Value Investing

Hi Everyone,

Considering Dan Villalon's assertion in this article that blending momentum and value strategies may yield superior returns, what challenges or suggestions have you encountered when integrating momentum with value?

Looking forward to hearing everyone's thoughts on this combo strategy. Thank you!

------------------------------
Jenna Brashear
AAII Community Manager
Chicago, IL
------------------------------

Ronaldo J from IL, thanks for sharing your analysis of this article. You were very kind.

It's my turn.

After I read this article first time, I went out and read a lot of factors research papers. I needed to chew on some data to get the empty feeling this article left since there is so little data ("empty calories") here.

Jumping out of a box, yelling "Me Quant!" and giving a Tarzan yell hardly convinces me you know what you are doing.

"Quant" as described here, is a redux of the same argument in the classic 1980's "Reese's Peanut Butter Cup" commercial -- you can have BOTH peanut butter (value) and chocolate (momentum) in one candy. My problem is: for a "quant," I do not see a lot of meat and potatoes data here; only empty calories and "dead air" space where data should be.

No (as in zero) data on performance or outcomes.

Two graphs with "hypothetical" ("just so")  data.

He argues that quants perform better than average – and provides zero data to support that -- because they have one foot on a block of ice (value factor) and one in a fire (momentum factor) and thus everything is "comfortable' on average.

Again, no side-by-side comparison data.

I do see a lot of unsupported "condescended assertions" wrapped in a lot of pretty "just so" faux MPT speak – beta, variance, covariance, diversification, etc. (implied, but again no data).

I see a lot of illusions to "factors theory" but only one source Fama. Even there, he offers no Fama citations, no data, no examples to support his assertions.

There is a lot of research on factors theory (currently there are over 200 factors that disagree with these assertions. Each with a quant bigot standing on ice and in fire and doing a Tarzan yell)

Most of what passes the smell test for data is hinted at in Charles' "lead the witness" (Ham Burger style, Perry Mason's DA arch foil) questions. 

Charles, invite him back and ask him back and ask him to bring data.

PS, Charles, I am pretty sure AAII has 20-30 years of data in the MSSP, factor (Growth Investing), and guru screens (ALL are based on different factors) to help us see how tasty this Peanut Butter Cup is. Me? I'm more of an almond M&M's type - fat value in the middle wrapped in sweet caloric momentum on the outside ... with red table wine of course.

I am filing this one in the "ignore the financial press" folder like William Berstein repeatedly recommends in "The Four Pillars of Investing," (2101).  

------------------------------
BARRY JOHNSON
------------------------------

Update 3/1/24

See below

UPDATED 3/1/24

I am posting this here because it almost fits the theme and am aching to tell this story because it may prove valuable to other AAIIers.

I am one of those people who is never satisfied with my portfolio ... even when it is producing better results than I expected.

In his annual rebalancing articles, our own Charles Rotblut shares the details of his portfolio and uses it to reinforce the value of rebalancing. Maybe Charles' need to rebalance is the same itch I have with my portfolio, but I expand my definition of rebalancing to include improving the alpha (asset) and beta (market) covariances through portfolio additions and deletions.

I will not bury the lede (yep it is not "lead" in the newspaper business and oddly enough the printing business was founded using "lead" type.)).

Charles' "minimalist" portfolio of only 5 Vanguard index funds impelled me on a journey around the internet where I learned a lot about diversification and tracking error.

Step 1 Last October (10/23) in his post "," I noticed that Charles' retirement portfolio uses only a 4-5 indexed mutual funds (because it's a 403(a) retirement account). All the funds came from Vanguard, and he used basic allocation and diversification schemes.

Step 2 I went to vanguard.com to get data on the 4-5 index funds Charles uses as my base case/role model prototype/strawman to "rebalance" my portfolio (which by my definition is a more expansive "design" process). 

At vangurad.com, I saw a lot of low-cost under 0.07 ER (or 7$ per $1,000 AUM), high-AUM (over $1B, higher the better), high liquidity (volume of transactions per trading day) ETFs – rather than actively managed index funds like Charles uses-- for each of Charles' holdings.

I also saw many other candidates that could help me reinforce/improve diversification and lower portfolio risks. I came away thinking Vanguard offerings are very cool!

Step 3 That led me to the bogleheads.com website. Wow! Those folks know how to party! And they know their stuff. They get the data on what they buy and share it openly. Lots of opinions, most supported by data. They are insular. They are Ravid Vanguard advocates. I learned a lot here. Got some significant leads (not lede).

Step 4 In several bogleheads.com comments, I saw links to the whitecoatinvesor.com website. There, I found a list of over 200 possible portfolios using mostly (>90%) Vanguard ETFs.

The sample portfolios start with only a single ETF, the Vanguard US Total Market ETF.

Then 2 ETFs - #1 + the Vanguard Ex-US Total Market ETF in a 60%/40% configuration.

From that primary geographical world markets division, an increasing number of portfolio possibilities expand the diversification theme using 3, then 4, then 5 ETFs up to around 20 total. Each addition added more "depth" to the quest for diversification incrementally increasing "slicing and dicing" the basic portfolio dimension of stocks and bonds, then adding additional diversification dimensions for stocks – geography US vs Ex-US, capitalization (Large cap, Small cap, then Mid cap), style/factor (Value vs Growth) and for expanding bonds (short, mid, and long term), adding real estate (REITs), and commodities (gold, precious minerals).

Along this journey through a modern Wonderland, I learned the pros and cons of each diversification option. You can stop at whatever level of diversification fits your risk profile and ability to deal with complexity. This tutorial taught me a lot and spurred me to seek more information on how to discriminate among these options to allocate my funds to achieve my low-cost, high-liquidity portfolio objectives.

Step 5 I kept coming across references to a book, "The Four Pillars of Investing" (2010) by William Berstein. I was familiar with another Berstein book, "Capital Ideas" (2005) which traces the implementation of modern portfolio theory (MPT). "CI" introduced me to the contributions of 20 or so MPT lead implementers who built the finance industry, which is newer than you think. MPT turns 50 in 2026.) Key pivot points for the finance industry were the 1972-1974 bear market drawdown, the 1976 invention of index funds, the 1987 flash crash, the 1998 LTCM bankruptcy, the 2000 dot.com technology bubble, and the 2008-2009 great recession. This litany makes me want to compute the "mean time between failure" rate to estimate the next "failure." Knowing this statistic would be a significant input for planning any portfolio to improve its "anti-fragility." (Coming soon.)

Step 6 I had previously read "In Pursuit of the Perfect Portfolio," (2021) by Andrew Lo of MIT and Stephen Foerster. It parallels Bernstein's chronology, but "PPF" focuses on the 10 or so Nobel Laureate academics + 2 key practitioners (Bogel and Ellis) that developed the theories that generated the math (mean-variance optimization) and principles (diversification, etc.) MPT is built on. These brainiacs planted the seeds for MPT in the 1950s and 1960s, but it took about 25 years for the "professional" financial industry to embrace MPT as its mantra. 

Step 7 I was starting to see a systematic way to "rebalance" my portfolio and to position it to accommodate the sociological, technological, economic, environmental, and political ("STEEP") forces that will inevitably impact markets as they have done frequently in the past. (That reminds me that I need to get that MTBF statistic.)

Step 8 The whole time I am "surfing the net" (Suddenly, I hear Brain Wilson, Mike Love, and The Beach Boys singing "Catch a Wave" (and you're sitting on top of the world") from 1964).

Step 9. I am also staying current on AAII.com through updates from the Premium programs. AAII screens implement portions of MPT through The Model Shadow Stock portfolio (MSSP) Coonan started the 55 or so "guru" screens that each relies on fundamental financial analysis (FA), technical analysis (TA), or "factors" theory which can be used to "tilt" (raise, lower, or balance) portfolio diversification to try to capture specific market "anomalies," that have proven to increase "equity premiums," e.g., (1) size/market cap/valuation, (2) value/low price, (3) growth/momentum, etc., or to "spread" portfolio risks (alpha (asset variation/risk), beta (market variation), PF to BM error tracking variation), etc. which begins with mean-variance optimization to allocate portfolio assets to the "mix" of expected returns and risks you can tolerate.

Step 10 After I revisited these MPT principles, I returned to vanguard.com (and schw.com and fidelity.com my other brokerage sites) to identify, select, and compare ETFs using the criteria listed in Step 2.

Step 11 The denouement. This "bundle" of step-wise analyses generated a portfolio "rebalanced" (tweaked) that it is conservative due to my goal of capital preservation with moderate growth implemented to achieve goals of 15% return on equities and 5.5% return on fixed income (money market funds) growth for 2024

Step 12 "The Hero of a Thousand Faces" returns home. "The Hero with a Thousand Faces" (1949) by Joseph Campbell explores the common elements found in myths and stories from around the world. It proposes that all hero stories follow a similar pattern, and, by understanding this pattern, we can better understand ourselves and our place in the world. In "HTF" the hero must leave his home/tribe and find his purpose and then return home to share his "bane" with his family/tribe to find his purpose in life.

After this journey, I implemented a diversified portfolio using 9 ETFs (mostly from Vanguard).

Overall. it is designed to achieve or surpass the average prediction of a 5% market growth in 2024 (by market maker banks (JPM, GS) and large brokerage (BLK, SCHW, FID, VGD) 2024 forecasts).

I have calculated the following statistical parameters for the portfolio.

Measures Used to Select EFTs

The final portfolio is allocated as follows:

Performance as of this update (@2/29/24) = 5.43%.

The point of this odyssey is that it all started with Charles sharing this portfolio information. Sometimes what you are searching for is right under your nose. Ask Odysseus/Ulysses, the Greek hero in Homer's Iliad famed for his intellect and cunning. He created the plan to sack the city of Troy using the "Trojan Horse." He is also famous for his long odyssey trying to return home after the Trojan War. After the destruction of Troy, Odysseus and his men left for home without paying proper respect to Poseidon, one of the most powerful gods in ancient Greek mythology, responsible for earthquakes, rivers, floods, droughts, and anything involving water in general. For his disrespect, Poseidon punished Odysseus with a ten-year journey home. Further insults by Odysseus against Poseidon complicated this journey. (That's an "mythical" understatement.)

------------------------------
BARRY JOHNSON
------------------------------

Jenna, I think a lot depends on how you define "value." As the term is generally used by "investment professionals," and as it seems to be used by Mr. Villalon, a "value" company is one that has been beaten down such that its price-related ratios (with price as the numerator) tend to be low. I call such companies "cheap." Blending such stocks with momentum probably yields a lot of "turnaround" stocks, and I do not regard buying "turnarounds" as an effective strategy. Indeed, as I look at Schwab's data on the AQR funds, not a single one has beaten the 10-year return for the S&P500. I don't know if there's a cause-and-effect thing going on there, but it doesn't look good for Mr. Villalon's strategy.

That said, I think momentum can be used to find real value companies, that is, companies that are valuable. I suppose my definition of a value company would put it in the category most "professionals" would call growth companies. Companies that are profitable and growing are valuable, and those are the ones I want to own. As Warren Buffett put it, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

O'Shaughnessy uses momentum as a factor in his most successful portfolios. It stands to reason that momentum can identify good investments, since a growing, profitable company is more likely than others to see positive momentum in its stock price. I just wouldn't try to pair momentum with companies that have until recently been losers.

Jenna, you must be promoting this 2023 article for a reason I missed. Obvious things get past me all the time. I am not the sharpest grape on the vine, but I am an oenophile.

To support your theme that "blending momentum and value strategies may yield superior returns," I posted an updated version of my recent experiences on some challenges I encountered trying to integrate momentum with value in my portfolio.

It is theme is how a basic article on the importance of rebalancing by Charles launched me on a personal discovery journey that resulted in increasing my knowledge about how these factors interact and how that interaction plays out in an ETF portfolio.

I hope my example helps someone else.

It helped me acquire more comfort with how to address/avoid/minimize the volatility, high valuations, market concentration, and increasing similarities of 2024 to the factors preceding the 2000 dot.com bubble -- which I find a formidable threat to transmogrifying the traditional understanding of the relationship between "value" and "growth. 

One example of this phenomenon. The iPhone, a key tool for the Internet revolution to build a user base by putting "apps" in the use to drive revenues, was launched in the US in 2007, 7 years after the dotcom era. If we halve this timeline (due to BCG's Bruce Henderson's famous learning curve effect for innovations), it will take until 2027-2028 for any AI products to generate earnings (growth). In the meantime, investors are loaded up on ANY stock that can spell "AI" (without asking Vanna to buy a vowel) but continue to promote enormous benefits ("value") that could only be delivered in the distant future. Another example. 5 of M7 are now called "value" stocks because analysts have blessed their inflated forward earnings estimates to "justify" their equally larger-than-the-market P/Es. Does anyone see a problem here?

LBJ used to tell a Texas Tall Story about a stationmaster who was monitoring the telegraph as he noticed that two trains were approaching each other on the same track - in opposite directions. He ran through the town announcing the pending disaster. Everybody ran to watch. No one manned the telegraph. Asked why no one sent a warning telegraph, the stationmaster said, "We ain't never seen a trainwreck before."  Sometimes sending a simple warning prevents a disaster.

As a simple-minded lad with a public education, I have to ask a simple question about the value-growth question to see if there is a simpler answer. My Brit pal William from Occam, Surrey, UK taught me that. I always listened to him. People said he had a razor and he used it to cut through the clutter to get to the simplest answer to any question.

Here goes. If want to invest in both value stocks and growth stocks, why not just buy a Blend index fund/ETF?

That is the usual definition of what a blend fund is - a "blend" of value and growth.

Play nice. Remember, the guy asking this question has a friend who carries a razor and only has a public school education.

Barry, I can't answer for everybody, but my simple answer has two components:

First, I've stopped investing in ETFs altogether in my own accounts. I still buy them occasionally for my children for different reasons, but for my account, I will not turn over any more voting power to evil, woke totalitarians. I have enormous gain built up in most of the ETFs I own, so I'm not about to commit financial suicide by suddenly dumping all of them. But I won't buy any more of them, and when the opportunity arises, I will unload them and buy individual stocks. 

Second, I think I can do better than an ETF by buying individual stocks. I lay no claim to being an investing genius. I make as many mistakes as anyone. But experience shows that my style of buy-and-hold works better than most ETF strategies over the long haul. All I do is buy good companies---those with a decent record of growth in revenues and cash flow, together with a few other characteristics---and I hold them until either (1) they're circling the economic drain or (2) I find a substantially better alternative. The longer I hold them and the more they've grown, the less likely it is that I will find a substantially better investment, because "substantially better" means the new company's prospects have to be good enough to overcome the taxes I have to pay upon selling my original investment. Thus, I hang onto my winners. I pay scant attention to what the market says about my companies. As long as the companies themselves are profitable, they're generally keepers. 

I suppose I should also mention that I try not to pay too much for those good companies. I'll probably hold MSFT, AAPL, and NVDA forever, but I wouldn't buy them at their current prices. I should also confess that I might still buy certain leveraged ETFs when their prices are beaten down.

My buy-and-hold method is what I used all my life until I diversified into ETFs for "safety" when I retired. I wish I could get a do-over on that. I especially wish I could recoup all the taxes I paid on selling my good stocks to buy those ETFs. 😥

I'm convinced that one could beat the market using a dart board to pick an initial portfolio and then managing it according to my rules. The only caveat is that it does require a bit of informed judgment in making reallocations, and it takes a boatload of patience and tenacity. But I'm living proof that doing well with this strategy doesn't take an enormous amount of intelligence.