Whether you call it factor investing, chasing the return premiums [1] – or you use the once-trendy but now sounding increasingly like walking into a bar and declaring “Hey daddy-o, I’ll have a Babycham” term Smart Beta – trying to get an edge by exploiting biases in the market remains controversial.
A few hedge funds do it to great effect.
Others flounder.
Among passive investors the debate is if anything fiercer.
Indeed the idea of a passive investor pursuing a specific ’tilt’ to try to beat the market smacks some as a contradiction in terms.
I’m not one of those people – my definition of ‘passive’ is wider than most – but plenty of big guns have had a shot.
Vanguard founder Jack Bogle says [2]:
“Smart beta is stupid; there’s no such thing. It’s an idiotic phrase.
Quoting Shakespeare, I guess: It’s a tale told by an idiot, full of sound and fury, signifying nothing.
It’s just another way of saying, “I know I’m going to be above average.”
Active managers are just trying to come back and say there is a better way to index, when they know damn well there isn’t a better way.”
I don’t think Jack’s a fan.
Everything but the Krypton Factor
One inevitable hurdle with factor investing is it takes a simple if weird [3] idea – that by just buying the market and not paying anyone to try to do better, you probably will do better – and obfuscates it to the n-th degree.
That’s not appealing to the passive investing mindset.
For example, we’ve covered most of the return premiums [4] on Monevator…
- Value [5]
- Size [6]
- Profitability [7]
- Low volatility [8]
- Momentum [9]1 [10]
…yet I suspect only the geekiest2 [11] of readers have read them all in full.
Even after explaining how to build a risk factor [12] portfolio, my own co-blogger The Accumulator then wondered [13] aloud whether it was really worth it.
Confusing stuff.
Video on factor investing
Still is your curiosity piqued?
Naturally I’d be delighted if you read all our articles on return premium [4]. (I suspect they’re feeling a little lonely).
But you could start instead by watching this interview with Cliff Asness, the founder of AQR Capital Management and a student of efficient market titan Eugene Fama [14].
Mr. Asness covers most of the bases and gives his views as to why these factors might exist – but he does it with the accent of a wise-cracking gangster from a 1950s crime flick.
I find him very personable:
Just don’t be scared when the interviewer says:
“Now, when I read the very latest papers on risk, let me tell you what I see.
I see talk of the third moment of probability distributions, the fifth moment, words like coskewness, terms like the U‑shaped pricing kernel, and talk of the volatility of volatility.
I’m just waiting on the paper on the volatility of the volatility of volatility.”
…because Asness waves all that away.
There’s also a full transcript on Medium [15].
Finally, for the other side of the argument you can read our own Lars Kroijer explaining why everything except [16] a total market tracker is hokum in his view.