"Alternative Indexing Strategies" talked in the latest Money

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itworks
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"Alternative Indexing Strategies" talked in the latest Money

Post by itworks »

Any diehard mind commenting on the diagram in page 74 of this issue? See http://www.bogleheads.org/forum/viewtop ... st=1920177

The article is "the new face of stock picking".

The diagram says "a test of alternative index strategies found that they all had an edge". Basically, it says "Equal Weighting", "Value Tilting", "Low Volatility", "Fundamental Indexing", heck even "Monkey throwing darts", all beat "Traditional Index", annually by 1.5% to 2%, from year 1964 to 2012. That is an impressive beat!

The diagram is drawn from this paper: http://www.iinews.com/site/pdfs/JPM_Sum ... RALLC.pdf‎

I will try to upload the image of the diagram once I find it online.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by itworks »

Looks like Money has not make all articles of the latest issue (Jan/Feb 2014) available online yet. Below is captured from my camera (sorry for the low quality):

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Re: "Alternative Indexing Strategies" talked in the latest M

Post by runner9 »

I believe, this thread is on the same research.

http://www.bogleheads.org/forum/viewtop ... st=1561461

Clicking Rick's link goes to Research Affiliates. Typing Money's source article title into google leads to the same group as the #4 result. I easily could be mistaken.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by itworks »

thanks -- this seems to be the topic with lots of good discussions on the paper:

http://www.bogleheads.org/forum/viewtop ... 0&t=105171
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by JoMoney »

It's my understanding that over a period where small-caps outperform (i.e. Russell 2000 earns more than S&P500) it improves the odds of a "stock picker" compared to the index. By the very nature of how cap-weighted indexing works, there are only a handful of stocks with potential to be the largest holdings. There's a larger variety of stocks to be held as you move down the ranks, this creates a lot of potential for tracking differences between an index and some other allocation.
In the charts John Bogle has on his Blog and many books, you can see how over different time periods how many active funds outperform/unperformed varies considerably with various time periods. Like every other chart, these are period dependent events, over periods where large-caps perform well it's extremely hard to beat the index (unless you concentrate into even fewer of the largest-cap stocks). It's often not so much that they beat the index, but that the index they measured against isn't really a comparable sample based on size. Over long periods of time, I believe this waxing and waning balances out, and the cost savings of a low-fee low-turnover index wins (i.e. "Cost Matters Hypotheses").
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by nisiprius »

It's not hard to beat the market if you are allowed to take on more risk than the market. Did they show comparisons of risk-adjusted reward?

Indexing is increasingly popular. When it comes to cap-weighted indices, Vanguard is dominant. It's pretty hard for anyone else to compete on cap-weighted index funds for major broad indexes because of Vanguard's economies of scale. I think this is why we are seeing such a rise in the "cap-weighting sucks" meme. There's not a lot of money to be made selling cap-weighted total stock market funds with 0.05% expense ratios, especially if your actual costs are greater than that, so companies are claiming they have new improved indexes so that they can sell funds with expense ratios of 0.30% (EPS, WisdomTree Earnings 500) or 0.32% (FNDB, Schwab U.S. Fundamental Broad Market) or 0.40% (RSP S&P 500 Equal Weight) or 0.45% (FLCEX, Fidelity Large Cap Core Enhanced Index).

In the case of the RSP Equal-Weighted S&P 500, the 10-year Sharpe ratio, according to Morningstar, is only a hair higher than for the (normal, cap-weighted) S&P 500. Almost all of the increased return was just commensurate with higher volatility over that same time period.

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Re: "Alternative Indexing Strategies" talked in the latest M

Post by nedsaid »

Darn!! All the time I wasted learning about investing. By golly, what I needed was the NY Times stock page and some darts and I would be retired by now.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by Rodc »

nedsaid wrote:Darn!! All the time I wasted learning about investing. By golly, what I needed was the NY Times stock page and some darts and I would be retired by now.
But you can only eat bananas.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by nedsaid »

You are right!!

If I outsourced the dart throwing to the monkeys, they would probably charge me 2%!! Maybe that is what really goes on in investment firms.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by JoMoney »

It's been posted previously, but this somewhat satirical Vanguard blog does a great job discussing "alternative" indexes:
http://vanguardadvisorsblog.com/2013/12 ... abet-etfs/

You can slice and dice the market in an almost infinite number ways, there are more mutual funds out there than there are stocks, and they will all tell you that their style/strategy is best. Some strategies lend themselves to better "stories" that are easier to sell to the public. Joshua Brown ("The Reformed Broker") has a chapter in his book "Backstage Wall Street" called 'Storytime' that goes over his view of the various stories and methods Wall Street builds to sell products... stocks, mutual funds, strategies, etc... I have to say that I disagree with his view on "buy-and-hold" (he uses flawed data to suggest things such as a basket of stocks bought in 1966 would be worth the same in 1982 - which is true in a price only context, but with dividends reinvested the S&P500 nearly tripled an investors who practiced buy-and-hold). Despite some of the problems I find in his arguments, the information on how "stories" are created to sell, and his inside view as a mutual fund sales person is enlightening.

For every "alternative" strategy that worked well over a period, I wonder how many failed, and how many other alternatives would have worked even better but were so bizarre they couldn't have a "story" built around them that could be packaged into a fund, strategy, book, or newsletter to sell.
The idea of indexing is destroying the old style of active mutual funds. But the market adapts to the customers, they just slap the name "index" on the same old mutual fund styles and strategies that have been going on forever and sell those as some newfangled alternative index. People always seem to want more, which may be great for achieving things in some parts of our life, but can be detrimental in our investments. Back when John Bogle created the first index fund, he was ridiculed and the idea was called "un-American". Fidelity Investments Chairman Edward Johnson was quoted as saying that he "[couldn't] believe that the great mass of investors are going to be satisfied with receiving just average returns" . I tend to think Edward Johnson was right, but it's to our detriment because we can't all be above average. The "average" return of the market has been quite good, and it's unfortunate that the data shows the vast majority of investors fail to achieve even "average" returns because of their attempts to try and outperform.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by Random Musings »

One can small or small-value load more cheaply than buying equally weighted products.

Now that Money is talking about it, expect equally weighted to underperform for a while.

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Re: "Alternative Indexing Strategies" talked in the latest M

Post by Akiva »

itworks wrote:Any diehard mind commenting on the diagram in page 74 of this issue? See http://www.bogleheads.org/forum/viewtop ... st=1920177

The article is "the new face of stock picking".

The diagram says "a test of alternative index strategies found that they all had an edge". Basically, it says "Equal Weighting", "Value Tilting", "Low Volatility", "Fundamental Indexing", heck even "Monkey throwing darts", all beat "Traditional Index", annually by 1.5% to 2%, from year 1964 to 2012. That is an impressive beat!

The diagram is drawn from this paper: http://www.iinews.com/site/pdfs/JPM_Sum ... RALLC.pdf‎

I will try to upload the image of the diagram once I find it online.
We've had several threads on this. Almost all of these "alternative" strategies are just different ways of getting you exposure to known risk factors. (Equal weighting gets you small-cap exposure. Fundamental indexing gets you value and gross profitability exposure. Etc.) The only one that does anything special is low-volatility b/c that's it's own effect. As for the others, the issue is simply whether or not they are more cost effective at capturing these risk premia than the other available options.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by steve r »

Thanks for the article.

With nearly 50 years of data some interesting observations ...

Optimization based on minimum variance has the highest Sharpe (and the only strategy with a higher return than standard deviation). This is good, because I am in this space.

A close second is inverse beta (which had one of the highest return).

Fundamental based strategies -- in general -- have the highest returns but correspondingly higher standard deviation.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by terrabiped »

JoMoney wrote:It's been posted previously, but this somewhat satirical Vanguard blog does a great job discussing "alternative" indexes:
http://vanguardadvisorsblog.com/2013/12 ... abet-etfs/
Great read. Thanks! I want one of these!
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by steve r »

I get the sarcasm of the vanguard blog ... but an article with 49 years of data published in an "A" rated academic journal tells us something .. doesn't it???

My favorite quote from the article "How can overweighting high-risk stocks on over weighting low risk stocks both lead to higher returns ...." The later has twice the value load and a smaller market load ... which is odd because the etfs do not characterize minimum volatility as value on M*.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by MapleHermit »

My guess:

Some of these strategies will continue to outperform traditional indexing until more and more people start to abuse them.

If you take on more risk, it makes sense that a possibly higher return can be achieved.

The thing is that not a lot of people like to take risk and they will "rationalize" that taking additional risk is stupid.

Therefore, the markets are not actually efficient and there's a boat load of "alpha" out there.

Note: Make sure to keep costs low though.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by JoMoney »

I think it's a little more complicated than what the "risk story" about picking some style class leads people to believe. There will always be some subset of the market that outperforms the market portfolio. It could be small-cap, large-cap, growth, value, dividends, tech stocks, utilities, REITS, or stocks beginning with the letter "Q", you can slice up the market a lot of different ways. You can pick period dependent time frames that show any of these subsets underperforming or outperforming the market. The great thing about the market portfolio is that you're guaranteed it will never be the poorest performing sub-set... and the periods of poor performance within some narrow groups can last a lifetime.
The further someone subdivides the market down to the idiosyncratic stocks, the more complicated the choices become, and the more chances you have to choose poorly (i.e. you choose between growth/value it's 50/50 , you choose between the 9 style boxes or 10 sectors the odds get worse).
I simply do not believe you can pick one sub-section and expect that it will grow faster than other areas of the market always and forever, it may continue for a long time, but not persistently. Trees don't grow to the sky. Things don't always grow proportionately, but they do eventually hit bounds that constrain everything within the system. At some point, the growth will return to a mean. If you're skillful and lucky enough, maybe you can hop from section to section as the growth speeds up, and avoid the things slowing down, but doing this consistently is another difficult feat. People develop all sorts of systems and valuation metrics to try and time when to get in and out, value plays, momentum plays, etc.. When a system seems to work, it "carries the seeds of it's own destruction" as more and more people try to duplicate it. As a group, all investors in aggregate will not achieve more than what the market earns in aggregate. For any portion that one earns more, another part will earn less. We can't all be above average. Most people fail to achieve the markets average performance by heat chasing various fads of the time.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by YDNAL »

nisiprius wrote:It's not hard to [potentially] beat the market if you are allowed to take on more risk than the market. Did they show comparisons of risk-adjusted reward?

Indexing is increasingly popular. When it comes to cap-weighted indices, Vanguard is dominant. It's pretty hard for anyone else to compete on cap-weighted index funds for major broad indexes because of Vanguard's economies of scale. I think this is why we are seeing such a rise in the "cap-weighting sucks" meme.
Fixed that a little bit for you.

Perhaps "cap-weighing sucks" because in a universe of 3,578 Companies - as measured by CRSP US Total Market - where 40% of $1 invested goes to 50 Companies, 40% goes to 450 Companies, and 20% goes to 3,078 Companies, means placing too much money on few Companies. I could be wrong, though. :)
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by berntson »

JoMoney wrote: I simply do not believe you can pick one sub-section and expect that it will grow faster than other areas of the market always and forever, it may continue for a long time, but not persistently. Trees don't grow to the sky. Things don't always grow proportionately, but they do eventually hit bounds that constrain everything within the system. At some point, the growth will return to a mean. If you're skillful and lucky enough, maybe you can hop from section to section as the growth speeds up, and avoid the things slowing down, but doing this consistently is another difficult feat.
It all depends on whether or not you believe the risks stories. If you find the implausible, then you have to think that small/value returns are just the inevitable result of a constantly churning market. Something will always be having a good run!

I'm convinced that equity will reliably beat bonds (over the long term) because holding equity clearly involves taking on extra risk when compared to bonds. I also think that junk bonds will (again, over the long term) reliably beat t-bills. It's not because I think that junk bonds have some sort of magic pixie dust. It's because I think they involve taking on significantly more risk, so investors better be compensated for holding them. Otherwise, everyone would just own t-bills.

The problem is that while it's obvious that stocks and junk bonds are more risky than t-bills, it's not so obvious that small stocks and/or value stocks are more risky than other segments of the market.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by dratkinson »

My opinion.

Indexes occur naturally in nature.

Alternative indexes do not occur naturally in nature, but are strategically constructed; therefore are not true indexes, but active management strategies based on value and size.

Example:
Vegetarians eat only vegetable.
Chickens and cows eat only vegetable.
I eat chickens and cows.
Therefore I am a vegetarian. Not!

In the same way, any active management style based on picking/choosing among pieces of true indexes is not indexing.

I would expect excess returns based on value/size to persist as long as the FF 3-factor model suggests.

Whether an actively managed alternative indexing strategy is a good idea for the shareholders comes down to how much the manager subtracts in costs.

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Re: "Alternative Indexing Strategies" talked in the latest M

Post by placeholder »

Your example makes no sense as the chicken and cow are vegetarians (ignoring that chickens aren't) and a vegetarian is not defined as something that eats other vegetarians.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by nedsaid »

What I would suggest as an Alternative Indexing Strategy would be to pair the Total Market Index Fund with an Extended Market Index Fund in order to overweight your mid-caps and small caps.

I pulled out John Bogle's Common Sense Investing book and referred to a table showing the composition of the S&P 500 and the Wilshire 5000 indexes. It showed that the top 100 stocks were just over 50% of the market capitalization of the Total Stock Market Index!! It would seem a good idea to dilute down the effect of those top 100 stocks by adding the Extended Market Index to the Total Market Index.

Most people don't realize how weighted the broad indexes are to the Mega-Cap stocks.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by YDNAL »

nedsaid wrote:I pulled out John Bogle's Common Sense Investing book and referred to a table showing the composition of the S&P 500 and the Wilshire 5000 indexes. It showed that the top 100 stocks were just over 50% of the market capitalization of the Total Stock Market Index!! It would seem a good idea to dilute down the effect of those top 100 stocks by adding the Extended Market Index to the Total Market Index.

Most people don't realize how weighted the broad indexes are to the Mega-Cap stocks.
I didn't use Bogle's book to refresh my mind, but today it may well be higher than that. So, 50 holdings represent 40% of TSM and the other 40% is represented by 450 holdings.

* Trust me, I dumped Vanguard VFINX's top 50 to Excel and the *current* market valuation is $74.7 Billion of $159.8 Billion total assets. The math is quite simple and straightforward.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by rkhusky »

nedsaid wrote:What I would suggest as an Alternative Indexing Strategy would be to pair the Total Market Index Fund with an Extended Market Index Fund in order to overweight your mid-caps and small caps.
Small caps will likely have higher volatility than large caps. You may get higher returns overweighting small, but you will likely also see higher volatility in your portfolio. If you have a long investing horizon and can time when to withdraw funds, you may come out ahead. If you are required to withdraw funds in a time period where small caps have done much worse than large caps, you may come out behind a cap-weighted portfolio.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by garlandwhizzer »

Actually I use cap weighted indexes with the majority of my portfolio and add some broadly based fundamental indexes at all cap levels. This winds up giving me increased exposure to small, value and other factors over a strict cap weighting and theoretically higher expected long term returns versus 100% cap weighted portfolio. The key words, however, are theoretically and expected, which do not in my opinion amount to certainty. No one knows for sure which will be optimal over a particular investors time horizon. I do not argue at all with those who use a simple and efficient 3 fund portfolio, but I love to tinker and choose to take positions in both cap weighted and fundamental indexing at all cap levels and keep my total costs low. I think that either cap weighted indexing or fundamental indexing with low costs or a mixture of the two will produce satisfactory results over time if investors stick to their plan.

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Re: "Alternative Indexing Strategies" talked in the latest M

Post by dratkinson »

placeholder wrote:Your example makes no sense as the chicken and cow are vegetarians (*ignoring that chickens aren't) and a vegetarian is not defined as something that eats other vegetarians.
Was constructed to be flawed, hence the "Not!" Was trying to humorously illustrate my point that an indirect link to something (vegetarianism/indexing), does not equate to that thing.

*I concede your point (insects, worms and all that), but a recent Perdue commercial claims their chickens are vegetarians, so was playing off that.

Guess I should keep my day job.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by Ged »

rkhusky wrote:
nedsaid wrote:What I would suggest as an Alternative Indexing Strategy would be to pair the Total Market Index Fund with an Extended Market Index Fund in order to overweight your mid-caps and small caps.
Small caps will likely have higher volatility than large caps. You may get higher returns overweighting small, but you will likely also see higher volatility in your portfolio. If you have a long investing horizon and can time when to withdraw funds, you may come out ahead. If you are required to withdraw funds in a time period where small caps have done much worse than large caps, you may come out behind a cap-weighted portfolio.
With a total market fund you don't have any control over what you are withdrawing. You get it all.

These 'new' indexes have been around for a while. Generally they fail because both risks and costs are higher. A cap weighted fund doesn't have to trade every time a stock price changes, other weightings have higher trading costs and worse tax efficiency.
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Re: "Alternative Indexing Strategies" talked in the latest M

Post by nedsaid »

Thanks everyone for your comments.

A Total Market Index strategy is just fine. But I suggested adding an extended market index to dilute the effect of the top 100 stocks or so that are 50% of the total market capitalization. YDNAL says it might even be more than that!! So in a sense, someone in a Total Market Index might be less diversified than they think. You are betting half the farm so to speak on 100 stocks or so.

It was also interesting that the three top tech stocks Apple, Google, and Microsoft are 5.26% of the total market. If you add IBM, four tech stocks are over 6% of the total market. Those of you that are risk averse, you got two pretty volatile stocks right at the top of the list. Conservative folks amongst us would never buy Apple or Google as an individual stock but don't realize how much of these they have in an index portfolio.

I own the US Total Market Index fund run by Vanguard's main competitor. It is my largest holding. But when you look at my total portfolio, I have 38% in mid-cap/small cap vs. about 30% for the Total Market. 17% in small-caps vs. 9% Total Market. So I am not going hog wild over this.

And yes, I realize that tilting towards mid-caps and small-caps will increase volatility a bit.

I just wanted to give folks some food for thought and to get them to think through the Boglehead conventional wisdom.
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