Should I tilt small-value? EM? How?

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Should I tilt small-value? EM? How?

Postby boggler » Thu May 09, 2013 12:48 am

The equity side of my portfolio is currently 100% VT. I love the simplicity of this... no rebalancing, unbelievably tax-efficient, hands-off, etc.

Yet I still have some cash on hand to invest, and I keep hearing about the small-value tilt and am trying to decide whether it makes sense for me. Here are my thoughts:
+ S/V seems to have improved returns while reducing portfolio volatility over time.
+ I never liked the fact that the stock market is so skewed towards major large companies, as I think smaller/value companies might do better over time.
- S/V premium is based on historical data. "Past performance does not predict future returns."
- People often attribute the S/V premium to factors like a preference for growth stocks, which might no longer hold in the 21st century with more efficient, HFT markets.
- Portfolio will require manual rebalancing to stay in shape
- Many financial advisors believe that S/V is currently overvalued, and growth stocks will outperform in the near future.
- There's no easy way to invest in international small value without DFA access, and I'd like to have a symmetric portfolio between domestic and international.

Similarly, many people recommend tilting towards emerging markets. Many of the above points hold for that as well.

It's hard to know what to do. Any tips? Are there any other asset classes that have similar expected returns to stocks but low correlation with the overall market?
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Re: Should I tilt small-value? EM? How?

Postby rickmerrill » Thu May 09, 2013 1:24 am

See Bogle's "TellTale Chart" speech https://personal.vanguard.com/bogle_site/sp20020626.html. Perhaps if you have enough assets and enough time...
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Re: Should I tilt small-value? EM? How?

Postby Cash » Thu May 09, 2013 6:54 am

Boggler,I thought you wanted the 100% VT portfolio (or VT + BND) for simplicity. It's perfectly fine for that. Tilting adds complexity. Do you want that? Will you be able to stick with it? I would suggest more reading and reflection before you invest anything else because right now you're looking like a weather vane, twisting whenever someone suggests something else.

FWIW, I use a combination of VT, VBR, and VSS. Is that right for you? Only you can decide.
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Re: Should I tilt small-value? EM? How?

Postby RobInCT » Thu May 09, 2013 7:22 am

Based on your previous posts, I would recommend doing nothing for at least 6 months. You are young, and many people tinker a bit before coming to their final allocations, but generally speaking, unless one's current allocation is objectively terrible/disastrous/incorrect, I think it's a good idea to sit with it for a while before tweaking. Builds good habits and combats the urge to constantly be reworking everything, which can lead to fad-chasing/market-timing.

You seemed pretty happy with 100% VT the other day. What has changed that would warrant a change? If you become convinced over time that you can capture a premium from these two funds, then by all means, tilt. But realize the premium is likely small and only appears over time, so waiting 6 months to do it likely won't make much difference. Similarly, if you do end up tilting, be prepared to have to hold it a long time to see the benefit. That is another reason to go slow. If you can't leave your current allocation alone for 6 months, what makes you think you'll stick to the tilt long enough to harvest the premium?

Disclosure: I have about 15% of my total portfolio in small-cap value. This was a recent change (3 months ago or so) after probably a decade of holding exclusively a Target Retirement fund. My reason for the change was that after many years of investing, my portfolio was big enough to be able to save some money on fees by mixing it myself using only admiral shares, and I like the small value premium and intend to stick with this allocation for many years to come.
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Re: Should I tilt small-value? EM? How?

Postby Rick Ferri » Thu May 09, 2013 8:19 am

There are advantages and disadvantages.

Advantages:

Potential for higher nominal and risk-adjusted returns

Disadvantages

More complexity
Higher cost
Greater discipline to stay the course

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Re: Should I tilt small-value? EM? How?

Postby Default User BR » Fri May 10, 2013 11:03 am

RobInCT wrote:You seemed pretty happy with 100% VT the other day.

Except for the thread asking about the Permanent Portfolio. The OP needs to stop the planning and go back to research. Read the books. Read the wiki. Stop jumping around.


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Re: Should I tilt small-value? EM? How?

Postby grayfox » Fri May 10, 2013 11:34 am

boggler wrote:The equity side of my portfolio is currently 100% VT. I love the simplicity of this... no rebalancing, unbelievably tax-efficient, hands-off, etc.

Yet I still have some cash on hand to invest, and I keep hearing about the small-value tilt and am trying to decide whether it makes sense for me. Here are my thoughts:
+ S/V seems to have improved returns while reducing portfolio volatility over time.
+ I never liked the fact that the stock market is so skewed towards major large companies, as I think smaller/value companies might do better over time.
- S/V premium is based on historical data. "Past performance does not predict future returns."
- People often attribute the S/V premium to factors like a preference for growth stocks, which might no longer hold in the 21st century with more efficient, HFT markets.
- Portfolio will require manual rebalancing to stay in shape
- Many financial advisors believe that S/V is currently overvalued, and growth stocks will outperform in the near future.
- There's no easy way to invest in international small value without DFA access, and I'd like to have a symmetric portfolio between domestic and international.

Similarly, many people recommend tilting towards emerging markets. Many of the above points hold for that as well.

It's hard to know what to do. Any tips? Are there any other asset classes that have similar expected returns to stocks but low correlation with the overall market?


The small-cap premium is not reliable. It comes and goes, so there are favorable times to invest in small-cap and unfavorable times to invest.

According to latest GMO forecast, small-cap stocks have low expected return at this time.

GMO March 31, 2013 year Forecast

On the other hand, Emerging Markets shows the best prospects at this time.
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Re: Should I tilt small-value? EM? How?

Postby grayfox » Fri May 10, 2013 11:56 am

As to how to do it? When you have money to invest, just stick it in whatever Vanguard index fund has the highest expected return at the time. 99% of the time it will be one of the stock index fund.

For example, if you already have $100K in VT and at the end of this month you have $5K cash to invest, and you decided Emerging Markets has the best prospects, then put all $5K in Vanguard VEIEX or ETF VWO. Then forget about it for 40 years and see how much it grows to.

Never sell anything. For instance, don't sell any of the VT you already have to buy to VWO. Only put the new $5K in VWO

You can think of every investment you make as a separate investment. Some will grow more than others. A lot depends on the prices when you make the investment.
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Re: Should I tilt small-value? EM? How?

Postby grayfox » Fri May 10, 2013 12:19 pm

On second thought, I would just stick with VT.

If, every time you have money to invest, you have to do research which asset class has the highest expected return it's too much work.

And the error bands on the expected returns are so large that the ranges of return all overlap. In GMO's chart,

EM 5.9 +/- 10.5 = -4.6 --> 16.4
Small -2.5 +/- 7.0 = -9.5 --> 4.5

So small could still outperform EM according to that forecast.

Expected returns are just not very precise, so it is probably better to just buy some of everything, i.e. stick with VT.
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Re: Should I tilt small-value? EM? How?

Postby Valuethinker » Sat May 11, 2013 3:17 am

1. On Small Value it might be worth 10% of your portfolio. If you are say under 35, 20%. But it has tax implications which can wipe out all the benefits.

International Small Value would be great, but yes, really only DFA seems to offer a 'pure play'.

2. On Emerging Markets not more than in proportion to the total world market. I suspect in the long run EM will simply track global indices. If you are internationally diversified it's not likely a huge benefit. The main reason is there are some 'emerging' markets in some definitions (or were) like Taiwan and South Korea that were really quite cheap, and really developed markets.

There is much to be said for simplicity although I do think even Americans should have international diversification (on the equity side).
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Re: Should I tilt small-value? EM? How?

Postby lwfitzge » Sat May 11, 2013 8:13 am

You can go with 3 fund simplicity or slice and dice (both camps are on this forum) either to increase diversification or to capture other risk premia. More expected return, is only expected and may not show up in your time frame and there is no free lunch re: risk/return. I am a slice and dicer and a believer of Fama-French framework so I tilt on size and value factors - more small cap weighting overall and more on value side (including international stocks), market weighting for midcap but w value tilt, and reduced large cap holdings but w value tilt. I would read the FF material and read the lengthy and frequent debates and discussion on FF on the forum w the search function, and then you decide.

I also have a small emerging markets tilt on my international portion (overall intn 25% of equity). I also have a REIT tilt to 15% of my equities, roughly 10% of my portfolio. I have more REITs as I believe they are a different asset class that only correlates on average 0.5% with SP500 index. On the fixed income side, you can do the same... stay with Total Market Bond or Intermediate Treasuries, or you can add additional classes such as HY Bond for diversification (see Rick Ferri's threads for more info/debate) or TIPS (to manage inflation risks further). I don't worry about complexity, for me managing 3 fund vs 6 funds is really moot, 6-8 is still simple in real life terms. I use TMB + TIPS (30% of FI) and have blended in more ST Bond for interest rate risk.

It comes down to your plan and whether you believe in benefits of slice and dice, or the incremental value of increasing portfolio diversification further w other asset classes. The reality is you will probably do well with either path if you follow the Bogle principles of own the market w index funds, hold a mix of equities and bonds according to your tolerance for risk, keep costs low, stay the course (no market timing, trading), and pay attention to tax efficiency. In terms of making choices based on what advisors say about the future, I'd completely ignore.... no crystal balls... you make your plan, stay the course.
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