Morningstar Advisor - October/November 2012 - (Page 55)
mean reversion. They miss it, because the one piece that would capture it, the value effect, is only a crude proxy for long horizon mean reversion. So, I would agree that momentum works and makes sense, but if you follow it too vigorously, you’re going to miss some really, really interesting opportunities.
Asness: All right, well, now we’re starting
this, because I have some of those days tattooed on my liver. We were monitoring it. Even though quant had grown a lot, we did not see evidence that basic cheap-versusexpensive was no longer worth pursuing. We did see that when a whole bunch of people tried to get out the same door; it was a disaster. It sent the value spread—as we called the cheap versus expensive—up to the mid-90s in percentile, meaning that cheap was not as cheap as it was at the peak of the tech bubble, but it was very cheap. But the very fact that it wasn’t so insane at the beginning is part of why it recovered so quickly. One thing I find ironic is that August 2007 was a month that aged many a quantitative investor. But if you look at the monthly data, you won’t find much, because two thirds of it reversed in the next 10 days. That month was really about survival. Many of us survived, some didn’t. If you ran your portfolio at reasonable amounts of tracking error, or if you used reasonable amounts of leverage, it was quite survivable and quite short term, and thankfully, it reversed itself. The last point I’ll mention is momentum. Rob is right. If you include some momentum, you do have less of a pure value tilt. They’re negatively correlated. But they’re not perfectly negatively correlated. Rob made the point that momentum doesn’t work over the long term for holding the same positions. I fully agree with that, but I think it’s kind of obvious, too. Momentum is about the short to medium term. We do use value and momentum simultaneously. But one way of thinking about it is value as an investing position and momentum as a trading position. Long term, you own your investing positions and you trade around them with your trading positions. Momentum is not meant to say that you will never own a stock that’s cheap. It says, you will wait until it starts to come off the bottom, that it’s not always easy to pick that bottom, and by waiting to see some of it,
you are a better and more consistent investor. Once it starts to come off the bottom and these two effects agree, they can agree for a very long time. So, momentum is, of course, more about the short term and more about timing, but combining that with a mostly value strategy, you end up still as a value investor; you just try to be a little more cowardly about getting in and then aggressive about ramping it up when it starts to work. When I want to criticize someone for buying what’s expensive on real long horizons, I often call them “a momentum investor operating a value time horizon.” That’s a geeky way to say that they’re buying what’s done better, but they’re buying what’s done better over five and 10 years, which tends to be when you want to do the opposite. So, I don’t think there’s any inconsistency or any problem adding momentum to a value strategy. I think it makes it better. But you wouldn’t want to use that as your long-term single strategy.
Arnott: I like your mention of the time horizon.
to have fun. (laughter) First, I will not sit here and beat the drums and say that long-only, cap-weighted value is the only way to go. A pure factor bet over those eight years has done better than a long-only value tilt, and I think Rob and I would agree on that. But just to get realistic, a lot of these factors individually have Sharpe ratios somewhere in the vicinity of 0.3 to 0.5, which would be a wonderful Sharpe ratio. Take the low end of that; say long-only constraints get you to 0.3. A nine-year underperformance is less than a one-standard-deviation event. These things are all very long term. I wrote a paper on momentum investing having a 30-year failure in Japan and why I thought it still made sense. So, Rob has a very appropriately long time horizon on many things. I would say it should be long on other things, too. It doesn’t mean we shouldn’t invest in better forms of value. I can argue for factor-based value investing, long and short. Rob can argue for fundamental indexing. It doesn’t mean we should give up on making them better. But eight years is not so crazy. Another point: We measure very carefully how cheap cheap stocks are versus their norm. That might sound like a tongue-twister, but that’s how you define them; they’re the cheaper stocks. Sometimes, they’re a little cheaper, sometimes they’re much cheaper. At the peak of the tech bubble, they were the cheapest we’d ever seen against growth stocks. Going into the quant meltdown in August 2007, they were right around median. I remember
Using momentum on a three- or five-year basis to make investment decisions, we agree, would be a disaster. Unfortunately, that’s the way most people act. You know what the answer would be if I go to a client and say, “We found this strategy that has performed horribly over the past three to five years, and we found this manager who’s the quintessential manager of this strategy and does it in a more intense and focused way than most. His numbers are unbelievably bad. Let’s invest with him.” Yet, it’s often the right thing to do. An intense, focused, deep-value emerging-markets manager in 2002—just imagine trying to hire that manager!
Asness: You are entirely right. Of course, we
both live in the paradoxical world that we want to convince our clients of this, but we do not want to convince the whole world.
MorningstarAdvisor.com 55
http://www.MorningstarAdvisor.com
Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2012
Morningstar Advisor - October/November 2012
Contents
Contributors
Letter From the Editor
Ill Communication
Do You Use Factor-Investing Strategies?
Practicing What She Preaches
How to Determine the True Price of ETFs
The Quant Factor
Managers Dispute the Death of Equities
Investments á la Carte
Investment Briefs
Five Inconvenient Truths of Manager Research
Health Care’s Outlook Clarifies
Exploring the World of Factors
Uncloaking the Alpha Machine
Factor Strategies Gain Footholds in Practices
Big Mo
Fitting Factors Into the Formula
Clients Have a Friend in Luther King
Less-Liquid Holdings Mean More-Solid Results
Retirement-Withdrawal Strategies Quantified
Amid Turmoil, Don’t Discount Foreign Equities
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Should I Stay or Should I Go?
Morningstar Advisor - October/November 2012
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2024q1
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2023q4
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2023q3
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2023q2
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2023q1
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2022q4
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2022q3
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2022q2
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2022q1
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2021q4
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2021q3
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2021q2
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2021q1
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2020q4
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2020q3
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2020q2
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2020q1
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2019winter
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2019fall
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2019summer
https://www.nxtbook.com/nxtbooks/morningstar/magazine_2019spring
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20191201
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20181011
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20180809
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20180607
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20180405
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20180203
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20181201
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20171011
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20170809
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20170607
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20170405
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20170203
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20171201
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20161011
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20160809
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20160607
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20160405
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20160203
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20161201
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20151011
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20150809
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20150607
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20150405
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20150203
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20151201
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20141011
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20140809
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20140607
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20140405
https://www.nxtbook.com/nxtbooks/morningstar/magazine_20140203
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20141201
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20131011
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20130809
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20130607
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20130405
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20130203
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20131201
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20121011
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20120809
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20120607
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20120405
https://www.nxtbook.com/nxtbooks/morningstar/investorconference2012
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20120203
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20121201
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20111011
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20110809
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20110607
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20110405
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20110203
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20111201
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20101011
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20100809_lincoln
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20100809
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20100607_lincoln
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20100607
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20100405_lincoln
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20100405
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20100203
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20101201
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20091011
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20090809
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20090607
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20090405
https://www.nxtbook.com/nxtbooks/morningstar/advisor_20090203
https://www.nxtbook.com/nxtbooks/morningstar/advisor_2008fall
https://www.nxtbook.com/nxtbooks/morningstar/advisor_2008summer
https://www.nxtbook.com/nxtbooks/morningstar/advisor_2007spring
https://www.nxtbook.com/nxtbooks/morningstar/advisor_2007fall
https://www.nxtbook.com/nxtbooks/morningstar/advisor_2007summer
https://www.nxtbook.com/nxtbooks/morningstar/advisor_2008spring
https://www.nxtbook.com/nxtbooks/morningstar/advisor_2008catalog
https://www.nxtbook.com/nxtbooks/morningstar/advisor_2008winter
https://www.nxtbookmedia.com