Indexing vs. rebalancing factor funds

aroominyork

I've been mulling over two approaches for equity investors who want to take a middle road. The natural route is an index fund. But how would this compare to investing 50/50 in growth and value factor funds and regularly rebalancing?

If the market ebbed and flowed between growth and value this would work nicely: you would consistently be selling high and buying low. But the market doesn't always ebb and flow; for most of the last 15 years growth outperformed value. And that is where my maths breaks down... how would an index fund have compared to pretty consistently selling rising growth and buying falling value?

Do index funds by their nature do this rebalancing? Or, if growth is in favour and P/Es are high, do index funds replicate this momentum and have a bias to growth? Or something else?

george4064

Why bother with all the faff and instead just invest in a multi-factor ETF such as FSWD?

Im invested in that in my LISA, happy days.

aroominyork

george4064 said:

Why bother with all the faff and instead just invest in a multi-factor ETF such as FSWD?

Im invested in that in my LISA, happy days.

Not really answering my question, but if way underperforming an index fund makes you happy... well, they say to make money someone has to be on the other side of the trade losing money, so I guess you are performing a service.

JohnWinder

Q1. No idea, but portfoliovisualizer will allow you to test this, including with ‘regular rebalancing’ or with several other timings. What a resource.
Q2. Read A1.
Q3. Not cap weighted ones, surely?
Q4. They track the market; call it ‘a bias to growth’ if you wish.
Q5. Question limit reached.
Q6. You might not be able to stick with FSWD during any longer periods of underperformance compared to a cap weighted fund, and it’s costing you a bit more. Otherwise, fine choice.

Linton

My growth portfolio strategy is based on managing a range of factor allocations as determined by Morningstar with the objective of minimising medium term risk rather than maximising long term return. This is done by careful choice of mainly active regional large and small company funds coupled with a single global factor fund. Annual rebalancing has been sufficient to keep all monitored factors within predefined bounds.

Back-testing of the portfolio limited by the launch dates of the funds involved shows performance between the FTSE World index and the more diversified but slightly lower performing Vanguard FTSE Global All Cap fund.  This is interesting in that my allocations are different to those of a global tracker with significantly less US and more EM and Small Companies.

This observation has led to my hypothesis that all sensibly-managed well-diversified portfolios will show much the same performance. There is nothing special about capitalisation weighting.

masonic

Linton said:

There is nothing special about capitalisation weighting.

There is one thing that's special about capitalisation weighting... that when your constituents' market cap drifts higher or lower, their target weighting also does so to match, so rebalancing is unnecessary.

JohnWinder

I think what’s special about the market cap weighted portfolio is that it is the most efficient, in theory. It can be expected to have the best return for the amount of risk. That’s handy, as one could forgo some returns and take less risk. The theory can be wrong, and probably doesn’t fit the real world, but the strategy to exploit the inefficiencies of the ‘efficient market’ haven’t be publicised yet.

We could deny it’s ‘special’,  but the cap weighted approach is the no-brainer, set and forget approach that does what it promises. But tweaking, rebalancing, and refining can all be good clean adult entertainment.

‘shows performance between the FTSE World index and the more diversified but slightly lower performing Vanguard FTSE Global All Cap fund.’

We need to be careful when comparing an index (no running costs and we can’t invest in it), with a fund which has and we can.

george4064

aroominyork said:

george4064 said:

Why bother with all the faff and instead just invest in a multi-factor ETF such as FSWD?

Im invested in that in my LISA, happy days.

Not really answering my question, but if way underperforming an index fund makes you happy... well, they say to make money someone has to be on the other side of the trade losing money, so I guess you are performing a service.

Tracking error and impact of fees is not ‘way underperforming’. Unless we’re looking at different things?

aroominyork

george4064 said:

aroominyork said:

george4064 said:

Why bother with all the faff and instead just invest in a multi-factor ETF such as FSWD?

Im invested in that in my LISA, happy days.

Not really answering my question, but if way underperforming an index fund makes you happy... well, they say to make money someone has to be on the other side of the trade losing money, so I guess you are performing a service.

Tracking error and impact of fees is not ‘way underperforming’. Unless we’re looking at different things?

I compared to Fidelity Index World, as both are developed markets only. Since FSWD launched in 2105 they were close until the end of 2018. Since then, the index fund has risen about 73%, FSWD just over 50%.

Linton, your hypothesis/conclusion may be right, but I'm not sure it aligns with your evidence. EMs and smaller companies haven't been the best place in recent years while the US has. If you have achieved similar returns, maybe you have made some good choices. It doesn't follow that all diversified and 'sensible' choices will do as well.

Linton

aroominyork said:

george4064 said:

aroominyork said:

george4064 said:

Why bother with all the faff and instead just invest in a multi-factor ETF such as FSWD?

Im invested in that in my LISA, happy days.

Not really answering my question, but if way underperforming an index fund makes you happy... well, they say to make money someone has to be on the other side of the trade losing money, so I guess you are performing a service.

Tracking error and impact of fees is not ‘way underperforming’. Unless we’re looking at different things?

I compared to Fidelity Index World, as both are developed markets only. Since FSWD launched in 2105 they were close until the end of 2018. Since then, the index fund has risen about 73%, FSWD just over 50%.

Linton, your hypothesis/conclusion may be right, but I'm not sure it aligns with your evidence. EMs and smaller companies haven't been the best place in recent years while the US has. If you have achieved similar returns, maybe you have made some good choices. It doesn't follow that all diversified and 'sensible' choices will do as well.

It is easy to check - put together a dummy portfolio on Trustnet choosing suitable funds chosen at random to give an overall reasonable allocation.

For example, with about 40% US as opposed to 70% for an MSCI global tracker:

aroominyork

Is passive investing the elephant in the room? It perpetuates momentum, and can growth be a rough proxy for momentum? Does that create a bubble which will periodically be pricked?