Marketing extraordinaire Robert Arnott and his Research Affiliates colleagues published a research paper last week claiming that the returns on "factor tilted" strategies have generally been less in the real world than the simulated data would suggest. In Arnott's world of finance, these strategies date back to the inception of his "smart beta" indexes about a decade ago. But, of course, we know that Dimensional Fund Advisors (DFA) has been managing index-like "asset class" mutual funds since 1982 designed to capture the returns of smaller and more value-oriented stocks globally (i.e. "small cap and value return factors").
What would we expect the returns to have been? First, we'll start with the simulated index data that we have on US stocks dating back to 1927. From 1927-1993, the returns on a small/value tilted stock index ("DFA Equity Balanced Strategy Index") was 1.5% per year more than the S&P 500. The S&P 500 outperformed Five-Year Treasury Notes by about 5% per year, which outpaced inflation (CPI) by 2% per year. In the second table, the data includes live mutual fund data net of expense ratios. The small/value-tilted DFA Equity Strategy returned +1.4% per year more than the S&P 500, which outperformed the DFA Five-Year Global Bond Fund by 4.4% per year. Both the small/value tilted portfolio and the S&P 500 returned about 1% per year less in absolute returns from 1993-2017 as compared to 1927-1993, but inflation in the latter period was also 1% per year lower, so "real" returns were almost identical in both periods.
Have the returns on "factor" portfolios diminished when we consider live mutual fund returns? Hardly. They are what we thought they were...
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