Swedroe versus Ferri on Recommended Asset Classes

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Swedroe versus Ferri on Recommended Asset Classes

Postby DaleMaley » Sun Feb 24, 2008 1:00 pm

I recently finished reading Larry Swedroe’s new book The Only Guide to a Winning Bond Strategy. I also just read Rick Ferri’s new book The ETF Book. Both books were excellent.

Swedroe’s book had a couple of surprises for me when I read it. The first surprise is that he does not recommend Vanguard’s Total Bond Fund (VBMFX) because it holds 33% mortgage backed securities (MBS). My understanding is that VBMFX mirrors the Lehman Brothers Bond Index, so Larry must be saying the Lehman Brothers Bond Index itself is flawed……because I assume the index has 33% MBS also. Maybe this a wrong assumption on my part.

I already knew that Larry is a fan of the commodities asset class, and Rick is not. From Larry’s book, I found out he is also not a fan of high yield (junk) bonds and emerging market bonds.

I thought it might be interesting to contrast and compare the differences between Larry’s and Rick’s recommended asset classes for asset allocation. Based upon reading their books and their postings to the Bogleheads, I constructed the chart below. My approach was to list the asset classes and Vanguard funds that Larry and Rick agree and disagree with. I used Vanguard funds because most people do not have access to DFA funds. I also used traditional mutual funds because I do not have all the ETF’s memorized yet. From what I can determine, Larry and Rick disagree on 4 asset classes or funds which are highlighted in yellow below:

Image

Of course the percentage allocations to each asset class vary depending on risk tolerance and whether you want simplicity or a complex slice-n-dice approach.

I really enjoy Larry’s saying in his book……and on the Boglehead’s web site…..
Do Not Take More Risk Than You Have the Ability, Willingness, or Need to Take.

I have found this saying to be very useful when trying to determine the stock to bond ratio of my own portfolio.
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett
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Postby larryswedroe » Sun Feb 24, 2008 1:08 pm

Dale
Glad you enjoyed the book

It is not that the Lehman Index is flawed, it is just that includes MBS which I don't think are the most prudent investments because of the nature of their risks (prepayment and extension). It is the way those risks interact with the risks of equities and nominal bonds that I don't like. Also I cannot find evidence that call risk has been rewarded.

As to high yield--the academic (and historical) evidence is that you have not been appropriately rewarded and for investors that have a choice of location it makes no sense to own high yield because you are owning one of the two risks (high yield is a hybrid with equity and bond risks) in the wrong location. Better to simply own investment grade bonds and then add either more equity or add size and value tilt. Also there is almost no unique risk here, so little diversification benefit.

As to EM bonds they at least have the benefit of unique diversification. But they are still hybrid securities with equity like risks. That is what the literature finds. The lower the country credit rating the more equity like the debt, and vice versa. And here too you have a location problem

I hope the above is helpful
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Postby DaleMaley » Sun Feb 24, 2008 1:14 pm

Larry:

Thanks for your reply!

What Vanguard short or intermediate term fund would you recommend for the bond portion of asset allocations?

Thanks again :)
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Postby SpringMan » Sun Feb 24, 2008 2:31 pm

How do the authors and others feel about using VEXMX (extended market index) instead of NAESX and VIMSX? Are there any advantages or disadvantages? Thanks.

Best,
Best Wishes, SpringMan
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Postby foodnerd » Sun Feb 24, 2008 2:43 pm

Springman, I don't know how the others feel, but since I only have a good S&P 500 index fund in my 401K (BTIIX) with the rest being very high ER active funds for small and mid, I am looking to purchase VEXMX to mimic the TSM by using both funds. Once I get that established, then I'll be able use other funds to tilt small and/or value.

Just my thoughts and I would love to hear what others think of this strategy.

FN
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Postby stan1 » Sun Feb 24, 2008 3:11 pm

SpringMan wrote:How do the authors and others feel about using VEXMX (extended market index) instead of NAESX and VIMSX? Are there any advantages or disadvantages?


The general thought on the small cap premium, if you believe it exists, is "the smaller the better". Extended Market is not very small compared to other choices like Small Cap Index, Tax Managed Small, small cap ETFs that track the Russell 2000 or S&P 600, or microcap choices like Bridgeway or IWC.

VEXMX is best when combined with an existing Index 500 fund to replicate Total Stock Market (about 75-80% Index 500 and 20-25% VEXMX).

The above small cap funds/ETFs are better choices than VEXMX for taxable accounts because the S&P 500 constituents are managed by a committee (it is NOT simply the Top 500 companies by market capitalization). There is no overlap between the S&P 500 and the S&P Completion index, so any movement in or out of the S&P500 forces purchase or sale of the top holdings in VEXMX. Because of this you could even stretch to make the claim that the top holdings in VEXMX are actively managed, since these are the companies the S&P committee has consciously chosen to leave out of the S&P 500. This all leads VEXMX to be theoretically less tax efficient than other funds (and VEXMX has thrown off some large capital gains in the past). Other S&P indices are structured with buffer zones to permit overlap (for example, the S&P 600 can also hold companies in the S&P 400). This helps improve tax efficiency as the capitalizations and financials of companies change.
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Postby SpringMan » Sun Feb 24, 2008 3:29 pm

stan1 and foodnerd,
Thanks for your comments. I am using extended market in a Roth IRA. I have some FSMKX in a taxable account (due to tax loss harvest of TSM). which is Fido's S&P500. It looks like the extended index would be more of a replacement for VIMSX, VG midcap index, but not small enough market cap to be a good replacement for NAESX. Additionally I do have some VBR VG SCV ETF. I could replace extended market with midcap index, I just don't see any advantage or disadvantage. Am I right?

Regards,
Best Wishes, SpringMan
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Postby larryswedroe » Sun Feb 24, 2008 4:23 pm

Few thoughts

The smaller the better for these reasons
a) the higher the expected return (higher loading)
b) the lower the correlation with the rest of the portfolio
c) the lower the allocation you need to the asset class to get the same benefit (and small caps cost more typically than TSM and are less tax efficient)


For fixed income, TIPS and other short to intermediate bond funds are fine and if want to stretch a bit for yield I would buy very high quality corporate (at least you get the state tax benefit, but you start to take call risks which I prefer to avoid)
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Postby DaleMaley » Tue Feb 26, 2008 8:21 pm

Larry has posted some alternative portfolios to Vanguard high yield bond portfolios Here
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Postby DaleMaley » Fri Feb 29, 2008 7:09 am

Some more research results that Larry found that indicated risk-adjusted returns of junk bonds same as high grade bonds.......Here
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Postby larryswedroe » Fri Feb 29, 2008 8:27 am

The biggest issue on high yield is the fact that high yield contains equity risks. And most investors probably don't know that.

If you are going to own high yield then you need to be sure to adjust your equity allocation to reflect that greater risk. And the lower the credit rating the more the equity allocation. In theory however you should bet the same type returns--a theory of unified pricing of risk

The second issue however is that the evidence is that only the Fallen Angels have provided appropriate risk adjusted returns--there is an apparent anomaly--and they are only about 30% of the market if my memory serves. So unless you own only the FAs you have not gotten appropriate returns, even before fund expenses. And unless the anomaly disappears (and Fridson offers the explanation for the anomaly and why it might continue) you will continue to earn less than appropriate risk adjusted returns.

The third problem for many taxable investors is the hybrid nature of junk, meaning one of the two risks (equity or bond) is being held in the wrong location, meaning you are getting returns in inefficient manner. Any one with the ability to choose locations should not own junk bonds. I wonder how many investors who own junk understand that?
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Dale and Larry

Postby ken250 » Fri Feb 29, 2008 12:03 pm

Dale,

First I want to thank you for a great thread topic.

Larry,

Your thoughts on:

1) Foreign bonds
2) Foreign Real Estate
3) Domestic Private Equity
4) Foreign Private Equity

Thanks guys.
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Postby larryswedroe » Fri Feb 29, 2008 12:30 pm

Ken
Foreign bonds are interesting. Adding them in on hedged basis to me is good idea as it diversifies rate risks and provides opportunities to look for more "attractive" places on the yield curve as DFA does.

Now if you go unhedged you gain political and economic diversification benefits but increase the volatility of the asset class and probably as well for the portfolio.

DFA now has a partially hedged strategy which hedges the low interest rate currencies but not the high interest rate currencies. This is based on the historical evidence. This seems to be a reasonable strategy. The increased volatility is relatively small for the asset class and for a balanced portfolio it seems to make little difference.

Foreign RE--I really like the diversification benefits. They should be large due to very low correlation. The problem is no good location due to tax inefficiency and the issue of FTC. So you have to decide if the diversification benefit is worth the extra costs. I own some of the new fund. I weigh the diversification benefit more than the lost FTC costs. But that is personal decision IMO.

Private equity-my next book will cover this in great detail. Bottom line is private equity has failed to deliver appropriate risk adjusted returns. At best, returns similar to say public SV but you lose all the benefits of public security---liquidity, daily pricing, broad diversification,etc. And the returns are lottery like--big skewness, with most having very poor returns and few big winners. If you are going to invest in PE (which I do not recommend) there is some evidence of persistence so invest in firm with very long track record of success (problem is most individuals are not likely to get access to these firms).
HOpe that helps
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For Swedroe and Feri

Postby mpt follower » Fri Feb 29, 2008 12:42 pm

Under which conditions would you recommend TIPs in regular, after tax, accounts? I seemed to recall proposals by you two that show TIPs in IRA and regular accounts in the same proportions, and I do not believe that it was because the proposal run out of room in the IRA account. Erwin
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Postby ken250 » Fri Feb 29, 2008 1:15 pm

Larry, That helps a lot, thanks.

I've read Arnott recommends foreign bonds, unhedged. If the correlation is low enough wouldn't the high volatility be what one wants?

I've come across a number of cheap foreign RE ETFs, it's good to know that you like foreign RE as a class.

I've read Swensen's comments on PE and he pretty much says the same, ie on a risk-adjusted basis PE is a loser. I would expect foreign PE to be even more so. However, isn't PE a low correlation class and can be it be used as a substitute for microcaps?
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Larry, Which Bond FUnds

Postby Self Directed » Fri Feb 29, 2008 1:33 pm

larryswedroe wrote:

For fixed income, TIPS and other short to intermediate bond funds are fine and if want to stretch a bit for yield I would buy very high quality corporate (at least you get the state tax benefit, but you start to take call risks which I prefer to avoid)


Larry, would you recommend an investment at this time, for a tax sheltered account and a 12% AA, a short to intermediate bond fund primarily with treasury/agency, such as VBISX, or a fund with primarily corporate industrial bonds, such as VFSTX? Any other short term corporate bond funds you recommend?

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Postby drjdpowell » Fri Feb 29, 2008 2:05 pm

larryswedroe wrote:The third problem for many taxable investors is the hybrid nature of junk, meaning one of the two risks (equity or bond) is being held in the wrong location, meaning you are getting returns in inefficient manner. Any one with the ability to choose locations should not own junk bonds. I wonder how many investors who own junk understand that?

That doesn't make any sense, Larry. There is no meaning to the idea of a "wrong location" for risk. There is a wrong tax location for particular securities (bonds in tax deferred) but it doesn't matter were the "equity risk" is. There is nothing wrong with High-yield bonds in a tax-deferred account.

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Postby stratton » Fri Feb 29, 2008 2:52 pm

ken250 wrote:I've read Arnott recommends foreign bonds, unhedged. If the correlation is low enough wouldn't the high volatility be what one wants?

Take a look here: Global Unhedged bonds in Gibson's Asset Allocation portfolios. There is data to roll your own tests in the backtest spreadsheet and a comprison and thoughts about unhedged foreign and global bonds.

Paul
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Postby stratton » Fri Feb 29, 2008 2:55 pm

larryswedroe wrote:DFA now has a partially hedged strategy which hedges the low interest rate currencies but not the high interest rate currencies. This is based on the historical evidence. This seems to be a reasonable strategy. The increased volatility is relatively small for the asset class and for a balanced portfolio it seems to make little difference.

Larry, do you know of any funds other than DFA's fund that engage in similar partially hedged strategies?

Paul
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Postby Bob K. » Fri Feb 29, 2008 3:22 pm

larryswedroe wrote:Ken

Foreign RE--.... I own some of the new fund.



Larry,

Could you be more specific? :happy

Thanks Bob
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Postby larryswedroe » Fri Feb 29, 2008 4:28 pm

stratton
I think there are now some ETFs that are going that route

Bob
I own the new DFA int'l REIT fund for my kids accounts.
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Postby Rodc » Fri Feb 29, 2008 5:00 pm

I might suggest that it is also useful and also interesting to note the large degree to which they agree.

The areas of disagreement are CFF, which at most are recommended to be 5% of the portfolio. One can certainly have a discussion of the benefits or lack thereof, but IMHO, any argument over a few percent here or there is just not a big deal.

Exact details of bonds. Again, JMHO, but this is very similar. Different bonds have different attributes, but most of the time the differences are quite small and follow more or less a nice reward/risk profile. I would not want to load up on all 30 year bonds (in fact the arguments against long term bonds seem sound to me and I own none), nor would I want to go 100% mortgage backed securities (again I own none), but in the end any more or less reasonable and balanced approach is likely to be nearly as good as another (if the only cost effective bond fund in my 401K were total bond, I'd still sleep well at night).

I'm sure Larry and Rick will disagree with me on this issue. But it is like arguing about oh, say picking two top quarterbacks and arguing about which is best athlete. Fun perhaps, but in the end the answer is they are both darn good athletes and worth having on your team, and the general scheme of things the differences are small.

And the fact that they largely agree, while not as fun a topic, is likely more important.
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Postby larryswedroe » Fri Feb 29, 2008 5:20 pm

Rod
Let me just add this
If we KNEW that the correlations of commodities would continue to be the same as historically and we also knew the diverisification return (as referred to by Erb and Harvey) would be the same then commodities should be 30% of a portfolio if you had room.

I recommend something like up to 10% of equity allocation only because we cannot be sure. And we also don't know if the roll return will be positive or negative or zero.

But it seems foolish to me to ignore the benefits of CCF because we are uncertain. That would be like ignoring the ERP because it is uncertain.

Just my opinion.

I have no problem with people not wanting to use CCF, my problem is the reasons Rick offers and how he uses two sides of an issue differently depending on what he wants to argue.

As to hi yield that is different. I cannot find any reason to own that. And I doubt that investors who own junk have a clue that they really have an equity allocation and are likely holding assets in the wrong location.

BTW-we don't agree either on EM bonds, though I do agree that there you have at least some more unique risk--while only a tiny amount of unique risk in junk bonds. But still the data shows you are taking equity like risks (the lower the credit rating of the country the more equity like the risk) and you end up with the same location problem for individuals that institutional investors don't have. But at least here there are some offsetting benefits. I just personally don't see the net gain. Someone else might.

Hope that is helpful
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Postby serbeer » Sat Mar 01, 2008 1:25 am

larryswedroe wrote:If we KNEW that the correlations of commodities would continue to be the same as historically and we also knew the diversification return (as referred to by Erb and Harvey) would be the same then commodities should be 30% of a portfolio if you had room.


Larry,
my own backtesting seems to show that optimal commodity allocation in the past would be 15% as I stated in
http://diehards.org/forum/viewtopic.php?t=10313
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Postby stratton » Sat Mar 01, 2008 2:05 am

serbeer wrote:
larryswedroe wrote:If we KNEW that the correlations of commodities would continue to be the same as historically and we also knew the diversification return (as referred to by Erb and Harvey) would be the same then commodities should be 30% of a portfolio if you had room.


Larry,
my own backtesting seems to show that optimal commodity allocation in the past would be 15% as I stated in
http://diehards.org/forum/viewtopic.php?t=10313

I think even though Larry favors commodities he is cautious about them and considers them as insurance favoring 5 to 10% of equities for them as oposed to thinking of them as an asset class to be a large part of the asset allocation.

Paul
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Postby looking » Sat Mar 01, 2008 8:15 am

larry
where do I find out about DFA fund and how to buy them ???

tom
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Postby DaleMaley » Sat Mar 01, 2008 8:28 am

Ken250:

Dale,

First I want to thank you for a great thread topic.

Larry,


Ken:

I thought the contract between Larry's and Rick's recommended asset classes would make an interesting comparison. IMO, for the most part they agree on what acceptable asset classes to use in your portfolio.

Hopefully Rick Ferri will weigh in when he returns to reading/posting on this site :)
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Postby larryswedroe » Sat Mar 01, 2008 8:44 am

Tom
DFAUS.com
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Foreign Small Value

Postby clay » Sun Mar 30, 2008 7:14 pm

An obvious gap here in the Vanguard offerings.

Any thoughts or suggestions about non-Vanguard alternatives for foreign small value (other than DFA, which I don't have access to)?

Thanks,
C
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Postby schwarm » Sun Mar 30, 2008 8:35 pm

clay,

This is a commonly cited resource:

http://www.altruistfa.com/dfavanguard.htm

in most asset classes listed there is a link to alternative investments.
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Postby clay » Mon Mar 31, 2008 10:50 am

schwarm wrote:This is a commonly cited resource:

http://www.altruistfa.com/dfavanguard.htm

in most asset classes listed there is a link to alternative investments.


Right. But they have a gap for this class too (save for a DFA fund). I guess that may in itself be a lot of the answer to my question.

Thanks,
C
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Re: Foreign Small Value

Postby stan1 » Mon Mar 31, 2008 10:59 am

clay wrote:An obvious gap here in the Vanguard offerings.

Any thoughts or suggestions about non-Vanguard alternatives for foreign small value (other than DFA, which I don't have access to)?

Thanks,
C


Closest you'll get is DLS, if you can accept that dividend weighting at least partially captures any "international small value premium" to be had. If you tax loss harvest DLS you'll probably be back to GWX.
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Postby Rick Ferri » Tue Apr 01, 2008 9:31 am

Larry Wrote:

I have no problem with people not wanting to use CCF, my problem is the reasons Rick offers and how he uses two sides of an issue differently depending on what he wants to argue.


I have no issue with someone jumping on the commodities bandwagon and paying ten times the cost of the Vanguard US Total Stock Market ETF (VTI). Just understand that doing so means lowering the long-term portoflio return because it gives up a 6% in real stock market return for the 0% real return of commodities (before fees). Is this worth lowering portfolio risk a tiny bit? No. But I cannot stop people from buying what was just HOT, HOT, HOT (BTW, it is now stone cold).

As to hi yield that is different. I cannot find any reason to own that. And I doubt that investors who own junk have a clue that they really have an equity allocation and are likely holding assets in the wrong location.


Expected HY returns = over 7%, expected S&P 500 return = 8%.
Expected Risk HY = 9% std dev, expected S&P 500 risk = 18%.

Over the the next 10 years, I expect the Vanguard HY Corporate Bond fund (VWEHX) to deliver returns equaling 90% of the expected return of the stock market with half the risk of the the stock market. That seems like a good trade-off to me.

What part of this equation does Larry not understand?

PS. Larry's will say you can get the same return as HY using a combination of Treasury bonds and stocks. Unfortunately, he is leaving out the risk factor. Sure, with 80% equity and 20% Treasuries you can get the same return, but the risk of that portfolio is 80% higher than the risk of the VG HY bond fund.

BTW-we don't agree either on EM bonds, though I do agree that there you have at least some more unique risk--while only a tiny amount of unique risk in junk bonds. But still the data shows you are taking equity like risks (the lower the credit rating of the country the more equity like the risk) and you end up with the same location problem for individuals that institutional investors don't have. But at least here there are some offsetting benefits. I just personally don't see the net gain. Someone else might.


Actually, we do agree now. The spreads on emerging market debt have become so narrow that the risk/return no longer makes sense given the high cost we have to pay for EM bond funds.

Emerging market bond spreads are highly correlated with commodities prices. When commodities surge in price to unsustainable levels, EM bond spreads diminish to unsustainably low levels. We are there, or rather, WERE there.

Here is a lesson to be learned from EM debt and equity; you do not need to own commodities to be in commodities.

Rick Ferri
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Postby dumbmoney » Tue Apr 01, 2008 5:54 pm

Rick Ferri wrote:Expected HY returns = over 7%, expected S&P 500 return = 8%.
Expected Risk HY = 9% std dev, expected S&P 500 risk = 18%.

Over the the next 10 years, I expect the Vanguard HY Corporate Bond fund (VWEHX) to deliver returns equaling 90% of the expected return of the stock market with half the risk of the the stock market. That seems like a good trade-off to me.


Let's say inflation is 3% and your tax rate is 35% on income and 15% on dividends/cap-gains. After tax real return:

7*.65 - 3 = 1.55
8*.85 - 3 = 3.8

1.55/3.8 = 40.8%
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Postby SmallHi » Tue Apr 01, 2008 6:01 pm

Rick:

Actually, we do agree now. The spreads on emerging market debt have become so narrow that the risk/return no longer makes sense given the high cost we have to pay for EM bond funds.


Does this mean you have sold EM bonds in client accounts, or do new clients just not get an allocation?

sh
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Dale excellent post

Postby hollowcave2 » Tue Apr 01, 2008 6:47 pm

Dale,

Excellent post.

I wonder if it would be instructive to post the past performance over different time periods of the two portfolios you constructed. Perhaps that would give an indication of which portfolio would do better in different climates.

The difference in Larry and Rick's ideas seems to be one of philosophy. But does either one actually give a better return based on past data?

I know the problems of data mining and choosing the time period. But I think a post like that would be helpful. I can try to assemble to data based on your portfolios, but I wonder if anyone else is more statistics literate than me.

Steve
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Postby jhd » Tue Apr 01, 2008 9:25 pm

Rick Ferri wrote:Expected HY returns = over 7%, expected S&P 500 return = 8%.
Expected Risk HY = 9% std dev, expected S&P 500 risk = 18%.


Where does this come from? This looks a bit off to me - first, the tiny equity premium, and second, predicting future returns to a fraction of a percent (i.e. "over 7%").
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Postby larryswedroe » Wed Apr 02, 2008 8:08 am

FEw quick points

A) Rick statements on adding CCF are incorrect--as I have show. And they are totally wrong because he fails to consider the total impact on the portfolio--he makes the error of looking at things in isolation. Adding CCF has produced similar returns with less risk even during periods when CCF have underperformed equities by about the return difference Rick expects--as I have shown. Now if CCF produce returns more similar to the longer term data (from 1970 instead of 1991) then you got higher returns with less risk. Now no one knows the future for certain but that is the data. The only right way to look at things is in the whole.

Also as I have pointed out Rick is overstating the costs of the PIMCO fund because the costs have come way down. Now total costs are about 80bp, not 110. And he also ignores the fact that TIPS should produce higher returns than the three month bills in the CCF index. TIPS, assuming one uses a 10 year (the average maturity) should probably outperform three month bills I would estimate by about 1%. That should be added to the return.

Now as to this statement:
;
PS. Larry's will say you can get the same return as HY using a combination of Treasury bonds and stocks. Unfortunately, he is leaving out the risk factor. Sure, with 80% equity and 20% Treasuries you can get the same return, but the risk of that portfolio is 80% higher than the risk of the VG HY bond fund.

The facts as I have presented are exactly the opposite of what Rick states, with no supporting evidence -just a statement. I have presented historical data showing that one could have gotten superior returns with less risk and that ignores the benefits of getting the location issue correct, a significant issue which conveniently Rick continues to ignore because it cannot be address. He agrees that hi yield is hybrid and he agrees that the correct location for equities is in taxable yet he violates this principle by owning high yield--except in case where investor has no choice of location.
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Postby Rick Ferri » Fri Apr 04, 2008 10:18 pm

Rick statements on adding CCF are incorrect--as I have show.


Larry, my statements are 100% correct, as I have shown. Individual collaterized commodity futures (CCF) have an expected real return of 0%. That is a fact even you agree with (see Erb and Harvey, Vanguard, Fama, French). The only hope for positive real returns from colaterized commodity future funds (CCF funds) is the active trading strategies they employ to potentially produce an Alpha (Harvey calls it Alpha, not me).

I have presented historical data showing that one could have gotten superior returns with less risk and that ignores the benefits of getting the location issue correct,


That is all hypothetical, best case, back-tested data designed to sell products - and you bite into it like a ripe apple. Those returns did not actually happen. NO ONE earned those returns. The truth is, no amount of diversification benefit is going to make up for the long-term loss in return from giving up stocks to buy CCF funds. If CCFs cannot stand by themselves and make a real return, then they do not belong in a portfolio. More and more people are beginning to see through the hype in CCF funds, and I do not know why you are holding on to hope when logic says stay away from this fad.

Rick Ferri
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Postby DaleMaley » Sat Apr 05, 2008 9:08 am

If you are interested in the asset allocations that Rick and Larry use for their personal portfolios........they are shown below.......with data coming from their previous posting Here

Rick:
There are 1,000 ways to invest a passive portfolio. My allocation is no better or worse than the next person who as put the time in. Consistency of management is the key.

Overall 75% Equity, 25% fixed

Fixed:
15% VG High Yield Corporate
10% VG TIPS

Equity
27% VG US Total Market ETF
1% BRKB
15% DFA US Small Value
5% Bridgeway US Microcap

7% VG REIT ETF

5% VG Pacific ETF
5% VG Europe ETF
5% DFA Int'l Small Value
5% DFA Emerging Markets Core



Larry:

First my portfolio is heavily fixed income--about 75%, mostly munis due to limited relative space in tax advantaged accounts.

Of the fixed income the munis are basically laddered with about average maturity in the 4-5 year range. The rest is in TIPS mostly 8-10 year now but just bought first 20 year when it went to 275.

The equities are about 50% US TM SV, 35% ISV and 15% EMV, all DFA funds.

Small amount of CCF via Pimco fund
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett
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Larry's highly unusual portfolio

Postby ilan1h » Sun Apr 06, 2008 12:26 pm

I find it unusual that not more discussion is directed towards Larry's highly unusual portfolio. Larry's comments and books are highly valued and quoted, yet his personal portfolio is one that very few of us have tried to emulate.

75% munis
25% equity (50% dfa TM small value, 35% dfa intl sv, 15% dfa EM SV)

Larry's explanation is that backtesting shows that this yielded similar return to 100% SP500 with less volatility.

Is anyone else doing this? Any thoughts on this approach? Obviously he has chosed munis for his core holding since his tax advantaged space is very limited. However, for the equity side of his investments he has gone for extremely "risky" and volatile asset classes. This is like the conservative gambler who goes to Vegas with the intention of only gambling with a small sum, but gambling hard with that small sum.

I think that this inherently makes sense. Each part of the portfolio is doing purely what it is supposed to: the bond portion is keeping things safe, the equity portion is going for every last bit of return possible. He is as far northwest as one can get on the risk/return graph.
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Re: Larry's highly unusual portfolio

Postby dumbmoney » Sun Apr 06, 2008 1:15 pm

ilan1h wrote:I find it unusual that not more discussion is directed towards Larry's highly unusual portfolio. Larry's comments and books are highly valued and quoted, yet his personal portfolio is one that very few of us have tried to emulate.

75% munis
25% equity (50% dfa TM small value, 35% dfa intl sv, 15% dfa EM SV)

Larry's explanation is that backtesting shows that this yielded similar return to 100% SP500 with less volatility.

Is anyone else doing this? Any thoughts on this approach? Obviously he has chosed munis for his core holding since his tax advantaged space is very limited. However, for the equity side of his investments he has gone for extremely "risky" and volatile asset classes. This is like the conservative gambler who goes to Vegas with the intention of only gambling with a small sum, but gambling hard with that small sum.


What happens if the risky stuff goes down? Do you add to it (rebalance), or do nothing? If the latter, then this portfolio makes some sense. If the former, then I don't understand it.
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Re: Larry's highly unusual portfolio

Postby ilan1h » Sun Apr 06, 2008 5:36 pm

What happens if the risky stuff goes down? Do you add to it (rebalance), or do nothing? If the latter, then this portfolio makes some sense. If the former, then I don't understand it.
[/quote]

I would assume that he rebalances. Most of his assets are in taxable accounts so he can shift between them as needed.
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Postby DaleMaley » Sun Apr 06, 2008 6:57 pm

Rick Ferris' personal portfolio seemed like a typical Boglehead slice-n-dice portfolio to me. The only unusual twist is the U.S. high yield (aka Junk) bonds. A 75:25 AA would also seem to be ordinary to me.

Larry's personal portfolio struck me as very odd.......with a 25:75 AA. I'm thinking to myself.......why wouldn't he have at least 60% stocks in his AA??

A previous poster said Larry's portfolio has given about the same return as 100% in the S&P 500 but with lower risk. To check this out.....I entered both Rick's and Larry's personal portfolio's in Simba's back-testing spreadsheet. Of course I can not replicate their asset classes exactly since..... for example...Simba's spreadsheet has no DFA funds......so I did the best I could:

Image

To summarize these results:

Image

I was surprised that Larry's 25:75 AA historically has given about the same return as a portfolio 100% invested in the S&P 500.....but with about only 1/3 of the risk level (as measured by Sigma).

Larry's portfolio would probably have given slightly higher returns than Simba's spreadsheet.......because I would assume DFA International Small Value and EM small value had higher returns than the proxies available to choose from.

I guess Taylor is right again.........there are many different roads to Dublin!!
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett
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Postby BlueEars » Sun Apr 06, 2008 8:12 pm

Dale, looking at your comparison I have a few comments. The Ferri portfolio with 2% incremental CAGR over Swedroe had a lot higher SD but 2% better is nothing to sneeze at. I think this very much depends on how much you feel you need the extra return (and added risk) to meet your objectives.

The comparison to an SP500 100% portfolio seems like the wrong choice. You might try at least a straight 75/25 with TSM and TBM or something like that. Thanks for your analysis.
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A warning

Postby Taylor Larimore » Sun Apr 06, 2008 8:29 pm

Hi Dale:

Thank you for your interesting and extremely well presented asset-class and performance statistics:

I am sure you will not mind (and probably be pleased) if I add this important caveat:

"Past returns are no guarantee of future returns."

Best wishes.
Taylor

PS: Your book, "Index Mutual Funds," is a valuable addition to our library. Thank you.
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Postby DaleMaley » Mon Apr 07, 2008 5:39 am

Les:

The reason I compared to a portfolio 100% invested in the S&P 500 was because the previous poster.....ilan1h....... said Larry's portfolio had about the same return as the S&P 500.....

Larry's explanation is that backtesting shows that this yielded similar return to 100% SP500 with less volatility.
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett
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Postby DaleMaley » Mon Apr 07, 2008 5:43 am

Taylor:

Thanks for your kind words.........and adding the "Past returns are no guarantee of future returns." :D
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett
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Postby DaleMaley » Mon Apr 07, 2008 6:01 am

Les:

Per your request, here is comparison with plain vanilla 60:40 and 75:25 portfolios (plain vanilla meaning only 2 funds, VTSMX and VBMFX):

Image

And as always..........."Past returns are no guarantee of future returns."
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett
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Postby james22 » Tue Apr 08, 2008 12:08 am

But compare the following two strategies: 100 percent of your money in stocks versus 90 percent of it in treasury bills or treasury bonds, and 10 percent in call options that give you more or less the same amount of upside exposure to the stock market as would 100 percent of your money in stocks.

- Zvi Bodie

http://www.zvibodie.com/files/BodieSieg ... script.pdf [p. 18]

How different is this from your thinking, Larry? From Taleb's?

Edited to add: No I-bonds, Larry?
Risk ≠ Reward
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