William Bernstein: Be Open To New Factor Tilts

July 02, 2013

 

IU.com: So you think they’ll be embraced by serious-minded investors and that they’ll enjoy a popularization?

Bernstein: I think so. If you look at the history of the public appreciation of the “value” factor and the “small” factor in the aftermath of the Fama-French factor in June 1992, what you saw is that from 1992 to 2000, if you invested in a tilted portfolio, you got hammered relative to the broad market.

But now, 20 years later, all around the world, Fama-French looks pretty good. If you had a small-value tilt for the past 20 years and you saved a reasonable amount of money, you’re on Easy Street right now.

I think the same thing will be true going forward with the newer risk factors, like profitability and momentum. You can identify a risk factor, you can invest in it, but 90 percent of people are going to bail on that approach in the rough patches, like what happened in the late ’90s with value and small investing, and that’s when the real money was made.

But there’s nothing wrong with just owning the market. But what’s more important than anything else is not how much tilt you have, but how disciplined you are in keeping your overall stock-bond allocation in place.

When I think of equity markets, I think it’s three basic asset classes: U.S. stocks, developed market stocks and emerging markets stocks. I currently see the U.S. markets as somewhat expensive—not horribly expensive. But I see developed market stocks and emerging market stocks now as being slightly cheap.

So, if you have a desire to tilt away from your usual allocation from a market portfolio, I don’t think there’s anything wrong with being heavy foreign stocks right now.

IU.com: You’re open to developed and emerging market stocks because of what’s been going on in those two pockets of the investment universe?

Bernstein: Right. You’ve seen Jason Zweig’s latest column? It’s the one he wrote after getting the Gerald Loeb Award. It’s a beautiful column. The implicit message there is that “naive contrarianism” that is usually spat out as an epithet usually works. When an asset class has been trashed for five or 10 years, it’s probably going to be better than average going forward.

IU.com: So between what people are saying about what’s going on in Western Europe and saying the bloom is off the rose in emerging markets, that’s when you start smelling opportunity?

Bernstein: Yes. And God bless Ron Paul—precious metals equities as well.

IU.com: I have a feeling you may say answering this question may be above your pay grade, but the Fed seems to be optimistic about economic data painting a picture of economic improvement in the U.S. Do you take the Fed at its word as it amends its policy posture, or do you think it’s guilty of wishful thinking? How do you see this shifting message out of the Bernanke Fed?

Bernstein: Thank you for answering that question for me ahead of time—I would never want to second-guess the former chairman of the economics department at Princeton and the authority on the Great Depression. I take him at his word.

 

 

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