FT: The myth of small-cap outperformance

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ratesguy
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FT: The myth of small-cap outperformance

Post by ratesguy »

Gist: small cap outperformance all comes in the first year of a bull market and underperforms the other 75pct of the time. So CAGR studies are very sensitive to start date. And now isn't likely the time for small caps...according to Ken Fisher

The myth of small-cap outperformance
--
By Ken Fisher
--
Smaller shares’ lead comes in short bursts; most of the time, large-caps win

Read the full article at: http://www.ft.com/cms/s/0/106e2ae8-f151 ... abdc0.html
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Re: FT: The myth of small-cap outperformance

Post by MN Finance »

Oh good, now thats a voice I trust. I guess its a coincidence he runs large cap portfolios
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Re: FT: The myth of small-cap outperformance

Post by kenner »

Seems to me that Ken Fisher is sort of like a used-car salesperson. When I deal with salespeople, I ask for valid long-term data in order to check on the veracity of what they are trying to sell. Please provide the data.
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Re: FT: The myth of small-cap outperformance

Post by jackholloway »

MN Finance wrote:Oh good, now thats a voice I trust. I guess its a coincidence he runs large cap portfolios
That is consistent, though. If you have what you consider compelling data that large caps win most of the time for most of the investors, why would you not run such a fund?
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Re: FT: The myth of small-cap outperformance

Post by cfs »

Heads up on that link

Actually, the link works, but the website is full of junk coming at you, proceed with caution or just avoid the whole thing.

Thanks for reading.
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Re: FT: The myth of small-cap outperformance

Post by Garco »

It's a myth that small cap beats large cap after the 1st year of a bull market?

From January 2, 2010 through December 31, 2013, i.e., 4 years, the total return on VINIX (SP500 index) was: 80.28%.

In the same time interval, the total return on VIEIX (extended market index) was: 101.81%.

This is a figment of my imagination?

In 2014 to date, VINIX has outreturned VIEIX, so maybe Fisher meant the 5th year of a bull market?
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Re: FT: The myth of small-cap outperformance

Post by JoMoney »

Garco wrote:It's a myth that small cap beats large cap after the 1st year of a bull market?

From January 2, 2010 through December 31, 2013, i.e., 4 years, the total return on VINIX (SP500 index) was: 80.28%.

In the same time interval, the total return on VIEIX (extended market index) was: 101.81%.

This is a figment of my imagination?

In 2014 to date, VINIX has outreturned VIEIX, so maybe Fisher meant the 5th year of a bull market?
What he said was small beats large in the first year of a new bull market every time, that small tends to perform best during the first 1/3rd of a bull market, but large caps beat small most of the time, and the purported small-cap performance is concentrated in only a few short time periods.
Jeremy Siegel points this out in "Stocks For the Long Run". Without the extreme performance that occurred during the 1975-1983 period the data since 1926 would not show any small-cap outperformance
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Re: FT: The myth of small-cap outperformance

Post by berntson »

[This most was redundant and not very illuminating.]
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Re: FT: The myth of small-cap outperformance

Post by berntson »

JoMoney wrote: Without the extreme performance that occurred during the 1975-1983 period the data since 1926 would not show any small-cap outperformance.
Well, if you throw out the extreme performance of large caps from 1990-1999, the small cap effect looks large and robust!

It's like this. "If we just threw out those five minutes where the Spurs outscored the heat by 10, the Heat would have won the game." Well yes. But it's also true that if we threw out the 10 point comeback by the Heat at the end of them game, they would have lost the game by twice as much as they did. Throwing out the best minutes for the Spurs and then calling the game a tie doesn't show that the Spurs didn't play a better game or that they wouldn't beat the Heat if the game were played again. It's hard enough to win games in the NBA final, let alone win them after your best minutes are thrown out.

Likewise, it's hard enough to get any long-term outperformance in the market, let alone get outperformance once your best years are thrown out.
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Re: FT: The myth of small-cap outperformance

Post by nedsaid »

I want to point out that the stock market as a whole often goes up in bursts. This phenomenon does not just happen with small stocks. It would not be a surprise to me that smaller stocks would be fastest out of the gate. Even if there were no small-cap outperformance, you still get a diversification benefit. Large-cap sometimes outperforms small-cap and sometimes small-cap outperforms large-cap. We saw the former in the 1990's and the latter from the year 2000 on.

I am a believer in small-cap outperformance over long periods of time. All I can say is WOW what a myth!!
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Re: FT: The myth of small-cap outperformance

Post by JoMoney »

berntson wrote:...Well, if you throw out the extreme performance of large caps from 1990-1999, the small cap effect looks large and robust! More generally, if you throw out what you know to be the best years of performance for asset x, asset x won't look so impressive compared to asset y (whose best years still count). After all, outperformance in the market doesn't come in steady streams. It comes in fits and starts....
Maybe... What Jeremy Siegel said (at least in the 1998 2nd edition of SFTLR):
...Some might object to drawing conclusions from return data where some of the best or worst years have been removed, since such a procedure can significantly distort returns. Yet that criticism is not applicable here. Computer simulations were performed that randomized the historical returns on small and large stocks, and then the nine best consecutive years were removed from the small stock series. Reversals of the magnitude that were found in the actual data were very rare and occurred in less than 10 percent of the cases analyzed. Even when the nine best consecutive years for large stocks (which ran from 1950-58) and the best nine consecutive years for small stocks have been removed, large stocks still outperformed small stocks over the past 70 years...
Either way, I think all these charts are period dependent and we could come to lots of different conclusions looking at other specific periods, and might change if more data was available or as time passes. The conclusions about "premiums" most people draw from this data makes as much sense to me as claiming there's a Microsoft (MSFT) premium
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Small-caps are a narrow segment of the market, making up something like 10% of the overall markets return. They're going to perform differently, perhaps for very long periods of time. But I don't buy the idea that they will persistently grow faster than the larger market that they're a part of. Sooner or later they all RTM.
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Re: FT: The myth of small-cap outperformance

Post by berntson »

JoMoney wrote: Small-caps are a narrow segment of the market, making up something like 10% of the overall markets return. They're going to perform differently, perhaps for very long periods of time. But I don't buy the idea that they will persistently grow faster than the larger market that they're a part of. Sooner or later they all RTM.
I definitely agree that drawing conclusions about markets can be dicey. One of the things going for the small cap effect is that it's not just about the bottom 10% of the market. If we slice up the market into deciles, the historic returns going from large to small form a nice upward slope. That's much less likely to happen by chance than, say, just decile 10 beating decile 1. Nothing decisive, but it is a pretty striking pattern in the historical returns. At the very least, it's plausible that something happened that wasn't just chance. Whether that something will continue going forward is anyone's guess.
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Re: FT: The myth of small-cap outperformance

Post by Call_Me_Op »

Even if he is correct, for buy/hold/rebalance types, small-caps out-perform over long time periods. So unless you are a market timer, why is this an important issue?
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Re: FT: The myth of small-cap outperformance

Post by JoMoney »

Call_Me_Op wrote:Even if he is correct, for buy/hold/rebalance types, small-caps out-perform over long time periods. So unless you are a market timer, why is this an important issue?
I think you missed the point. His statement is opposite of yours, saying that none of the various cap-sizes show persistent outperformance, in particular he noted that in the past small-caps only outperformed for a very short period of time. It's an issue because there are Boglehead's who are either putting money in or deciding whether to put money in to subsections of the market with the expectation that over the long term they will outperform some other section of the market.
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Re: FT: The myth of small-cap outperformance

Post by steve r »

JoMoney wrote:
Call_Me_Op wrote:Even if he is correct, for buy/hold/rebalance types, small-caps out-perform over long time periods. So unless you are a market timer, why is this an important issue?
I think you missed the point. His statement is opposite of yours, saying that none of the various cap-sizes show persistent outperformance, in particular he noted that in the past small-caps only outperformed for a very short period of time. It's an issue because there are Boglehead's who are either putting money in or deciding whether to put money in to subsections of the market with the expectation that over the long term they will outperform some other section of the market.
+1 I think that this back and forth summarizes well.

Backtesting, I think we can acknowledge, has limits. For me, you need a "theory" as to why the outperformance of one asset and the underperformance of another. The greater risk theory HAD (past tense) some plausibility. This is particularly true when diversification (buy a basket of small stocks) was costly as was clearly the case decades ago.

So I ask ...

Is it still costly to buy a basket of small cap stocks?
Would one basket of stocks outperforming another violate the efficient market hypothesis?
Is there another reason why a cheap to own basket of stocks should outperform any other basket?

FWIW: I underweight large caps slightly. I have no particular reason for doing so other than portfolio simplification.
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Re: FT: The myth of small-cap outperformance

Post by ratesguy »

I have seen this argued back and forth in a lot of

Much of this seems so sensitive to start and end dates. Since 1926 you had an epic rally, crash, depression, devaluation vs gold, world war 2, the baby boom and post war growth "miracle" - from rebuilding bobbed out Europe and Japan, the great inflation, the great moderation, another boom in the market in the 1990s another bust, more wars, a Great Recession ..massive CB intervention, a euro crisis and today

I doubt looking at too much in the way of "patterns" is that useful a la Fisher, or even CAGRs from some arbitrary start point

Ex-ante I can't see a great argument for a particular subset of the market or really any asset class to deliver better RISK-ADJUSTED returns.

So I imagine in the future returns will tend to be higher in riskier things but they carry the tail risk of realizing a worse outcome. I can also just take more risk by using more or less leverage. Minimizing ERs and being tax efficient seem about the limits of what is really controllable. Apart from that you can express a "view", which I'm not dogmatically against.
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Re: FT: The myth of small-cap outperformance

Post by JoMoney »

steve r wrote:...FWIW: I underweight large caps slightly. I have no particular reason for doing so other than portfolio simplification.
And doing so probably "beat the market" over the past couple years.
Let me throw something out there I've been looking at, maybe interesting, maybe not, maybe I'm missing something...
I've been looking at the Vanguard Index funds annual reports for the period of the past decade.
It appears that shortly after the dot-com boom of the 2000's that the "Median Market Cap" for the Total Stock Market started shrinking, this was the case for several years and then the "Median Market Cap" started growing again, but what I notice is that the growth in median market-cap isn't coming from the largest-cap stocks. If we look at the "Top Ten Stocks" their share of the overall market has continued to shrink. What seems to be happening is growth in the middle of the market. Big enough to move the average size up, but smaller than the largest which continue to shrink in share of the market.
What I also noticed, is that the super-small micro-caps like BRSIX had their best performance during this period where the overall "Median Market Cap" was still shrinking (up through 2005), but it was the Mid-Caps that took the lead during the phase where the "Median Market Cap" started rising even as the largest large-caps were shrinking in share of the market.
This makes sense to me, if one cap-size is growing faster than another it should take on a larger share of the overall market drawing the "Median Market Cap" in the direction of that subsection of the market.
But if small-cap outperformance was a persistent phenomenon, where above average growth happened in small-caps over the long term, shouldn't we see the "Median Market Cap" shift lower and lower towards those smaller cap stocks (over the long term)? Conversely if large caps were the persistent outperformers we'd see the market share of the top 10 (or 100 or whatever) growing larger and larger (which is what happened during the late '90s large-cap boom). What seems to happen is each section growing in fits and starts with various periods of over/under performance and "return to the mean", and shouldn't that "mean" in the long-run be the cap-weighted Total Stock Market... ???
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Re: FT: The myth of small-cap outperformance

Post by stlutz »

Well, if you throw out the extreme performance of large caps from 1990-1999, the small cap effect looks large and robust!.
Serious question here--Does anyone know *why* small stocks did so well in the late 70s? With big stocks, we know what happened in the 90s--there was a tech bubble. It burst and the large cap outperformance was wiped out. There was no corresponding bubble in smallcap stocks in the late 70s/early 80s that I see.

This small time period is so critical to the concept of small-cap outpeformance that it seems we need a better understanding as to what happened then. This understanding should help investors made better judgments as to whether this kind of thing can occur again or not.
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Re: FT: The myth of small-cap outperformance

Post by Call_Me_Op »

JoMoney wrote:
Call_Me_Op wrote:Even if he is correct, for buy/hold/rebalance types, small-caps out-perform over long time periods. So unless you are a market timer, why is this an important issue?
I think you missed the point. His statement is opposite of yours, saying that none of the various cap-sizes show persistent outperformance, in particular he noted that in the past small-caps only outperformed for a very short period of time. It's an issue because there are Boglehead's who are either putting money in or deciding whether to put money in to subsections of the market with the expectation that over the long term they will outperform some other section of the market.
My point is that small-caps have tended to out-perform over very long time periods - not during every selected period - but a general tendency. See the long-term data in the link below. (I will note that 40 years is not exactly a "very short period of time.") That doesn't mean it is guaranteed to happen in the future, although I am comfortable believing it is likely to happen (along with higher volatility for small caps). The (long-term) effect is much stronger if we look only at small-cap value.

https://www.ridgeworth.com/includes/fil ... B-0313.pdf
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Re: FT: The myth of small-cap outperformance

Post by dbr »

JoMoney wrote:
Call_Me_Op wrote:Even if he is correct, for buy/hold/rebalance types, small-caps out-perform over long time periods. So unless you are a market timer, why is this an important issue?
I think you missed the point. His statement is opposite of yours, saying that none of the various cap-sizes show persistent outperformance, in particular he noted that in the past small-caps only outperformed for a very short period of time. It's an issue because there are Boglehead's who are either putting money in or deciding whether to put money in to subsections of the market with the expectation that over the long term they will outperform some other section of the market.
Yes, and that is always with the understanding that for long periods of time the expected outperformance may not materialize. There is nothing contradictory here. It may be true that some investors who tilt do not understand how the process may work but only they are responsible for investing in something they don't understand IF it is the case that they don't understand. That is one reason the best answer to someone who asks if they should take a small value tilt is that if you have to ask, you probably should not.
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Re: FT: The myth of small-cap outperformance

Post by steve_14 »

I'd think folks would be more interested in what's likely to happen going forward than history. I posted this in another thread recently:

When large caps were dramatically more expensive than small caps back in 2001, Dr. Bernstein predicted a 2% return premium for small (based on this valuations differential):

http://www.efficientfrontier.com/ef/701/cheap.htm
First, large-cap stocks are quite expensive in most of the developing world, with P/Es in the 25 to 30 range. The earnings yield of a market is a fair predictor of its future long-term real return: both the discounted dividend model and P/E predict a real return of about 3% for U.S. stocks. So at best, expect a 4% real return from large-cap foreign stocks.

Second, small stocks are somewhat cheaper than large stocks in most of the world, with P/Es in the 20 range. So expect perhaps a 5% real long-term return from them.
Eyeballing the M* returns from that period, I'd say Bill's estimates were quite accurate - large returned around 3% real, and small returned 6.5% real. So, where does that leave us today?

Then:
S&P 500 P/E: 31.2x
Russell 2000 Small Cap Index: 22.1x
DFA Small Company Index: 21.1x
Source: Dr. Bernstein

Now:
Vanguard 500 Fund P/E: 18.3x
Vanguard Small Cap Index: 28.8x
Source: Vanguard
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Re: FT: The myth of small-cap outperformance

Post by freddie »

What you really want to know is how many 10/15/20/30 year periods did small caps out perform large. The other questions is lets say the risk adjusted returns are the same. If I want to take on more risk is it cheaper/easier to buy small caps or to buy leverage?

And once you make a decision on small, then you can have the same discussion about tilting towards value. In the lastest cycle, value hasn't been rewarded (i.e. compare small growth to small value over the past 15 years). Does that mean the value premium is gone or just resting:)
ratesguy wrote:I have seen this argued back and forth in a lot of

Much of this seems so sensitive to start and end dates. Since 1926 you had an epic rally, crash, depression, devaluation vs gold, world war 2, the baby boom and post war growth "miracle" - from rebuilding bobbed out Europe and Japan, the great inflation, the great moderation, another boom in the market in the 1990s another bust, more wars, a Great Recession ..massive CB intervention, a euro crisis and today

I doubt looking at too much in the way of "patterns" is that useful a la Fisher, or even CAGRs from some arbitrary start point

Ex-ante I can't see a great argument for a particular subset of the market or really any asset class to deliver better RISK-ADJUSTED returns.

So I imagine in the future returns will tend to be higher in riskier things but they carry the tail risk of realizing a worse outcome. I can also just take more risk by using more or less leverage. Minimizing ERs and being tax efficient seem about the limits of what is really controllable. Apart from that you can express a "view", which I'm not dogmatically against.
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Re: FT: The myth of small-cap outperformance

Post by midareff »

ratesguy wrote:Gist: small cap outperformance all comes in the first year of a bull market and underperforms the other 75pct of the time. So CAGR studies are very sensitive to start date. And now isn't likely the time for small caps...according to Ken Fisher

The myth of small-cap outperformance
--
By Ken Fisher
--
Smaller shares’ lead comes in short bursts; most of the time, large-caps win

Read the full article at: http://www.ft.com/cms/s/0/106e2ae8-f151 ... abdc0.html

LOL... I was called several years ago by a Ken Fisher portfolio salesperson. I asked them to send me his track record and what portfolio he used to obtain those results and never heard from them again.
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Re: FT: The myth of small-cap outperformance

Post by garlandwhizzer »

JoMoney wrote:It appears that shortly after the dot-com boom of the 2000's that the "Median Market Cap" for the Total Stock Market started shrinking, this was the case for several years and then the "Median Market Cap" started growing again, but what I notice is that the growth in median market-cap isn't coming from the largest-cap stocks. If we look at the "Top Ten Stocks" their share of the overall market has continued to shrink. What seems to be happening is growth in the middle of the market. Big enough to move the average size up, but smaller than the largest which continue to shrink in share of the market.
The impressive rise in median market cap of TSM was influenced by consolidation, some companies usually large caps taking over other companies. This would tend to put upward pressure on the median market cap irrespective of which segment (SC,MC, LC) outperformed. Likewise the buyback of shares as opposed to distributing those funds as dividends to shareholders tends to support market cap weight. Last year I believe that the S&P 500 used 30% of their profits to repurchase and retire existing shares. Had they distributed those funds to investors, share prices and therefore market cap would have dropped in value. So I think it's hard to make any sound conclusions about the differential performance of SC, MC, or LC based on median market cap weight of TSM without taking these changes into effect.

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Re: FT: The myth of small-cap outperformance

Post by berntson »

On a side note, I'm not at all convinced that "large caps outperform except for a few periods at the beginning of a bull market." Take a look at the 5-year rolling performance difference between small and large (using the standard SMB series). I just don't see it.

Image

Most of the time the chart is above zero. Take out the 70s and early 80s and still, most of the time, the chart is above zero.

And there is nothing funny or fishy about this. Small cap stocks lose more money during market crashes. They're more volatile. We would be living in a fairly land if large stable stocks that lost less money during downturns had the same long-term performance as volatile stocks that predictably lost more money.
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Re: FT: The myth of small-cap outperformance

Post by JoMoney »

berntson wrote:...Take a look at the 5-year rolling performance difference between small and large (using the standard SMB series). I just don't see it...
Looking at that chart, and comparing long-term returns of the S&P500 to the Russell2000 or DFSCX, it would seem the best time to buy small-caps is when the blue line is below the 0% mark.
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Re: FT: The myth of small-cap outperformance

Post by JoMoney »

stlutz wrote:...Does anyone know *why* small stocks did so well in the late 70s? With big stocks, we know what happened in the 90s--there was a tech bubble. It burst and the large cap outperformance was wiped out. There was no corresponding bubble in smallcap stocks in the late 70s/early 80s that I see.

This small time period is so critical to the concept of small-cap outpeformance that it seems we need a better understanding as to what happened then. This understanding should help investors made better judgments as to whether this kind of thing can occur again or not.
Jeremy Siegel, Stocks For the Long Run 5th edition wrote:...What caused the tremendous performance of small stocks during the 1975-83 period? In the late 1970s and early 1980s, pensions and institutional managers found themselves attracted to smaller stocks following the collapse of the large-growth stocks, known as the "Nifty-Fifty," that were so popular in the preceding bull market. In addition, the enactment of Employee Retirement Income Security Act by Congress in 1974 made it far easier for pension funds to diversify into small stocks, boosting there holdings of these issues...
Jeremy Siegel, Stocks For the Long Run 2nd edition wrote:...First, at the beginning of the period the U.S. was recovering from the worst economic slowdown since the Great Depression, and small stock always do well coming out of recessions. Second, the OPEC oil price increases slammed many of the largest U.S. firms, such as the steel and motor companies, whose production process was not energy efficient. And finally, investors found themselves attracted to smaller stocks following the collapse of the "Nifty Fifty," large-cap growth stocks that were so popular in the preceding bull market. In 1975, money managers were able to find many undervalued stocks among these smaller issues. But by 1983, many of these stocks became overpriced and significantly underperformed large stock in subsequent years...
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Re: FT: The myth of small-cap outperformance

Post by longinvest »

To help with the discussion, here is the Telltale chart of DFSCX vs VFINX (http://morning-wave-7809.herokuapp.com/#DFSCX/VFINX):
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Re: FT: The myth of small-cap outperformance

Post by Marketmap »

One method of achieving alpha over the small cap buy and hold : https://docs.google.com/presentation/d/ ... sp=sharing
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Re: FT: The myth of small-cap outperformance

Post by nisiprius »

Since everyone says different things at different times it's hard to be definitive, but I think what small-cap advocates are now saying goes something like this.

a) Once upon a time Rolf Banz said that small-caps had had not only higher returns, but higher risk-adjusted returns than the market as a whole. He may not have expressed any opinion about whether that should be expected to persist, but a lot of people who read his work expected it to.

b) Nobody think that's true any more, and I think it's generally accepted that there were flaws in Banz' data set. All that is claimed now is that small-caps have higher return, higher risk, and about the same risk-adjusted return as large-caps.

c) Nevertheless, slice-and-dice advocates believe that small-caps are valuable because they have imperfect correlation with large caps and they say it is enough to be worthwhile.

d) I haven't read Larry Swedroe's new book, but he has a theory that by using a smaller allocation to small-caps instead of a large allocation to the total market, you can get about the same results in "normal" times but lower black swan or tail risk in bad times.

e) The slice-and-dicers also seem to think there is a sort of synergy between small-cap and value. Small caps are no good unless you get rid of the small-cap growth stocks, and while value is always good, value is much more powerful within the small-cap universe than within the total stock universe.

I'm not saying any of that is true, I'm saying that is my current understanding of the "small-cap outperformance" proposition.

Ken Fisher has such a strong vested interest of his own that I do not trust him as a reliable source of neutral information. I read some of "The Only Three Things that Still Matter" and it was clear that there was spin inextricable entangled with information.
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Re: FT: The myth of small-cap outperformance

Post by matjen »

nisiprius wrote:Since everyone says different things at different times it's hard to be definitive, but I think what small-cap advocates are now saying goes something like this.

a) Once upon a time Rolf Banz said that small-caps had had not only higher returns, but higher risk-adjusted returns than the market as a whole. He may not have expressed any opinion about whether that should be expected to persist, but a lot of people who read his work expected it to.

b) Nobody think that's true any more, and I think it's generally accepted that there were flaws in Banz' data set. All that is claimed now is that small-caps have higher return, higher risk, and about the same risk-adjusted return as large-caps.

c) Nevertheless, slice-and-dice advocates believe that small-caps are valuable because they have imperfect correlation with large caps and they say it is enough to be worthwhile.

d) I haven't read Larry Swedroe's new book, but he has a theory that by using a smaller allocation to small-caps instead of a large allocation to the total market, you can get about the same results in "normal" times but lower black swan or tail risk in bad times.

e) The slice-and-dicers also seem to think there is a sort of synergy between small-cap and value. Small caps are no good unless you get rid of the small-cap growth stocks, and while value is always good, value is much more powerful within the small-cap universe than within the total stock universe.

I'm not saying any of that is true, I'm saying that is my current understanding of the "small-cap outperformance" proposition.

Ken Fisher has such a strong vested interest of his own that I do not trust him as a reliable source of neutral information. I read some of "The Only Three Things that Still Matter" and it was clear that there was spin inextricable entangled with information.
Shorter version...everyone on this forum who is not a total market person or TM + REIT person talks about/invests in SCV whenever possible not SC.
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Re: FT: The myth of small-cap outperformance

Post by longinvest »

Just in case someone wanted to discuss small-cap value funds, here's the Telltale chart of DFSVX vs VFINX (http://morning-wave-7809.herokuapp.com/#DFSVX/VFINX):
Image
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JoMoney
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Re: FT: The myth of small-cap outperformance

Post by JoMoney »

matjen wrote:...Shorter version...everyone on this forum who is not a total market person or TM + REIT person talks about/invests in SCV whenever possible not SC.
If that was the case, why are there so many posts discussing overweighting the extended market index, or mid-caps, or Vanguard's Small-Cap fund, or BRSIX, etc... ? (Not that I give any more credence to the idea of a persistent "premium" existing in SCV over SC)
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Re: FT: The myth of small-cap outperformance

Post by rkhusky »

berntson wrote: Likewise, it's hard enough to get any long-term outperformance in the market, let alone get outperformance once your best years are thrown out.
Or even best days. I saw an analysis once (perhaps from Vanguard or John Bogle) that showed the effect of missing the 10 (or 50 or 100) best days of the market. The effect on performance was striking. That was enough to convince me that moving in and out of the market was a bad idea. I knew that not only would I not be able to get back in before the biggest days, but I would also not be able to get out before the worst days (I don't watch the market that closely).
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Re: FT: The myth of small-cap outperformance

Post by longinvest »

From https://www.vanguardcanada.ca/individua ... a-tlrv.htm:
While small-cap and value stocks have outperformed the broad market over the past 15 years, both have gone through extended periods of underperformance. The question is: Will investors remain committed to these strategies once they begin to underperform?Image
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Re: FT: The myth of small-cap outperformance

Post by freddie »

Can't you just invert question: Will TSM investors remain committed to their strategy when they underperform? The TSM guys who stick with it will do ok. The SV tilters who stick with it will do ok. The guys that try to chase the latest fad are likely to get killed.
longinvest wrote:From https://www.vanguardcanada.ca/individua ... a-tlrv.htm:
While small-cap and value stocks have outperformed the broad market over the past 15 years, both have gone through extended periods of underperformance. The question is: Will investors remain committed to these strategies once they begin to underperform?
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Re: FT: The myth of small-cap outperformance

Post by berntson »

JoMoney wrote:
berntson wrote:...Take a look at the 5-year rolling performance difference between small and large (using the standard SMB series). I just don't see it...
Looking at that chart, and comparing long-term returns of the S&P500 to the Russell2000 or DFSCX, it would seem the best time to buy small-caps is when the blue line is below the 0% mark.
Indeed. I would be much more excited about small tilting if we had just watched small caps get beat up for ten years. On the other hand, as an accumulator, periods of underperformance are also helpful because they give you time to increase your position at lower prices. From my perspective, the Great Small Cap Reckoning can't happen soon enough. :beer
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Re: FT: The myth of small-cap outperformance

Post by berntson »

rkhusky wrote:
berntson wrote: Likewise, it's hard enough to get any long-term outperformance in the market, let alone get outperformance once your best years are thrown out.
Your post inspired me to do some digging. I found a helpful chart from JP Morgan.

Image

I can imagine someone making this sort of argument: Well, if you throw out a few big days for stocks between 1993-2013, stocks only returned about 5.5% a year (before inflation even) and were soundly beat by bonds. So we shouldn't believe that stocks can be expected to have higher returns. Stocks just got lucky.

This style of argument is so silly and so common that I think we should give it a name. I propose to call it the Fisher Fallacy. :D

The chart also reinforces rkhusky's point. Missing a few big market days is really bad for your portfolio. Even worse, those really good days typically follow really bad days. So investors who bail on the way down are especially likely to miss them.
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Re: FT: The myth of small-cap outperformance

Post by steve r »

matjen wrote:
nisiprius wrote: .... think there is a sort of synergy between small-cap and value. Small caps are no good unless you get rid of the small-cap growth stocks, and while value is always good, value is much more powerful within the small-cap universe than within the total stock universe.

I'm not saying any of that is true, I'm saying that is my current understanding of the "small-cap outperformance" proposition.
Shorter version...everyone on this forum who is not a total market person or TM + REIT person talks about/invests in SCV whenever possible not SC.
... and yet the performance premium over the life of the Vanguard fund (for roughly two decades) for SCV over SCG has been virtually non-existent.

Perhaps we should exclude the 5 or 10 days that SCG outperformed SCV by the most ... or do some risk adjusted basis .. wait ... if a value premium exists ... it must mean higher risk (but not risk measured by standard deviation .. value does not have greater risk measured that way) ... or only look at DFA funds ... (who like Fisher have their own set of incentives) ...... or simply compare small to large ... yeah, that works, SCG and SCV outperformed LC during that period, the data is solid ... or look back over longer time periods when it was neither cheap nor easy to implement such a small or SV strategy .... by longer I mean either just before the SC run in the 1970s or to the 1920s ... or ...

Just saying.

That said, I am enjoying this thread ...
I still would like to know why the sc run up in the 1970s ... (as STLUTZ asked above) ... any insights here? Tax law change? Mutual fund investment options making it easier to buy SC? Any insights?
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Re: FT: The myth of small-cap outperformance

Post by freddie »

Clearly the vanguard fund isn't valuely enough:) Or maybe we have just had a 15 year period were there was no reward for value and that starting next week there is going to be a run of 5 years of outperformance. Or maybe the premium has been priced out forever.

When you look back at the numbers most of the value gains are over short periods of time. Using portfolio visualizer for example lets look at the 2000s

2000-2013
SV 10.52
SG 9.01

Not quite the value premium you would expect but not bad. But all of that premium showed up a the start of the period
2000-2004
SV 15.05
SG 7.12

and since then small value has underperformed
2005-2013
SV 8.09
SG 10.05

Picking and choosing your end dates will change you results a lot when looking at 15 year samples (or even 30 years. Add in 1 good year and take out 1 bad can really change the numbers). It is impossible to know if the cycle is going to revert or if this time is different and that the overgrazing of SV is going to result in substantially less of a premium.


The question I always ask my self is what is the risk of tilting small. Lets say no size premium (or value premium) shows up. How much underperformance should I expect? Would it make sense for small stocks to underperform large ones for say a 20 year period? That doesn't make sense to me. What does make sense is that I will be paying more in ER (that has dropped a lot but it used to be up in the .2% range) and maybe taxes (tend to have a bit more turnover). I am pretty comfortable with that risk.

The theory I have heard about the 70s is that inflation favors small caps. Large caps in the 70s had huge pension and debt obligations so that when inflation hit, there obligations also went up. There is also the theory that small caps were able to raise prices quicker. But I am not sure I would put too much faith into any of that. It may have just been random (i.e. small caps were undervalued when the cycle began). We don't have too many periods of hyper inflation to look back at.



steve r wrote:
matjen wrote:
nisiprius wrote: .... think there is a sort of synergy between small-cap and value. Small caps are no good unless you get rid of the small-cap growth stocks, and while value is always good, value is much more powerful within the small-cap universe than within the total stock universe.

I'm not saying any of that is true, I'm saying that is my current understanding of the "small-cap outperformance" proposition.
Shorter version...everyone on this forum who is not a total market person or TM + REIT person talks about/invests in SCV whenever possible not SC.
... and yet the performance premium over the life of the Vanguard fund (for roughly two decades) for SCV over SCG has been virtually non-existent.

Perhaps we should exclude the 5 or 10 days that SCG outperformed SCV by the most ... or do some risk adjusted basis .. wait ... if a value premium exists ... it must mean higher risk (but not risk measured by standard deviation .. value does not have greater risk measured that way) ... or only look at DFA funds ... (who like Fisher have their own set of incentives) ...... or simply compare small to large ... yeah, that works, SCG and SCV outperformed LC during that period, the data is solid ... or look back over longer time periods when it was neither cheap nor easy to implement such a small or SV strategy .... by longer I mean either just before the SC run in the 1970s or to the 1920s ... or ...

Just saying.

That said, I am enjoying this thread ...
I still would like to know why the sc run up in the 1970s ... (as STLUTZ asked above) ... any insights here? Tax law change? Mutual fund investment options making it easier to buy SC? Any insights?
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Re: FT: The myth of small-cap outperformance

Post by Ketawa »

freddie wrote:Clearly the vanguard fund isn't valuely enough:) Or maybe we have just had a 15 year period were there was no reward for value and that starting next week there is going to be a run of 5 years of outperformance. Or maybe the premium has been priced out forever.
Or, it could be that the Vanguard funds had an index switch that was lucky for the growth fund, unlucky for the value fund.
Ketawa wrote:The Vanguard Small Growth fund managed to beat either index it followed over this time period, while the Small Value fund barely managed to match the one that returned less. Even if you don't bother to look at F/F loadings, it's clear that the index switch is the reason for the outperformance of the Small Growth fund.
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Re: FT: The myth of small-cap outperformance

Post by stlutz »

The Vanguard Small Growth fund managed to beat either index it followed over this time period, while the Small Value fund barely managed to match the one that returned less. Even if you don't bother to look at F/F loadings, it's clear that the index switch is the reason for the outperformance of the Small Growth fund.
I have to give credit to nisiprius for originally making this comment, but the value effect can't be *that* strong if it's wiped out by a change in who the index provider is.
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Re: FT: The myth of small-cap outperformance

Post by Phineas J. Whoopee »

I can't help but read this thread as boiling down to "small value outperforms on principle but when it doesn't the principles don't apply."
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