Factor investing: The patience tax

Theo Leimer

Theo Leimer

— 4 min read
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If factor investing actually works, and it's been documented for forty years, why hasn't every fund piled in and arbitraged it away?

The textbook answer is that factor premia compensate investors for taking risk.

The premium isn't free money: you earn it because you're bearing something other people won't.

But that answer feels thin: Risky compared to what, exactly?

The honest answer, I believe, has very little to do with the risks most finance textbooks discuss.

The textbook answer is incomplete

Eugene Fama's explanation is that value stocks are riskier:

  • More distressed
  • More cyclical
  • More likely to cut dividends

The premium is rational compensation for bearing that risk.

Cliff Asness, building AQR over three decades, has increasingly argued the opposite. He states the premium reflects behavioral error. Investors:

  • Overextrapolate growth
  • Overpay for narrative
  • Abandon boring, cheap businesses

Yet, the market eventually corrects.

Both camps agree the premium is real but disagree on who's getting paid for what.

Here's what bothers me about both stories:

Each explains why value pays a premium. Neither explains why low-volatility stocks pay one too (even though, by construction, they're less risky than the market). Or why quality companies, with the cleanest balance sheets and steadiest earnings, do the same.

If you're paid for taking risks, why are the safest factors paying you?

Something else is going on...

What you're actually being paid for

The factor premium survives because holding factors through their bad stretches is both financially and professionally painful.

Consider what happened to value over the ten years through March 2020:

Ten years. That's longer than most fund mandates, CIO tenures, than the patience of any board, investment committee, or client.

To this day, the financial press is still running the same obituaries; except now the headline asks whether quality investing is dead.

The point isn't that the textbook risk story is wrong. It's that the most binding risk being compensated isn't market risk at all. It's the risk that you look stupid for long enough to lose your job, your clients, and your nerve.

Momentum (buy past winners, sell past losers) tells the same story, on a shorter timeline: When the market bottoms and rebounds, the stocks that fell furthest snap back the hardest — and those are exactly what momentum is short.

In the three months from March to May 2009, the losers momentum was shorting rose 163% while the winners it owned gained only 8%. The strategy lost roughly a year of returns in a quarter, right as the recovery began.

Same lesson: At the end of the day, you're being paid for what your career can survive.

The implementation gap is a career gap

The pattern shows up clearly in the data.

Morningstar's 2025 Mind the Gap report looked at the ten years ending December 2024 and found something striking: the average fund investor earned about 1.2 percentage points less per year than the funds they were invested in.

Put differently, bad timing (buying high, selling low) costs investors roughly 15% of the total return their funds actually delivered.

And this isn't a one-off. Every 10-year window ending in 2020 or later (as measured by Morningstar) shows the same pattern: investors lose between 1.1 and 1.7 percentage points per year to their own behavior.

Factor strategies make this even more painful to watch. Take AQR, the world's largest systematic-factor manager. Its assets peaked at $226 billion in 2018 and bottomed near $95 billion in 2022. More than half of its money walked out the door, with outflows worsening as the value factor's drawdown deepened. Then value bounced back. By September 2023, 15 of AQR's liquid alternative and nontraditional funds were in the top 20% of their peer group over three years.

But most of the investors who would have benefited had already left. It turns out that even patient, sophisticated capital couldn't sit through a decade of looking wrong.

Factor investing is a governance problem

The implication has reframed how I think about the conversation.

The interesting question for an allocator isn't "do I believe in value, or quality, or momentum?"

It's "Does my governance structure let me hold this position through a forty-percent relative drawdown without firing the manager or firing myself?"

The factor literature is full of "ten-year horizons" because that's the timescale on which the patterns work. But few institutions are set up on that timescale. Career incentives get measured in quarters. Sometimes in years. Rarely in decades.

Antti Ilmanen, in Investing Amid Low Expected Returns, puts it cleanly:

The fact that so many investors capitulate from almost any factor after a few years of underperformance justifies the word 'risk' in alternative risk premia strategies.
Wise men have said 'no pain, no premium' — it is precisely the painful times that will sustain the premium and prevent it from being arbitraged away.

Elsewhere in the book, he names the relevant career risk plainly:

Either I replace this losing investment, or I may be replaced.

That's the patience tax.

What I keep coming back to

Factor premia aren't compensation for market risk. They're compensation for career risk.

That changes the choice to be made.

Factor investing isn't a strategy you pick off a shelf alongside discretionary stock-picking and passive indexing. It requires a governance structure first.

Mandate length, performance review windows, comp structure, client communication, continuity of conviction across CIO turnover.

Without the foundation, the strategy cannot survive a bad decade. Or two.

I haven't run a portfolio (yet!). But the more I read, the more I suspect the durable edge in markets has less to do with finding the right model and more to do with structuring a seat from which you can hold the model when it's losing.

The patience tax is real. You either pay it, or you collect it.

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