Earlier this week, I attended the Evidence-Based Investing Conference (West) and spoke on “The Factor Zoo” panel. I present a few highlights / takeaways from the event before you begin the 4th of July weekend. Of course, these are just my personal reflections, so anything excluded is simply because I could not be everywhere at once!
- Investor Behavior Matters
- Embrace Transparency
- Being an Evidence-Based Investor is difficult!
Investor Behavior Matters
Day 1 began with Barry Ritholtz’ talk on investor behavior. A takeaway from his talk (and from the event overall) is that investor behavior matters. (1) Barry makes a key point for advisors: there are (1) Things that matter and (2) Things that you control. A good advisor helps clients focus on the overlap between the two. Helping clients with items such as spending, planning, and simple asset allocation are things that matter and that can be controlled. Some clients may already be experts on the spending and planning side; however, the idea of redirecting a client’s focus to controllable items is invaluable for the overwhelming majority of investors. Here I discuss the idea of advisors serving as “money doctors”, and David highlights their impact in crisis situations.
But the topic of investor behavior did not stop there. Day 2 had a great discussion with Robin Powell moderating a panel of Dan Egan, Bob Seawright, Brian Portnoy, and Nicholas Carr. In addition to being entertaining, the panel shared some ideas on (1) how to educate investors on their behavior, (2) how to help advisors communicate more effectively with clients, and (3) how to nudge clients into making better decisions with their investments.(2)
It is a welcome event to hear the investment management industry helping advisors communicate more effectively with clients and facilitate the suppression of behavioral biases. This focus allows many (including us) to benefit from the great takeaways of behavioral finance.
Transparency is a core belief at Alpha Architect and many other emerging advisors and asset managers. But this way of thinking is different than it was 5 or 10 years ago.
“This next generation of investors…they look sh!t up. They look sh!t up [right] in front of you!”
Josh’s summary couldn’t be more spot on. Attempting to get away with financial BS nowadays is nearly impossible.
We welcome this development to the world of financial advice and financial services more broadly. More informed clients make better decisions, and better decisions lead to better client outcomes.
More advisor transparency = more client trust. More client trust = more sustainable business model and win-win partnerships.
I have attended a myriad of conferences (as an attendee, panelist, and speaker). A common question I hear all the time is some variant of the following: “Where do you think the market is headed and what should we be investing in?” Thankfully, most at this conference would reply to the market question as follows: “I have no clue.”
In general, that is a good (and transparent) response.
Throughout the entire conference, prognosticating in a “fact free manner” was kept to a minimum, there was little use of the word “proprietary.” Adding opaqueness to the process generally ends in bad results, as the end client doesn’t understand the risk/reward.
As we have mentioned in the past, open secrets such as Value and Momentum investing can be simple, but not easy. The key’s to success in these open secrets is investor education and a dedication to transparency and building trust in the process.
Evidence-Based Investing is Difficult
Is being an evidence-based investor is difficult?
Does attending a 3-day conference answer all the questions?
Don’t get me wrong, the conference was great and informative; however, the conference underscored just how difficult it can be to truly become an evidence based investor. Let’s take my panel, “The Factor Zoo” (picture below) with Andy Berkin, Frederic Babu, Mo Haghbin, and yours truly. The Panel was moderated by Morgan Housel.(3) Note: Here is a write-up of my opening position on factor investing prior to the conference.
We discussed a few topics pertinent to factors–I mentioned a paper on the aggregate smart beta ETF factor loadings as well as transaction cost models. If you didn’t get your Factor fix from our stellar panel, here were the other topics related to factor investing (sourced from the conference agenda):
- The Launchpad: Exploring New ETFs
- The Triumph & Trouble with Indexes
- Pitfalls in Smart Beta: Data Mining, Selection Bias and Performance Chasing
- Smart Beta: Further Down the Road
- Decisions, Decisions: Determining Which Factors Matter Most
- Tactical ETF & Index Usage: Understanding Active/Passive Hybrids or Making Alpha out of Beta
That is a lot of information! Remember, these are just the panels and presentations on factor and factor related topics–there were many other panels on other topics. Hence my statement — being an evidence-based investor is difficult.
And don’t assume we all agree. For example, a headline speaker at this event was Rob Arnott. For the East-Coast EBI conference in the fall (11/2/17), a headline speaker is Cliff Asness. As Corey highlights here, Rob and Cliff don’t exactly see eye-to-eye on factor timing. So for someone attending both conferences, with little background on factor investing and factor timing, they may just throw their hands up and say, “Huh?”.
The truth is, factor timing is difficult, and while Rob has some basis for his idea on factor timing (certain factors are more expensive than others), the pure amount of information needed to comprehend and make an evidence-based decision on one side or the other is significant.
Here are some other issues that evidence based-investors (and advisors) must grapple with (and this is not a comprehensive list):
- Academic papers generally highlight long/short portfolios–however most investors apply factors in a long-only manner. Trying to decouple the two styles can require your very own R&D team. Don’t worry, you can always read our blog to get started.
- Unfortunately, some industry experts cite only one paper(4) in a manner that supports their argument. One example of this practice is highlighting that there are many momentum Mutual Funds and ETFs in the marketplace, where the total amount invested is above the academic model-based capacity of the factor itself. Thus, Momentum is dead. However, these funds do not exist in a vacuum, as there are other smart beta funds that implicitly bet against the momentum factor — here is a paper showing that the aggregate smart-beta ETF loadings are essentially zero (i.e. the market!).
- See my first takeaway above — Investor Behavior Matters. Evidence highlights that using more holistic measures of shareholder yield is more predictive of future returns. Nevertheless, some investors love dividends. But we should not immediately chastise the investor’s love of dividends per se. In fact, sometimes making sub-optimal investment decisions can be the best advice. Sounds strange, right? Here is a new paper on the topic of dividends and investor behavior that goes in detail. Let’s start with a simple example. Let’s take Joe Investor. Joe loves dividend paying firms. He can invest, live off the dividend payments, and not touch a thing. Joe is 100% comfortable with his portfolio–in other words, Joe will invest and never question the portfolio because of the dividend features he craves. Of course, an alternative option would be to to invest in a comprehensive portfolio similar to an endowment; however, the portfolio (from time to time) would need to sell small fractions of shares to make the “synthetic” dividend Jim needs. However, now Jim cares about stock prices, he is watching the financial media everyday, and crushing red bulls while yelling at his TD Ameritrade screen(5). Ironically, the endowment portfolio actually contributes to bad behavior. Investor. Behavior. Matters.
So in total, an investor (or advisor) needs to (1) understand the research and (2) understand the client’s behavioral reactions to that research in order to give the best evidence-based advice that the client can stomach. Many advisors are great at understanding the investor behavior and really help their clients focus on what they can control. However, (realistically) not all advisors are going to understand the research (e.g., factor investing). Thus, the default result is to simply invest in a purely passive, market weighted portfolio.(6) We constantly send many potential clients down the road to Vanguard as we understand investor behavior (at some level), and we know that what we do (high concentration factor investing) is not for everyone.
Summing it Up
The conference was terrific. I feel positive about the progress of the investment management industry overall and the prospects for clients in particular. Firms are helping investors better understand their biases and enabling them to make fewer behavioral errors. The move to transparency is real and hiding behind opaque curtains is going the way of the dinosaur. And finally, while being an evidence-based investor is difficult, many firms are helping to translate these important topics to those who need them most.
Have a great 4th of July Weekend!
(The Ritholtz crew certainly know how to choose a location!)
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References [ + ]
|1.||↑||A copy of Barry’s slides can be found here|
|2.||↑||I am a huge fan of the book “Nudge” and drew several parallels between this book and some of the ideas proposed by some those on the panel.|
|3.||↑||Here is a picture of Josh Brown, Morgan, and me after the panel.
|4.||↑||or sets of papers, highlighting the same issue|
|5.||↑||Hat tip to Pat for this sentence|
|6.||↑||Alternatively, some are great at understanding the factor research, but are not great at understanding the behavior of clients|