Episode 79: Financial Theory in Practice: Gaining Insight from Models with Marlena Lee

Today on the show we welcome the Head of Investment Solutions at Dimensional Fund Advisors, Marlena Lee. Marlena has a Ph.D. from the University of Chicago where she served as the TA to Eugene F. Fama. She has been at Dimensional for 11 years where a big part of her role is communicating what their research team is doing for the advisors and clients who are using their products. In this fascinating episode, we discuss and define models, factors, and the importance of understanding the risks involved with any investment decision. We talk about the many different reasons why stocks have different returns, and what the research says about underperformance and our expectation of positive premiums. Marlena has some interesting perspectives on whether risk or behavior drives higher returns, and shares some of her biggest lessons gained from working with Eugene Fama, and Dimensional Fund Advisors. 

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Key Points From This Episode:

• The uses and limitations of models when making investment decisions. [0:02:30.0]
• Understanding the concept of ‘factors’ and why the word is evolving. [0:04:35.0]
• Why Dimensional doesn’t combine Price-to-Book with price sales and cashflows. [0:13:10.0]
• Marlene’s thoughts on whether risk or behavior drives higher returns. [0:15:15.0]
• The theoretical rationale for why we expect the value premium to be positive. [0:21:00.0]
• The role of company size in identifying differences in expected returns. [0:25:10.0]
• The split between dividend income and capital gains: What is the trade-off? [0:27:40.0]
• How to choose which Factor Model to use for your investing decisions. [0:31:15.0]
• The good arguments for owning bonds in your portfolio as a young investor. [0:35:00.0]
• Risk factors and equities when it comes to fixed-income and bonds versus stocks. [0:38:00.0]
• Questions investors should be asking about fees, risk, and portfolio worth. [0:41:48.0]
• Evidence that investors can use Yield Curve Inversions to time the market. [0:43:33.0]
• Marlena shares her most fascinating research topics and economic debates. [0:43:33.0]
• Marlena shares her biggest lessons gained from working with Eugene Fama. [0:48:13.0]

Tweetables:

“We think of models as something useful to simplify reality.” — Marlena Lee [0:02:40]

“Most research says that investors are best served by acting as if markets are efficient.” — Marlena Lee [0:03:43]

“How you pursue value might be different to how you pursue momentum because they behave differently in the data.” — Marlena Lee [0:20:20]

“The range of outcomes suggests that a 10-year period of underperformance isn’t that unusual.” — Marlena Lee [0:22:37]

“Don’t read too much into the output of any one model. Looking at something in a variety of ways can be helpful.” — Marlena Lee [0:31:56]

“There’s a lot of noise in empirical asset pricing research and you have to look at the data in a lot of different ways.” — Marlena Lee [0:47:20]

Links from Today’s Episode:

Rational Reminder Website — https://rationalreminder.ca/

Dimensional Fund Advisors — https://www.dimensional.com/

Marlena Lee on LinkedIn — https://www.linkedin.com/in/marlena-lee-47474011/

“Volatility Lessons” — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3081101

Fama and French Three-Factor Model — https://www.investopedia.com/terms/f/famaandfrenchthreefactormodel.asp

Download the transcript of this episode here: Rational Reminder Podcast – EP. 79 – Transcript