Thoughts on Quantitative Value

Strategy Shift

As I’ve documented on this blog, I’ve shifted my strategy from a widely diversified portfolio of quantitative bargains.

I’m running this portfolio with a different strategy: a concentrated portfolio of high quality businesses that are temporarily selling for cheap multiples.

This portfolio that I track on this blog is a “variable” portfolio, as Harry Browne put it. I wrote about variable portfolios on Medium here.

I also have my asset allocation strategy, which is where I’ve decided to put the rest of my savings. That’s the weird portfolio, which I’ve written about here.

That portfolio has a strong focus on small cap value, but also has built in protections for different economic environments.

Even though I’ve shifted from a quantitative approach in my variable portfolio, I’m still a believer in it.

Quant Value: Challenges With a DIY Approach

I am still very much a believer in quantitative value strategies and think they’ll come back even though they have underperformed the market for many years. I just think that the manner in which I was implementing it is not the best way to actually do this.

I think that the best way to implement a quantitative value strategy – for me, anyway – is to do it with an ETF. In my passive portfolio (which is where I have most of my net worth), I do that with VBR and VSS, to create a small value portfolio that’s globally diversified.

There are other excellent value ETF’s out there, many of which are more focused on the factor. Probably the best examples of this are Alpha Architect’s IVAL and QVAL, which quantitatively implement a deep value strategy.

One of the coolest value ETF’s out there is Tobias Carlisle’s ZIG ETF – which gives an investor a long/short value oriented hedge fund without the 2 & 20 fee and does it in an optimized tax structure.

When quant value comes back (and I strongly believe it will), my opinion is that the more focused ETF’s ought to experience a more significant outperformance – just like they’ve experienced more significant underperformance during value’s season of woe.

The Vanguard value ETF’s have less exposure to the factor and have underperformed less during value’s troubles. The Vanguard ETF’s are lower octane, which probably reduces long term returns but can help prevent behavioral errors during the bouts of underperformance.

An investor needs to decide how hardcore they want to go, which is a personal preference.

I think that ETF’s are the ideal way to implement a quant value strategy. A quant value approach works over the very long run even though it can underperform for years. It’s a lot easier to deal with that when done passively.

I think the best approach is to put it on autopilot and not look at it for a long time. Give the strategy a long time to work. Value works because it doesn’t always work. An investor can buy an ETF and not look at it for 20 years, which is probably the better approach to take with a quant value strategy.

Actually DIY’ing it – pick the stocks, buy and sell, deeply analyze the companies – can be very labor intensive. When value enters one of its funks as it has for the last 5 years – you can feel that all of those hours were spent fruitlessly. That’s an extremely frustrating process, which is what I’ve been dealing with.

That’s what I’ve discovered over the last 5 years or so. With an ETF, it’s a lot easier to deal with the seasonal underperformance of the strategy.

ETF’s > DIY

As a DIY investor, I think it makes more sense to implement a quantitative value strategy by passively owning ETF’s rather than try to DIY it. This is based on my own experience trying to implement a quant value strategy with a discretionary element, which I documented on this blog.

I found that actually analyzing all of the companies in a 30-stock deep value portfolio and trying to buy and sell at the right times is an exhausting process.

It’s also a recipe for behavioral errors. I made plenty of behavioral errors. These companies look like they have severe handicaps and it takes an extremely skilled business analyst to distinguish between those that have permanent impairment from those that are temporary. I think it’s best to do this in a diversified portfolio and not obsess too much over picking the winners.

For me, doing this in a discretionary way also led to foolish market timing. I tried hard to predict the crash and figure out the economic cycle and I completely failed at this.

These errors can be avoided by simply owning the ETF and letting it do its work over a long period of time. I don’t have to actually obsess over and follow closely all of the stocks in the portfolio. I can let the factor work. I can give the factor time to work.

To further prevent behavioral errors, I own my small value ETF’s in a portfolio with safeguards for different economic environments. That’s why I own things like gold and long term bonds to protect against economic catastrophes because I have a pessimistic bent and always worry about this sort of thing. Long term bonds protect against deflation and recessions. Gold protects against extreme inflation, currency collapse, and a global Depression.

I’ve found that these defensive elements were essential for me. They kept me from making behavioral errors in March. In the depths of the crisis, I was only down about 14% in the weird portfolio and I didn’t sell like I did with this variable portfolio. I was able to stick to it. It’s nice to have that asset allocation doing its thing, with the confidence of knowing that it has all kinds of built in protections for different economic environments.

Another consideration is taxes. The account I track in this blog is money I’ve saved up over the years in an IRA and has deferred taxes, so this wasn’t a major consideration.

For a taxable account, though, a high turnover quant value portfolio is going to generate a lot of taxes because there is a lot of trading. That’s the beauty of an ETF. The taxes only need to be paid when the ETF itself is sold. The trading within the ETF – the selling of stocks when the multiples pop, buying new stocks at compressed multiples, doing it over and over again – doesn’t create taxable events due to the ETF structure.

You might still want to pursue a deep value strategy and DIY it, which is fine if that’s your bag. I just found it to be extremely difficult to implement on my own and concluded that it’s easier to simply have an ETF do the work for me.

You Do You

You might feel that you want to implement a DIY, quantitatively oriented, deep value strategy. That’s totally fine.

With that said, I found it extraordinarily difficult to do on my own. I made a number of behavioral errors in implementation. When the turds hit the fan, I found my portfolio terrifying to own.

My conclusion is that implementing a value factor strategy through an ETF – and letting someone else (or a computer) do the work – is the ideal approach. You can just enjoy the sausage and not concern yourself too much with how it is made.

Another great thing about ETF’s is that you can spend your time doing something more important than following companies and the market.

These were the lessons I learned. You might have a different conclusion, which is totally fine. Investing is a personal process and you have to figure out what works for you.

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