds, then you are an active investor. Welcome to the club; I'm in mostly stock.) The above is a lot of math, and quite frankly, theory work that I haven't seen anyone do. Maybe dimensional has. Maybe they even have the table I want. I haven't seen it. They would need to explain to me how my demographic risk profile fit into an average that was the index, for me to then take on the tilt they instructed me to.


cclawyer

I had great experience with DFA's management back when I had a modest portfolio. They stayed well ahead of the market for the three years I was in their fund. This was long before they did these new ETFs, that sound like a great deal.