Increasing US Sm Cap to compensate for lack of Intl Sm

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Tamahome
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Increasing US Sm Cap to compensate for lack of Intl Sm

Post by Tamahome »

I realized that my desired allocation has a certain percent for US and International. It has a ratio for Small, Mid, and Large caps. Yet, my international options for small cap stocks are lacking in a ROTH (sinceVanguard wants to give me a load for that). I therefore plan on increasing the US small and mid caps to maintain the desired proportion. Is there a reason that this is a bad idea?
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grap0013
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by grap0013 »

Small cap international is a must. Either pay the load or buy VSS. Don't let the expense ratio tail wag the strategy dog. Afterall, you could buy a money market with a cheaper expense ratio, but that wouldn't make much sense.
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Gleevec
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by Gleevec »

Or international explorer has lower fees than international small cap and can be a proxy if the fee of intl small cap is bothersome
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G-Money
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by G-Money »

grap0013 wrote:Small cap international is a must. Either pay the load or buy VSS. Don't let the expense ratio tail wag the strategy dog.
I disagree.

Nisiprius showed in this thread that on a risk-adjusted basis, domestic small caps have outperformed large caps by about 0.30% per year. I would assume the historical risk-adjusted premium for international small caps would be roughly similar.

If you believe that's a reasonable expected premium going forward, then costs definitely matter. For example, VFSVX has an ER of 0.45% and purchase and sale fees of 0.25%. In comparison, Vanguard's small-cap and small-cap value funds have ERs of 0.10%. So if you believe 0.30% is the risk-adjusted small-cap premium, and you end up paying >0.35% in higher ER to access small caps, then the increased cost would more than swallow up the expected premium.

Granted, lower-cost options like VSS make it a closer call, but I would disagree that small-cap international is a "must" or that the OP shouldn't consider expenses when determining strategy.
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G-Money
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by G-Money »

Dulocracy wrote:I realized that my desired allocation has a certain percent for US and International. It has a ratio for Small, Mid, and Large caps. Yet, my international options for small cap stocks are lacking in a ROTH (sinceVanguard wants to give me a load for that). I therefore plan on increasing the US small and mid caps to maintain the desired proportion. Is there a reason that this is a bad idea?
I don't think it's a bad idea, and I've toyed with the idea myself. I have VFSVX, and I've paid the purchase fees to do so. So far, my VFSVX (even with the purchase fee) is ahead of VTIAX, so I'm not complaining. But the lack of Admiral shares and higher expense ratio bothers me, so I've contemplated doing what you propose.

The downside would be that, just like with the equity premium in general, it's possible the small-cap premium shows up in international equities at a time when it doesn't show up in the US. The two don't need to move in sync. If you can live with that, and the expenses bother you, then go for it.
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pingo
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by pingo »

G-Money wrote:Nisiprius showed in this thread that on a risk-adjusted basis, domestic small caps have outperformed large caps by about 0.30% per year.
Hmm. If memory serves me, he determined that his back-tested, small cap tilted portfolio obtained about a 0.30% benefit. For that to happen, the small cap premium had to have been much more than 0.30%.

I don't have time to re-read the thread, but I appreciate the link so that I can do so later on, just to be sure.
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G-Money
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by G-Money »

pingo wrote:
G-Money wrote:Nisiprius showed in this thread that on a risk-adjusted basis, domestic small caps have outperformed large caps by about 0.30% per year.
Hmm. If memory serves me, he determined that his back-tested, small cap tilted portfolio obtained about a 0.30% benefit. For that to happen, the small cap premium had to have been much more than 0.30%.
I think you're right.

My overarching point was that to invest in small-caps, one should expect a risk-adjusted premium. If the costs to invest in those small-caps exceeds, or even eats substantially into that expected premium, there's probably no point in doing so.

As for what the actual risk-adjusted expected premium is . . . :?:
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Call_Me_Op
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by Call_Me_Op »

G-Money wrote:
grap0013 wrote:Small cap international is a must. Either pay the load or buy VSS. Don't let the expense ratio tail wag the strategy dog.
I disagree.

Nisiprius showed in this thread that on a risk-adjusted basis, domestic small caps have outperformed large caps by about 0.30% per year. I would assume the historical risk-adjusted premium for international small caps would be roughly similar.
Not sure why risk-adjusted return is the important metric. Some may like to dial-down their allocation to stocks and up the risk of the stock portion. In that case, they may want a small allocation to very risky securities - in which case they might tilt to small caps - regardless of risk-adjusted return relative to large caps.

I disagree that a risk-adjusted premium is necessary to make riskier stocks useful.
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grap0013
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by grap0013 »

G-Money wrote:
grap0013 wrote:Small cap international is a must. Either pay the load or buy VSS. Don't let the expense ratio tail wag the strategy dog.
I disagree.

Nisiprius showed in this thread that on a risk-adjusted basis, domestic small caps have outperformed large caps by about 0.30% per year.
I disagree. Standard deviation does not tell the whole story. Small caps have historically delivered much more consistent 10 year returns for example than large caps. This important point is not reflected in the Sharpe Ratio. Long periods of poor performance are dangerous. The Sharpe Ratio also does not reflect correlations. I've been tilting since early 2010. Here are the US premiums for small and the global premiums for small since 2010:

US small premium
2010: 13.58
2011: -6.00
2012: 0.44
2013: 7.89

Global small premium
2010: 12.62
2011: -5.41
2012: -2.55
2013: -0.46

Looks like about 3% annualized for US and 1% international. I'll take it.
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G-Money
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by G-Money »

Call_Me_Op wrote:
G-Money wrote:
grap0013 wrote:Small cap international is a must. Either pay the load or buy VSS. Don't let the expense ratio tail wag the strategy dog.
I disagree.

Nisiprius showed in this thread that on a risk-adjusted basis, domestic small caps have outperformed large caps by about 0.30% per year. I would assume the historical risk-adjusted premium for international small caps would be roughly similar.
Not sure why risk-adjusted return is the important metric. Some may like to dial-down their allocation to stocks and up the risk of the stock portion. In that case, they may want a small allocation to very risky securities - in which case they might tilt to small caps - regardless of risk-adjusted return relative to large caps.

I disagree that a risk-adjusted premium is necessary to make riskier stocks useful.
If small-caps didn't offer superior risk-adjusted returns to large caps, then investors could more efficiently increase the expected returns of their portfolio by simply increasing equity exposure. My understanding was that it was because small stocks offered higher expected returns (with higher risk) that made Larry's approach of heavy-tilt/lower-equity allocations feasible. If there was no improvement in efficiency, what would be the point?
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G-Money
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by G-Money »

Grap0013,

Do you expect the premia to persist at those levels going forward? I don't.

And it's fine if you don't believe that standard deviation isn't the whole story. But either you believe the excess historical/expected return is compensation for higher risk, or you believe the market is benevolently providing you with a massive free lunch.
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grap0013
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Re: Increasing US Sm Cap to compensate for lack of Intl Sm

Post by grap0013 »

G-Money wrote: If small-caps didn't offer superior risk-adjusted returns to large caps, then investors could more efficiently increase the expected returns of their portfolio by simply increasing equity exposure. My understanding was that it was because small stocks offered higher expected returns (with higher risk) that made Larry's approach of heavy-tilt/lower-equity allocations feasible. If there was no improvement in efficiency, what would be the point?
I think investing is 10% science, 10% art, and 80% willpower. Trying to quantify the benefit of small caps is difficult.

Holding small caps is by no means a free lunch even if they have higher risk adjusted returns. Sometimes you have to hold them for lengthy amounts of time to see the premium AND you have to listen to seasoned posters named G-Money tell you some skeptical points of view. :) Lots of psychological variables in there that cannot be quantified.

I think a 2% premium for domestic and international small caps is very reasonable.

I need to dig up an old post I made about waiting for premiums from my personal experience. US was about 10 months, international SCV was 1 day, and EM was 1 week I believe.

I can shoot standard deviation in the foot pretty easily. I bought SFILX (iSCV) and it got ahead of VEA (iLCB)immediately. About 2.5% annualized over the past 4 years. Also, with a lower standard deviation. It's a free lunch other than listening to some people say that it is too Japan heavy.
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