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Who knows? Does the market know who knows?

     There is a famous scene in "Friends" were the characters are trying to mess with each other regarding who knows what. Fans of the show might remember the sequence ending with Phoebe blurting out "They don't know that we know they know we know"

     The scene is somewhat similar to what's going on in the investment business with risk factors and market anomalies. In recent decades, researchers have documented hundreds of factors that were correlated with stock market returns. As a result, many have invested in strategies trying to profit from the anomalies. But reminiscent of the friends quote, it has become a game of who knows and who is trying to take advantage of whom. The problem is the more money that gets invested in a strategy, the less likely it is to work. It generally became accepted that value historically outperformed growth in the stock market. But over the last decade or so, it hasn't worked anymore - in fact growth has outperformed value.

Source: JP Morgan

     In the conclusion of my new book The Peaceful Investor I point out that if you are going to try to outperform the stock market using historical data, stock market anomalies, or risk factors (like Smart Beta, Fundamental Indexing, or other quantitative methods) you have a choice of trying to beat the current players on your own, or by joining them. Many of the creators and primary commentators in the field are aligned with investment firms.

     One of the biggest debates in the investment community is whether value investing (the most famous anomaly or risk factor) still makes sense. For instance, the following prominent commentators have weighed in on these topics recently.

Source: Research Affiliates

     Campbell Harvey and Yan Liu have a 2019 paper A Census of the Factor Zoo and they even maintain a spreadsheet of the hundreds of documented factors


     Bloomberg also has Sixteen Leading Quants Imagine the Next Decade in Global Finance (January 29, 2020) and J.P. Morgan’s Dubravko Lakos-Bujas suggests a massive rotation into value stocks and out of momentum names that began in September is not even halfway done via CNBC.

     Should investors try to beat the market and the big players, or should they join some of the big players trying to navigate the zoo? I suggest the default is to buy the whole stock market in a free (or just a few basis points) index fund, unless you are into speculating about whether you or someone you want to invest with knows more than the market does. If you are going to buy anything other than the market index you should ask yourself how confident you are whether it is you that knows what someone else doesn't, or you are the one being messed with. If you play that game, odds are you will be the one not in the know. I'll close by noting that Jack Bogle was not a fan of fundamental indexing and smart beta (see Reflections on a Revolution - May 23, 2017). I have had thoughts about trying to develop new options in this area for many years, in fact I originally registered the domain name a few decades ago. But I doubt that's going to happen, so if you know someone that wants to buy the domain, let me know.

More "who knows" scenes leading up to the scene in the video at the top of this page.
Gary Karz, CFA
Author of The Peaceful Investor and Publisher of (email)

Check out Peaceful Investor at Amazon

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