Sm Cap Growth - Black Hole ?

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Sm Cap Growth - Black Hole ?

Postby Jerilynn » Wed Dec 05, 2012 10:04 pm

I've read posts where people have called the small cap growth asset class the black hole of investing. I don't see it. What am I missing?
Here is sm cap value vs. small cap growth over the last 10 years.

Image
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Re: Sm Cap Growth - Black Hole ?

Postby nisiprius » Wed Dec 05, 2012 11:03 pm

Congratulations on posting the chart, by the way.

What you're seeing is something I've seen over and over again: the value of checking things out for yourself. An awful lot of statements are made that are made confidently, and with plausible explanations of why they work that way, are either wrong, or inconsistent, or refer to things that are so subtle that they're lost in the noise and only show up under careful statistical analyses of very long-term data. Analyses which are then often disputed.

The other thing you're seeing is that anything can happen, anything at all, over periods of ten years. Ten years proves nothing either way. The famous Bill Miller's famous mutual fund beat the S&P fifteen years running, before losing back all the gains in just three years.

Ten years is almost ideally misleading because it seems long enough to count as "a track record," and heaven knows it seems like a long time if it's real dollars in your own portfolio, but the various factor effects people make much of are not reliable over periods of a decade or two.

One I chose to look at carefully because I had the data was the SBBI "small company" versus "large company" data. Supposedly small beats large. When I made my own decisions about how to analyze the data, what I found was that over the period 1925-2004, using portfolios adjusted to have the same standard deviation (= volatility = risk), the best large stock + small stock + intermediate bonds portfolio did beat a 60/40 large stock/intermediate bonds portfolio. It confirmed that small helps over a long period of time. But it only beat it by 0.33% annualized, and, this is the big point:

the portfolio with the small-caps, the "better" portfolio,
outperformed by 2.27% 1930-1949.
underperformed by 2.01% 1945-1964.
outperformed by 1.42% 1974-1993.
underperformed by 1.31% 1964-1983.

In short, the "better" portfolio won by 0.33% BUT there were periods AS LONG AS TWO DECADES during which the "wrong" portfolio won, and by amounts much larger than the overall advantage.
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Re: Sm Cap Growth - Black Hole ?

Postby Jerilynn » Wed Dec 05, 2012 11:46 pm

nisiprius wrote:The other thing you're seeing is that anything can happen, anything at all, over periods of ten years. Ten years proves nothing either way.


agreed. The only reason I used 10 yrs is because that's as far back as those funds went.

But certainly even with only 10 years of data you would think a 'black hole' of investing would show *something bad*, eh?
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Re: Sm Cap Growth - Black Hole ?

Postby larryswedroe » Thu Dec 06, 2012 12:27 am

Jerilyn
From 1969-2008, 40 years, large cap growth stocks underperformed 20 year treasuries--do you think that's long enough to convince you that they will in future?
10 years means very little --something most investors don't understand---

Now try this from 1969-2008 small cap growth stocks returned just 5.1% vs 9.0 for 20 year Treasuries and 11.6 for small value.

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Re: Sm Cap Growth - Black Hole ?

Postby zaboomafoozarg » Thu Dec 06, 2012 12:53 am

I was just reading The Intelligent Asset Allocator tonight and saw the graph in there with LV, LG, SV and SG. From 1920 to 2000 it showed that SG ended up far below the other 3, even thought it had looked comparable in recent years. Bernstein did say the data before 1960 was spotty though.
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Re: Sm Cap Growth - Black Hole ?

Postby Jerilynn » Thu Dec 06, 2012 1:43 am

larryswedroe wrote:From 1969-2008, 40 years, large cap growth stocks underperformed 20 year treasuries--do you think that's long enough to convince you that they will in future?


Nope.
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Re: Sm Cap Growth - Black Hole ?

Postby stlutz » Thu Dec 06, 2012 2:09 am

When people talk about the history since 1920 or 1950 or whatever of small-cap growth stocks, they are talking about a rather small group of stocks that Fama and French lumped into "smallcap growth". Those aren't really representative of what the VG index funds hold. A while back I compared the returns of Vanguard SV vs. SG since inception--over that time frame growth beat value by just a little bit. However, in the Fama/French series, small value beat small growth by 6% per year. That's a big difference. In other words, I don't know that anybody is really investing the way that "small growth" is typically definited in academic literature, so it's a pretty easy black hole to avoid.
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Re: Sm Cap Growth - Black Hole ?

Postby LH » Thu Dec 06, 2012 2:52 am

SCG could underperfom TSM or SCV in our financial lifetimes.

Diversification is not FF math. diversification is holding different entities with resulting different correlations.

The people who do barbells with SCV and TIPS, are taking a real risk of underperformance. If the risk shows up (if you believe the circular risk story, higher risk ego higher return ergo higher risk, or buy into that its impossible the behavoiral not sexsy ergo not bought as much mechanism wont change) then SCV may not perform well, and TIPS may not do much either if unexpected inflation never shows up in our lifetimes either.

Then the barbell, even though it looks swell on FF math, will fail. LTCM, portfolio insurance, 1959 stock bond yield inversion (nice risk story there too, or was till it wasn't for 50 plus years), tra la la la la, rinse repeat.

SCV bets are basically a religion, you have to go in with premise that damn the torpedoes, stick it out long term, even if FF themselves renege on the SCV expectation of outperformance.

Sounds ok to me, I took a bit of a SCV bet at 14 percent. Figure what the heck, its likely to move around versus TSM (essentially LC) index, and maybe the outperformance will show up, but if it doesnt, thats ok too.
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Re: Sm Cap Growth - Black Hole ?

Postby rkhusky » Thu Dec 06, 2012 9:22 am

What happens if we are entering a new era of finance where the old rules don't apply anymore and analysis of past data isn't relevant? An era where small weak companies just can't survive due to lack of financing and high taxes, or something else completely unexpected? Then bets on small value will not look too smart. On the other hand, the opposite could occur, the government could step in and support small weak companies to keep people employed, and tax high-flying growth companies to level the playing field. Or something else totally unexpected. No one knows for sure, all you can do is try to estimate the probabilities. As one of my professors said, "Anything can happen, with a given probability".
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Re: Sm Cap Growth - Black Hole ?

Postby larryswedroe » Thu Dec 06, 2012 10:28 am

Jerilyn
Since you said no that a 40 year period would not convince you why are you so influenced by a 10 year period?

Re data
If we restrict the data to the post 1962 period where no one questions the data 1963-2011
SG 8.4
SV 14.9

Don't like that try 1970-2011
SG 70
SV 13.8
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Re: Sm Cap Growth - Black Hole ?

Postby Aptenodytes » Thu Dec 06, 2012 10:32 am

I agree with the point already expressed that ten years is too short to base any decisions on. An additional point is that these on-line comparison graphs are extremely misleading, because they really only let you compare the effects of a one-time investment left to accumulate for a period. But nobody invests like that in the accumulation phase. The only meaningful comparison is of the comparative performance of portfolios that have regular new investments.

I can think of no compelling reason to tilt to small-cap growth, based on theory and long-term evidence. So I wouldn't even both hunting for time periods where a particular small-cap growth fund might have done better than small-cap value. There's no way any answer would affect any decision I might make, so why bother? That is, my expectation that small-cap growth does not deserve a tilt is based on an understanding within which I expect there to be periods when small-cap growth does well.

In the same way, I expect playing the roulette table to be a losing proposition, so I don't do it. But it isn't a surprise if I hear that somebody won money there. My understanding of roulette being a losing proposition contains the expectation that there will be roulette winners.
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Re: Sm Cap Growth - Black Hole ?

Postby Ketawa » Thu Dec 06, 2012 10:48 am

These issues have been discussed many times before on the forum. These Vanguard funds switched from S&P to MSCI indexes in May 2003.

For the Value fund, the S&P 600 Value Index underperformed the MSCI US Small Cap Value Index. After the switch, the MSCI US Small Cap Value Index underperformed the S&P 600 Value Index. The end result is that since inception of the fund, it has underperformed the total return of either index individually. I believe the discrepancy in performance was mainly caused by differences in how the indexes reconstitute.

I think the inverse was true for the Growth fund.

These issues were described in greater detail in this thread. http://www.bogleheads.org/forum/viewtopic.php?f=10&t=104246
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Re: Sm Cap Growth - Black Hole ?

Postby nisiprius » Thu Dec 06, 2012 11:27 am

Ketawa wrote:These issues have been discussed many times before on the forum. These Vanguard funds switched from S&P to MSCI indexes in May 2003... discrepancy in performance...
As they used to say, "you can't buy an index." You have to use some actual flesh-and-blood real-world mutual fund, and the results you get are not what some academician's spreadsheet shows, it's what the actual mutual fund really does. When the theory doesn't show up, whether it be a theory about gold or dividend stocks or small-cap value, there's always an alibi:

"O, you looked at the wrong dates."

"O, you looked at the wrong fund."

"O, Vanguard sux. Stinky Vanguard!"

"No, no, don't look at your own data, stop it, look over here, look at the mutual fund I've picked between the dates I've picked. See? See?"

Does this mean the academics are wrong? No. It just means they're using powerful techniques to find weak effects, and the stuff is tenuous. If an effect can't even survive a change of index provider, that's a weak effect. (And it also tells you that nobody agrees on the definition of terms like "small growth" or "small value" stock, opening up the possibility of further alibis, "the small value stocks you looked at shouldn't really count as small value.")

Can anyone know for sure whether Wellington Fund is better or worse than LifeStrategy Conservative Growth? I doubt it. Can anyone tell whether an exquisitely mixed gourmet recipe of DFA funds is better or worse than a meat-and-two-veg blue-plate special three-fund portfolio? I doubt it.
Last edited by nisiprius on Thu Dec 06, 2012 11:34 am, edited 3 times in total.
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Re: Sm Cap Growth - Black Hole ?

Postby BBL » Thu Dec 06, 2012 11:31 am

Can anyone know for sure whether Wellington Fund is better or worse than LifeStrategy Conservative Growth?


Ex-post: Yes

Ex-ante: No

:|
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Re: Sm Cap Growth - Black Hole ?

Postby Jerilynn » Thu Dec 06, 2012 12:47 pm

larryswedroe wrote:Jerilyn
Since you said no that a 40 year period would not convince you why are you so influenced by a 10 year period?



I'm not.
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Re: Sm Cap Growth - Black Hole ?

Postby Jerilynn » Thu Dec 06, 2012 12:48 pm

larryswedroe wrote:Jerilyn
Since you said no that a 40 year period would not convince you why are you so influenced by a 10 year period?

Re data
If we restrict the data to the post 1962 period where no one questions the data 1963-2011
SG 8.4
SV 14.9

Don't like that try 1970-2011
SG 70
SV 13.8
Best wishes
Larry


Larry, are you using the vanguard funds for these calculations?
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Re: Sm Cap Growth - Black Hole ?

Postby BlueEars » Thu Dec 06, 2012 1:31 pm

Jerilynn wrote:I've read posts where people have called the small cap growth asset class the black hole of investing. I don't see it. What am I missing?
...

As others have stated the time period matters. The other thing you are not missing is the hyperbole here, e.g. "black hole". :wink:

Here are the MSCI (what Vanguard had been using since 2003) CAGR's for two roughly 10 year periods:

Code: Select all
March 1993 to March 2003  (note: growth bubble popped in this period)
SG=6.9%  SV=10.2%

April 2003 to present
SG=12.1%  SV=10.9%
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Three things to remember.

Postby Taylor Larimore » Thu Dec 06, 2012 1:45 pm

Bogleheads:

When I look at threads like this (and we are fortunate to have hundred's of them), I want to shout three things:

1. Past performance does not predict future performance.
2. No one can predict the future.
3. Diversify

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: Sm Cap Growth - Black Hole ?

Postby DaveS » Thu Dec 06, 2012 1:49 pm

Larry I think there is a typo in your first post where you said "Large Cap."

As you have written, the most common reason for small cap lagging over long periods is they are a favorite place for speculators hoping to find the "next Microsoft." Those people are not long term investors who are going to patiently hold the stock if it does not grow in line with projections. They just bid up one stock and bail at any bad news. I also think it is easier to turn around a distressed small company - Value stocks - than it is to reinvent the wheel with the next best thing - growth stocks. Further a lot of the financials that got clobbered in 2008 were value stocks. It's easy for the OP to nay "nope", but doing so does not have much convincing force. Do you have a logical reason why growth should beat value when it has not done so over longer periods? Dave
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Re: Sm Cap Growth - Black Hole ?

Postby BBL » Thu Dec 06, 2012 2:04 pm

Jerilynn,

If you are trying to make an investment decision here regarding where to put an allocation to a VG small cap index and are not convinced about value v. growth you could choose the neutral path: small blend.

It is the ‘Switzerland’ option; you won’t ‘win’ but you won’t ‘lose’ in the sense that if/when small value outperforms you’ll get some of that and if/when small growth outperforms you’ll get some of that too.

Your only ‘loss’ from a tracking perspective is when small underperforms – but that was going to get you in either of the other [small value or small growth] funds anyway.

Now you can remain unconvinced by any of the arguments and fence-sit in the blend fund. :happy
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Re: Sm Cap Growth - Black Hole ?

Postby Clearly_Irrational » Thu Dec 06, 2012 2:16 pm

Beta explains about 70% of stock price returns, so when you start talking about the other risk factors you need to realize that they're a fairly small effect. Over a long period though small effects can have a very big difference in results, 0.5% fees vs. 0.05% for example. For me, the small cap growth results make sense, people like a story with an aggressive underdog who ends up a winner so they tend to overpay for those sorts of companies and that reduces results. These effects don't show up very reliably except on multi-decade timespans so if you're not comfortable with that idea, you should stay away. Just like with long term bonds, you get paid extra for moving out your time horizon, precisely because it's risky and may not work out.
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Re: Sm Cap Growth - Black Hole ?

Postby Aptenodytes » Thu Dec 06, 2012 2:20 pm

Keep in mind that tilts are relative. For me, the logic that small growth will outperform large growth is strong, so within the growth universe I tilt small. But at the same time I expect small value to outperform small growth, so within the small universe I tilt to value. Taken the two together, my small-growth holdings are about 1.9 times market weights. This contrasts to my small value holdings which are almost 3.5 times market weights. (for reference large growth is at about 0.6 market weight).

In order to strike the right mix I do make use of Vanguards small-cap growth fund, but its role in the portfolio is to tilt the growth holdings toward small.
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Re: Sm Cap Growth - Black Hole ?

Postby Epsilon Delta » Thu Dec 06, 2012 2:54 pm

Clearly_Irrational wrote:These effects don't show up very reliably except on multi-decade timespans so if you're not comfortable with that idea, you should stay away.

We only have one multi-decade timespan. Granted that the effect showed up over that timespan, it's stretching to say the effect is reliable.
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Re: Sm Cap Growth - Black Hole ?

Postby Clearly_Irrational » Thu Dec 06, 2012 3:17 pm

Epsilon Delta wrote:
Clearly_Irrational wrote:These effects don't show up very reliably except on multi-decade timespans so if you're not comfortable with that idea, you should stay away.

We only have one multi-decade timespan. Granted that the effect showed up over that timespan, it's stretching to say the effect is reliable.


It all depends on what data you allow to be used for the analysis. My best data set is from Simba's backtest spreadsheet and it's pretty clear there. If you don't like that span of data then it becomes kind of iffy.
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Re: Sm Cap Growth - Black Hole ?

Postby larryswedroe » Thu Dec 06, 2012 3:33 pm

Jerilyn
Using Fama French data of course--Vanguard did not have funds back then.

Dave5,
No mistake
Large growth 69-08 returned 7.8% and 20 year Treasuries 9.0, note S&P returned same 9.0 (so in terms of annualized returns no equity premium)

As to any logical reason why growth would beat value ----
a) the risks of value stocks show up as they tend to during financial crisis
b) markets become irrational (see 90s bubble)

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Re: Sm Cap Growth - Black Hole ?

Postby Jerilynn » Thu Dec 06, 2012 6:59 pm

BlackBeltLurker wrote:Jerilynn,

If you are trying to make an investment decision here regarding where to put an allocation to a VG small cap index and are not convinced about value v. growth you could choose the neutral path: small blend.



What I am trying to do is get Larry to answer a simple question.
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Re: Sm Cap Growth - Black Hole ?

Postby larryswedroe » Thu Dec 06, 2012 7:16 pm

Jerilyn
I would not own small growth period. Either own small blend or own small value (which has additional benefit of allowing you to hold less equity or earn an expected risk premium--your choice)
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Re: Sm Cap Growth - Black Hole ?

Postby azanon » Tue Dec 11, 2012 11:38 am

larryswedroe wrote:Jerilyn
Since you said no that a 40 year period would not convince you why are you so influenced by a 10 year period?

Re data
If we restrict the data to the post 1962 period where no one questions the data 1963-2011
SG 8.4
SV 14.9

Don't like that try 1970-2011
SG 70
SV 13.8
Best wishes
Larry


A contrarian looks at those numbers and thinks, wow what a great time to scoop up some SCG. All things being equal, when I look at past returns within a same asset class (US stocks, for instance), if anything, I'm more inclined to buy the more poor past performer than I am the winner for a set time period. 40 years sounds like a lot? Maybe, until you realize, for instance, that interest rates have steadily dropped for the past 30 years. I'm guessing, they won't drop for the next 30 and, if not, how will that change the investment picture.

Speaking of past performance, I bet the historical returns on precious metals and Gold look atrocious right up until they exploded some 10 years ago. Had someone made a similar post, just think how unwise following that line of reasoning would have been.

When I design a portfolio, I want the "stink bomb". I want my holdings to embarrass me if I were to mention them at a social gathering.
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Re: Sm Cap Growth - Black Hole ?

Postby larryswedroe » Tue Dec 11, 2012 11:44 am

azanon
that's generally true, but not where you have valuations that don't support it
Human behavior doesn't seem to change much and the literature is filled with anomalies that persist even well after discovery and the main one perhaps is investors overpay for assets with positive skewness--lottery like distributions

best wishes
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Re: Sm Cap Growth - Black Hole ?

Postby azanon » Tue Dec 11, 2012 12:14 pm

larryswedroe wrote:azanon
that's generally true, but not where you have valuations that don't support it
Human behavior doesn't seem to change much and the literature is filled with anomalies that persist even well after discovery and the main one perhaps is investors overpay for assets with positive skewness--lottery like distributions

best wishes
Larry


Don't get me wrong, I'm not convinced to actually tilt SCG, just saying that I haven't been convinced to tilt SCV either for reasons including, but not necessarily limited to, the ones I mentioned above. Re: Valuations do interest me, but I only approach them from the standpoint of an overall perspective (P/E 10 applied to S&P 500, or to various foreign markets), and I may make adjustments if a given market (overall) goes very low or high.
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