behind the scenes at the factor factory

come with me to learn how numbers get made!

I think stocks are dumb; you may know this from in a line in my book which unexpectedly became a hit; I didn’t know so many people agreed. But last year a story about stocks fell into my lap and it was so fascinating I had to suspend my biases and go with it.

The falling-in-lap moment: an offhand remark, at a conference I attended last April, about an academic research paper, which set me on an 11-month reporting quest that united me with the brilliant Justina Lee at Bloomberg and culminated in this: A Fight Over Factor Investing Tests a Pillar of Modern Finance. (Thank you to our perfect editor Pat Regnier, whose tirelessness and delight in nuance is unmatched!!)

The article caught the attention of my wonderful friend Felix Salmon, who was characteristically perfect in immediately diagnosing all the most interesting parts. So he had me on Slate Money’s Money Talks to money-talk about it; that episode came out yesterday. It was SO much fun. I am talking way too fast on it, sorry, I was really hungry and also am maniacally obsessed with this story.

some old-timey academics gather ‘round a bunch of charts and debate. credit: me loving Canva’s Magic Studio (AI image generator)

The necessary backdrop: in the early 90s two brilliant academics invented a model to explain why some stocks outperform others. This model — the Fama French factors — was pretty good, and everyone else started using it too, for their own research and for their investing. So the model became the foundation for so much of modern finance; it helps us determine what companies are worth, how portfolio managers perform, how we should invest our money.

The three “factors” they (initially) found: the “market” factor (some stocks are more sensitive to the market’s gyrations); the “value” factor (some stocks are undervalued, cheap, for whatever reason); and size (little companies are a lil riskier and so compensate investors more).

Generally I have heard people talk about factors when they are explaining why their hedge fund underperformed. Oh value got beat up in the second quarter as growth stocks blah blah and in the second half of the year we anticipate a reversion etc. This was so ubiquitous and annoying on finance twitter I think it was kind of a meme, tho in retrospect I can’t remember if posters were self-aware or not.

Then: in 2021, three researchers noticed that the Fama-French factors, which are shared for free on French’s Dartmouth website, were changing. The numbers were different depending on when you looked. Without (in the view of these three researchers) adequate disclosure or transparency. As one of them put it:

“It would just never occur to you that the equivalent of the temperature on Jan. 27, 1989, depends on when you downloaded, if you checked this year or last year. Which is the equivalent of what we were finding.”

They looked into it and wrote up their findings in a paper they called Noisy Factors. One thing they learned: the changes to the numbers seemed to improve historical returns for the value factor — had the effect of boosting how “value” appeared to perform.

This is against the backdrop of the value premium not exactly crushing it in recent years, and — of course // one must note — Fama and French are advisors to and stakeholders in asset manager Dimensional Fund Advisors, which on its website says it “pioneered factor investing” and lists value as one of three factors that “drive outperformance.” So…the paper had a ~subtext.~

At this point I had to get a quick honorary finance PhD. Because Noisy Factors turned out to be a Rorschach test: to some, it’s a potential bombshell. To others (usually market practitioners, some in academic finance and asset pricing research), the revelations are so not radical, are actually obvious.

Drafts of this paper made the rounds at academic conferences and kicked up quite an academic stir.

And I got to go to one of those conferences! The Western Finance Association one, last June, at the Hyatt Regency in San Francisco, which demands that you photograph it:

obligatory documentation of the Hyatt Regency’s staggering lobby

WFA is one of the big academic conferences and let me just say — yall have been gatekeeping these!! I had no idea! But I know now!! Yes I’m aware of their flaws (eg this), but a full day of kicking idea-tires with people who really care??? (also, personal preference but in general I LOVE being trapped in a location with a defined group for a defined short period of time. Grown-up camp! send me on any cruise, any day)

Sicong Li, of the London Business School, presents his work

Noisy Factors author Pat Akey after his presentation at WFA, talking to peers and friends about gardens of forking paths and accounting rule changes etc

This story kept returning me to the idea that economics and financial markets trick us into thinking they are like the physical sciences, that they are governed by natural laws. Felix and I talked about this. It feels true because of that lie of precision: sometimes you can discover tidy formulas that seem to explain, and even predict??!, why numbers act a certain way. Black-Scholes is an example of this, I think — all the parts click together so perfectly, it feels like a golden ratio, too pretty to be just manmade.

If you are into econophysics — taking the principles of physics and grafting them onto financial markets — get in touch! I want to learn more.

that same lobby again. manmade but also pretty

millennial proof-of-life, the corporate bathroom selfie

So. Stocks remain dumb, but, as you can hear on Money Talks, thinking about stocks in this way got me to some fundamental metaphysical truths, and for that I appreciate them ♥️

You can read the whole story on Bloomberg here. Don’t forget to invite me to your next conference!!

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In case you are ISO more content, here’s some stuff I’ve been reading lately:

• How To Baby: A NO-ADVICE-GIVEN GUIDE TO MOTHERHOOD, WITH DRAWINGS by Liana Finck

• Dysplacement and the Professionalization of the Home

• newly added to my rotation a few months ago: Feed Me by Emily Sundberg, alongside mainstays: Hung Up by Hunter Harris, Today in Tabs

My turn: what are you reading? I want really good book recommendations, please!!

Thank you for being here! <3