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.
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.
- A January 29, 2020 article at Institutional Investor asks whether the "Value Premium Is Disappearing" including a discussion with Ken French (who summarizes ‘There Is No Way to Tell’). French and Eugene Fama documented factors in academic papers starting in 1992 and they are on the Board at Dimensional Fund Advisors, which manages over $600 Billion in funds. That was followed by a February 6, 2020 article titled Why Value Investors Shouldn’t Expect a ‘Massive’ Comeback.
- Reports of Value's Death May Be Greatly Exaggerated is a January 2020 commentary by Rob Arnott, Campbell Harvey and others, who are affiliated with Research Affiliates, which develops investment strategies used in managing about $200 Billion. "Value investing has underperformed relative to growth investing over the last 12 years ... the stage is set for potentially historic outperformance of value relative to growth over the coming decade."
- Cliff Asness at AQR, which also manages close to $200 billion, also weighed in with his perspective on value investing in November in It’s Time for a Venial Value-Timing Sin.
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 stylefunds.com 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.
Gary Karz, CFA
Author of The Peaceful Investor and Publisher of InvestorHome.com
Check out Peaceful Investor at Amazon