Cliff Asness’ recent essay describing his belief that markets have become less efficient over last 30 years and that periods of underperformance and out performance may be deeper and longer makes a lot of sense to me.
After 20 years of underperformance by complex factor based strategies relative to simple beta, you have to say something to keep factor heads on board and remind them that the game is not over yet, that SCV, multi-factor funds, and long/short, multi-asset, multi-factor funds were more than a waste of time and money. They theoretically improved diversification according to factor theory, hence were theoretically worth it. The problem is that the aim of diversification, its entire reason for being, is to reduce portfolio volatility and deep drawdowns. SCV has not only underperformed beta substantially for 20 years, but it has done so with increased volatility and deeper drawdowns relative to simple beta which can be purchased without an advisor for 0.03%/yr. The diversification benefit from factor approaches showed up only in factor theory not in real world objective results.
I personally hold 25% SCV which I believe does provide diversification relative to my 75% TSM. As for more complex, more expensive approaches using options and factor theory, based on results over the last 20 years it has been more di-worse-ification than diversification.
Twenty plus years ago, after impressive outperformance by SCV for 23 years since its inception, factor mavens were suggesting 100% SCV for US equity. Why waste time with losers like one factor beta? Those who followed their advice paid a big time opportunity cost over the next 18 years relative TSM. Now the mavens no longer focus on SCV outperformance. Market action has made SCV portfolio dominance a hard sell. Now the marketing focus after these long years of underperformance has switched from increased returns to increased diversification. That increased diversification oddly doesn't show up in volatility measures like standard deviation, or measures of risk like maximum drawdown, or in measures of risk adjusted returns like Sharpe ratios. They do not show up at all in objective measurements but only in factor theory itself. A skeptic might wonder about this.
Most market observers believe that markets which are dominated by full time professionals and AI based algorithms are more efficient now than they were from 1929 - 1992, the period which give us the small and value factors. In that early period naive mom-and-pop investors moved the markets. Some even suggest that it was the inefficiencies of those old markets--the public largely ignoring small cap and value stocks like many do today--that produced the factors in the first place. Backtesting showed that ugly ducklings won out in the end. Those were different times. Today private equity and venture capital buy up early the most promising small cap stocks destined to be long term winners, so they never even make it into the public market. PE and VC remove the SCV quality cream, the most likely future winners, and what's left over gets into the public market. 43% of the Russell 2000 had negative profits last year. Firms like that would been unable to borrow and would have gone under 1929 - 1992. Mr. Asness is certainly brilliant and knowledgeable, but his opinion that market efficiency is seriously decreased is a minority view. I suspect there were more hidden SCV gems, sure fire future winners in that early period than there are now.
Garland Whizzer
Statistics: Posted by garlandwhizzer — Fri Jan 03, 2025 3:58 pm — Replies 56 — Views 2708