Does anyone expect tilts to *under*perform?

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stlutz
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Does anyone expect tilts to *under*perform?

Post by stlutz »

In the incessant back and forth over various tilts/smart beta/active bets (pick your favorite phrase), we have people who:

a) Say that they expect such strategies to outperform, some going so far as to say that there are no circumstances in which they shouldn't be expected to do so;

b) That free lunches are arbitraged away and that such strategies should simply be expected to do no better or worse than that market over the long run.

Is there anyone who will contend for option (C): that such strategies should be expected to underperform the market over the long-haul (e.g. 20 years)?

Included in this list of strategies would be value, small, momentum, quality, and low volatility.
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Kalo
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Re: Does anyone expect tilts to *under*perform?

Post by Kalo »

Do you mean under-perform on a risk-adjusted basis?

Kalo
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stlutz
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Re: Does anyone expect tilts to *under*perform?

Post by stlutz »

FWIW, year-to-date they are all underperforming. :D
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Ketawa
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Re: Does anyone expect tilts to *under*perform?

Post by Ketawa »

stlutz wrote:FWIW, year-to-date they are all underperforming. :D
Huh? Every Vanguard value fund is beating its corresponding growth fund. However, small caps have lagged TSM.
brigboy
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Re: Does anyone expect tilts to *under*perform?

Post by brigboy »

I guess I shouldn't feel bad that my 401(k) is all allocated into the S&P500 and Index Bond Fund each with an expense ratio of 0.08 and 0.13 respectively. The rest of the fund options I have are all 0.5-3% (plan to max going forward)

My Roth IRA is basically all in a Vanguard Total Stock Index Admiral (VTSAX) (~11k).

I have a taxable account consisting of Vanguard Total International - it's doing quite poor.

I just feel like I'm "missing out" by not tilting my portfolio I guess, seeing as my whole portfolio is basically US domestic stock. What do you guys think?
I was thinking of making changes perhaps getting rid of my VTSAX and replacing it with like one of the following:
a) Vanguard Extended Market Index (small, mid cap)
b) Vanguard Small Cap Index
c) Vanguard Mid Cap Index
d) Vanguard Emerging Markets Index
e) Vanguard REIT Index
Tamales
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Re: Does anyone expect tilts to *under*perform?

Post by Tamales »

stlutz wrote:In the incessant back and forth over various tilts/smart beta/active bets (pick your favorite phrase), we have people who:

a) Say that they expect such strategies to outperform, some going so far as to say that there are no circumstances in which they shouldn't be expected to do so;
b) That free lunches are arbitraged away and that such strategies should simply be expected to do no better or worse than that market over the long run.
Is there anyone who will contend for option (C): that such strategies should be expected to underperform the market over the long-haul (e.g. 20 years)?
Included in this list of strategies would be value, small, momentum, quality, and low volatility.
Could you give an example of such a portfolio and the weightings?
lee1026
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Re: Does anyone expect tilts to *under*perform?

Post by lee1026 »

I suspect that small-value will badly under perform in the future. My suspicion comes from the following.
1. There is in truth very little data that tells us that there is small-value premium in the long run.
2. Small-value stocks have been looking more and more expensive on every single valuation metric relative to the stock market at large. (P/E, P/B, P/(cash flow), you name it) which means that it is fundamentally hard to tell between the recent out performance is due to valuations getting more expensive or due to any actual outperformance from those company.
3. The idea that small-value will out-perform if you don't care about risks have been in every book and every lecture for a very long time now, and it is so very easy for any random person to dump more and more cash into small-value, as it is a simple ETF buy order away.
4. There is actually very little market cap in small cap. By the looks of it, VBR represent around 1% of the total shares issued by many of the companies that are in the index, which means that market cap of all small-value companies are somewhere on the order of 500 billion dollars. That is about the size of AAPL, and almost any large inflow of money will quickly raise valuations though the roof. And make the small-cap premium story look even better and drive even more investment, and so on.

Worst part is, there is so much volatility in small cap that even if it tanks for the next 20 years, it is still plausible that the premium exists, and the volatility just happened to swing against us, so I will never know if I am really right.
Last edited by lee1026 on Sun Jul 13, 2014 1:18 am, edited 1 time in total.
ASUGrad
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Re: Does anyone expect tilts to *under*perform?

Post by ASUGrad »

stlutz wrote:In the incessant back and forth over various tilts/smart beta/active bets (pick your favorite phrase), we have people who:

a) Say that they expect such strategies to outperform, some going so far as to say that there are no circumstances in which they shouldn't be expected to do so;

b) That free lunches are arbitraged away and that such strategies should simply be expected to do no better or worse than that market over the long run.

Is there anyone who will contend for option (C): that such strategies should be expected to underperform the market over the long-haul (e.g. 20 years)?

Included in this list of strategies would be value, small, momentum, quality, and low volatility.
Well of course they can underperform. And some of the strategies above kind of go against each other anyway. Its really hard to be small, value, momentum, quality, and low volatility at the same time. So it only stands to reason if some strategies do better over the next 20 years others have to do worse.
ks289
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Re: Does anyone expect tilts to *under*perform?

Post by ks289 »

A.
Who knows? Tilting may underperform. Equities may underperform treasuries.
I hope Dr Bernstein and Rick Ferri and others are right.
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IlliniDave
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Re: Does anyone expect tilts to *under*perform?

Post by IlliniDave »

I certainly expect that the various classes people tilt to will underperform at times, maybe even over long stretches. But I also expect that in the long haul they will outperform slightly. I could very easily be wrong. There's additional risk in the approach.
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in_reality
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Re: Does anyone expect tilts to *under*perform?

Post by in_reality »

Large cap performance is more explained by country and global macro economic conditions.

Small cap performance is more explained by stock specific factors.

So under or over, I really can't say much about performance other than I'd like more than one basket for my eggs.

http://institutional.invesco.ca/institu ... n_0113.pdf
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Taylor Larimore
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Re: Does anyone expect tilts to *under*perform?

Post by Taylor Larimore »

Every Vanguard value fund is beating its corresponding growth fund. However, small caps have lagged TSM.
These are the returns for Vanguard Growth Index (VIGRX) and Vanguard Value Index (VIVAX):

Period---VIGRX---VIVAX
YTD--------7.14%----7.60%
1-year---22.42%---17.88%
3-years--16.50%---16.24%
5-years--20.26%---19.65%
10-years--8.67%----7.35%
15-years--3.54%----5.00%

Past performance does not forecast future performance.

Best wishes.
Taylor
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nedsaid
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Re: Does anyone expect tilts to *under*perform?

Post by nedsaid »

My expectation is that the small/value tilts will probably experience underperformance for a while as they did in the 1990's. There is some difference in the way value behaves and how growth behaves. Ditto for small cap and large cap. So you have a bit of a teeter-totter effect in that one tends to do better than the other for a while and then things shift. I have been reading threads that indicate that the tilting strategies are getting more popular and that small-cap and mid-cap are getting more expensive compared to the rest of the market.

I believe the performance factors that Larry Swedroe and others mention are rooted in human nature and human behavior. Thus sooner or later these factors like small and value will reassert themselves. Most investors who tilt their portfolios will at some point lose interest and go on to the next best thing. This is a long term strategy.

It is like the dividend and dividend growth strategies. I actually like these approaches but with everyone chasing yield, it is time to cool it for now. The tilting strategies have gotten more popular and just as I advise not piling into the high dividend stocks so I would advise not to pile into the small-caps and small-cap value. So if you have not been tilting and want to tilt, remember this is a long term commitment.

I have chosen to slightly tilt my portfolio because I want the possibility of higher returns. The academic research says that I am putting the odds in my favor but at the same time I acknowledge the possibility of being wrong. I am willing to take the chance and so far so good.
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Re: Does anyone expect tilts to *under*perform?

Post by richard »

There are generally two explanations for why SV has outperformed over some time periods.

1) A risk story. If so, and if risk means anything, you'd expect there to be long periods of underperformance, perhaps very long and very severe underperformance.

2) A behavioral story. If so, no reason SV can't win over any given time period.

The stories are not necessarily mutually exclusive.
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Re: Does anyone expect tilts to *under*perform?

Post by steve_14 »

I expect the expensive asset class everyone is making big bets on to underperform. In 2000 that was large caps. Today it's small caps and REITs.
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nedsaid
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Re: Does anyone expect tilts to *under*perform?

Post by nedsaid »

I am not convinced that value is a risk story. We get told that Value stocks are riskier but mostly the proof is narrative. That is pretty much the "bad company" argument. One of the really respected Bogleheads took a bit of issue with my argument that the value premium is based on human behavior. He linked to a story and asserted that Value was a risk story. When I actually read the article, the performance of large value beat large growth and small value beat small growth. In each case however, the standard deviation of the value stocks was LESS than the growth stocks. More reward for less risk.

The argument then went something like this. If Value outperforms Growth then is HAS to be a risk story. Without the statistical evidence to back this up, the author fell back to the "bad company" argument. To me, this was delicious as most of my arguments are by narrative. I have yet to post a chart and I am rather sparing on the use of statistics and numbers in my posts. But a non-quant like me delighted in pointing out that the quants really had no mathematical proof that value stocks were riskier. They just "knew it" because "we all know" that more risk is more return.

My take is that the Value premium exploits the foibles of human nature. We tend to chase what is popular and we tend to chase performance. Larry Swedroe does think that value stocks are riskier but rather than being a free lunch, he thinks it is more like a free dessert. If I recall correctly, he believes that Value stocks are riskier than the rest of the market but not as much as the collective judgments of the market believes. In other words, the market puts too much of a discount on these stocks. Hence the free dessert.
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midareff
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Re: Does anyone expect tilts to *under*perform?

Post by midareff »

stlutz wrote:FWIW, year-to-date they are all underperforming. :D

and what happens when you look at total 12 month? and three year? and 5 year? Looking at a period of 6 months and ten days to determine asset class performance is cherry picking dates to support a statement or position.
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Re: Does anyone expect tilts to *under*perform?

Post by ks289 »

steve_14 wrote:I expect the expensive asset class everyone is making big bets on to underperform. In 2000 that was large caps. Today it's small caps and REITs.
So maybe tilters should bail out of overweighting small caps and/or REITs right now? I guess it wouldn't be the worst thing to get out now (as opposed to say 5 -6 years ago) after the recent run for small caps last few years and REITs this year.
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Re: Does anyone expect tilts to *under*perform?

Post by livesoft »

I am not too concerned about what a buy-and-hold strategy of something like small-cap value will give the other guy. I am not overly concerned with the 10-year performance of small-cap value or even the 1-year performance. Proof of that is that I have held TIAA Real Estate since inception even though its performance is not that good compareed to other things I could've held.

But the main reason I don't like to directly compare to a buy-and-hold strategy is because I am doing a buy, hold, and rebalance strategy. My holdings will not be static. When something drops, I will buy more. When something goes up, I will sell some. We will have to argue in another thread whether there is a rebalancing bonus or not. I think there is the way that I rebalance. Maybe it is only 0.5% or 0.2%, but its something.

So for me to tell, I use benchmarks such as LifeStrategy Moderate Growth.
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nisiprius
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Re: Does anyone expect tilts to *under*perform?

Post by nisiprius »

What do you mean by "expect?"

1) Obviously I expect them to underperform at times. And based on past history--and I think even "slice and dice" advocates will agree--I expect those times of underperformance will often last long periods of time, on the order of a decade, and that when they occur they will require almost superhuman steadfastness to stay the course, and that even if mean reversion occurs and creates a long-term benefit, very few followers will keep holding it long enough to reap the rewards.

In other words, I expect "behavioral shakeout" during any period of underperformance. This means that over any period of time long enough to include them, investor returns will be lower than the theoretical stay-the-course growth-chart returns, and the size of the gap will be larger the greater the difference is. Thus I expect that even if tilts "work" over sufficiently long periods of time, in real life the behavioral losses will exceed the intrinsic benefits.

IMHO, people who don't think they commit behavioral errors are displaying overconfidence--a behavioral error.

2) If you mean, "do I believe that a tilted portfolio, constructed as advocates recommend currently, is so likely to underperform the market portfolio going forward from 2014, over some period of time, short, intermediate, or long, that I am willing to bet in the other direction," no. I wouldn't dream of switching from Total Stock to 500 Index, in order to exclude small-caps. Nor would I dream of switching from Vanguard Total International to Vanguard Developed Markets Index in order to exclude emerging markets.

3) I expect that tilts, and all the latest hot new discoveries in investing "science", will experience the same "decline effect" regrettably seen in scientific studies. And that people investing according to the best "science" will find that even if they faithfully stay the course, that fifteen years from now, they have experienced little if any benefit--but, contrariwise, little if any loss.

I also expect the received version of the tilt "story" to evolve gradually and subtly evolve over time, and that the advocates of tilts will look at today's portfolios and say "Oh, that old thing--that's the old, outdated version of the 'profitability' factor, and regardless of what was said at the time, I personally never believed in it. Everybody who is actually competent will tell you that what you need is not Novy-Marx profitability. If you want it to work, you need to base it on the Szent-Györgyi honorificabilitudinitatibus factor, which is Novy-Marx after you exclude the lower-mid-cap stocks and consumer non-durables, and average on the Bessel function instead of the mean. Here are the numbers based on the MSCI Global Honorificabilitudinitatibus Index--all the way back to its inception seven years ago."
Last edited by nisiprius on Sun Jul 13, 2014 9:48 am, edited 2 times in total.
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Re: Does anyone expect tilts to *under*perform?

Post by steve_14 »

ks289 wrote:
steve_14 wrote:I expect the expensive asset class everyone is making big bets on to underperform. In 2000 that was large caps. Today it's small caps and REITs.
So maybe tilters should bail out of overweighting small caps and/or REITs right now? I guess it wouldn't be the worst thing to get out now (as opposed to say 5 -6 years ago) after the recent run for small caps last few years and REITs this year.
I'm a stay the course kind of a guy, but if I were a tilt-and-bail, kind of a guy, I'd certainly be bailing from US small caps and REITs today. Small caps should have a higher, not lower cost of capital than blue chips. Of course, the market can stay irrational for longer than I can stay solvent.
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nedsaid
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Re: Does anyone expect tilts to *under*perform?

Post by nedsaid »

Nisiprius, your posts are brilliant. I laughed as you poked fun at factor based investing. Humor is a great way to make a point.

I agree with one of your points about investor behavior. "Behavioral shakeout" is an excellent way to describe what I believe will happen.

I am still tilting. I don't think it will hurt me and I have a good chance of getting a bit of a boost in performance. From my reading of your post, you don't think it will hurt these investors either if they stick to their plan. You are skeptical that there will be a performance premium from these tilts.
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peppers
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Re: Does anyone expect tilts to *under*perform?

Post by peppers »

This thread reminded me of an old fishing story....

Two friends get up early and set out on their boat, equipped with the latest electronic fish finders and the best rods, reels and lures money could buy. As the day goes on they are seen darting back and forth across the lake, hitting all the known "hot spots". At the end of the day they come in with the look of disgust on their faces. "The fish weren't biting, too much sun, no wind, water clarity is poor" and so on went the excuses.

A young boy fishing at the end of the pier, called it a day and pulled his stringer of fish out of the water. It was loaded with good size fish. The two friends looking on with amazement asked, "What were you using ?"

The young lad replied, "worms....grandpa always said stick to the basics."
"..the cavalry ain't comin' kid, you're on your own..."
steve_14
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Re: Does anyone expect tilts to *under*perform?

Post by steve_14 »

nisiprius wrote:I also expect the received version of the tilt "story" to evolve gradually and subtly evolve over time, and that the advocates of tilts will look at today's portfolios and say "Oh, that old thing--that's the old, outdated version of the 'profitability' factor, and regardless of what was said at the time, I personally never believed in it. Everybody who is actually competent will tell you that what you need is not Novy-Marx profitability. If you want it to work, you need to base it on the Szent-Györgyi honorificabilitudinitatibus factor, which is Novy-Marx after you exclude the lower-mid-cap stocks and consumer non-durables, and average on the Bessel function instead of the mean. Here are the numbers based on the MSCI Global Honorificabilitudinitatibus Index--all the way back to its inception seven years ago."
You'd never make it in the restaurant business, nisiprius. Your menu would be focused on steamed broccoli with tofu and brown rice, while I'd just come along with one full of sugary, deep fried goodies and bankrupt you in no time. People invest like they eat. They don't want to think about what's right (high mental effort). They want to do what feels good (low mental effort).

It's a warm, summer Sunday morning, so I say just for today we give the people what they want:

YES! You can beat the market by investing in Fund X.
YES! It's that easy.
YES! There are 1,061 irrefutable academic studies proving this.
YES! The market is completely predictable.
YES! This free lunch will last forever because it's risk based even though it's risk no one can actually find.

I'm gonna go celebrate with a Malboro and a maple glazed Krispy Kreme.
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Re: Does anyone expect tilts to *under*perform?

Post by berntson »

nedsaid wrote:I am not convinced that value is a risk story. We get told that Value stocks are riskier but mostly the proof is narrative. That is pretty much the "bad company" argument. One of the really respected Bogleheads took a bit of issue with my argument that the value premium is based on human behavior. He linked to a story and asserted that Value was a risk story. When I actually read the article, the performance of large value beat large growth and small value beat small growth. In each case however, the standard deviation of the value stocks was LESS than the growth stocks. More reward for less risk.
The 2011 Credit Suisse Yearbook has a nice chart illustrating Ned's point. Dimson, Marsh and Staunton look at the value premium (more precisely, the high-yield premium) in 21 countries over the last 45 years.

Image

High-yield stocks had lower standard deviation and lower beta than the rest of the market, despite having higher returns. Here is a chart for the value premium across those 21 countries.

Image
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Re: Does anyone expect tilts to *under*perform?

Post by steve_14 »

peppers wrote:This thread reminded me of an old fishing story....

Two friends get up early and set out on their boat, equipped with the latest electronic fish finders and the best rods, reels and lures money could buy. As the day goes on they are seen darting back and forth across the lake, hitting all the known "hot spots". At the end of the day they come in with the look of disgust on their faces. "The fish weren't biting, too much sun, no wind, water clarity is poor" and so on went the excuses.

A young boy fishing at the end of the pier, called it a day and pulled his stringer of fish out of the water. It was loaded with good size fish. The two friends looking on with amazement asked, "What were you using ?"

The young lad replied, "worms....grandpa always said stick to the basics."
Great story. Unfortunately if everybody goes with worms and simple rods, nobody gets paid. The fishing industry doesn't, the media covering latest fish finding developments doesn't, and the academic world publishing-or-perishing about the latest advances in fishing technology (who make most of their money as "consultants" to the fishing industry) doesn't. And a lot of folks don't have have grandpas to provide advice.

So it's no wonder the pair in your story wound up with all that gear.
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Taylor Larimore
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Tilting.

Post by Taylor Larimore »

I am still tilting. I don't think it will hurt me.
It can "hurt":

This was Morningstar's annualized returns for various periods ending 6-30-00:
Style.......1 Yr.....3 Yr.....5 Yr....10 Yr....15 Yrs.

LCG......27.19...27.04....24.98...17.85....17.15
LCB........8.93...17.29....20.35...15.60....15.23
LCV.......-5.21....8.74.....15.16..13.36....13.45

MCG.....57.24....31.09...24.81...18.14....16.82
MCB.....11.87....12.36...16.09...14.12....14.23
MCV.....-2.56......7.23...13.20...12.77....12.64

SCG.....55.14....24.42...20.86...17.12....15.64
SCB.....17.77....10.08...15.30...13.03....12.02
SCV......3.29.....3.55....12.58...11.80....11.34

Past performance does not forecast future performance.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
steve_14
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Re: Does anyone expect tilts to *under*perform?

Post by steve_14 »

berntson wrote:High-yield stocks had lower standard deviation and lower beta than the rest of the market, despite having higher returns. Here is a chart for the value premium across those 21 countries.
I'll assume that's one of those academic data sets where value always wins, not real fund results, where it does not.
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packer16
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Re: Does anyone expect tilts to *under*perform?

Post by packer16 »

Taylor,

Don't returns include funds that are categorized as value/growth versus actual index funds with stocks having these attributes? Wouldn't this also affect returns as there is uncertainty in the categorization methodology which mask the value/growth factor. Index funds remove this uncertainty.

I have graphed this on M* and the difference is significant. Over 21 years since the DFA SCV fund started the after-fee total is $125,140 vs. $86,493 for the small value M* average fund. On an annualized basis that is almost 200bp. The largest period of underperformance was from 1998 to 2000 but that more than reversed itself by the end of 2001.

Packer
Last edited by packer16 on Sun Jul 13, 2014 12:34 pm, edited 2 times in total.
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Re: Does anyone expect tilts to *under*perform?

Post by Longtimelurker »

Steve - you show up to every small value thread. You admit there Are 1000's of papers show the existence and persistence of these premiums. You ignore real fund results like DFA. Then you basically say "I don't believe it, and you all are stupid if you don't trust me." It's... Odd
Stay the course. If you can't resist greed, and fear is proven to be 2x as strong, you are doomed as an investor.
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Taylor Larimore
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Morningstar category definition ?

Post by Taylor Larimore »

packer16 wrote:Taylor,

Don't returns include funds that are categorized as value/growth versus actual index funds with stocks having these attributes? Wouldn't this also affect returns as there is uncertainty in the categorization methodology which mask the value/growth factor. Index funds remove this uncertainty.

I have graphed this on M* and the difference is significant. Over 21 years since the DFA SCV fund started the after-fee total is $125,140 vs. $86,493 for the small value M* average fund. On an annualized basis that is almost 200bp. The largest period of underperformance was from 1998 to 2000 but that more than reversed itself by the end of 2001.

Packer
Packer:

As you suggest, I understand that Morningstar categorizes managed funds and index funds together within categories.

Past performance does not predict future performance.

Best wishes.
Taylor
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Bracket
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Re: Does anyone expect tilts to *under*perform?

Post by Bracket »

Longtimelurker wrote:Steve - you show up to every small value thread. You admit there Are 1000's of papers show the existence and persistence of these premiums. You ignore real fund results like DFA. Then you basically say "I don't believe it, and you all are stupid if you don't trust me." It's... Odd
I too have noticed this, and find it...annoying.
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Re: Does anyone expect tilts to *under*perform?

Post by American In Korea »

brigboy wrote:I guess I shouldn't feel bad that my 401(k) is all allocated into the S&P500 and Index Bond Fund each with an expense ratio of 0.08 and 0.13 respectively. The rest of the fund options I have are all 0.5-3% (plan to max going forward)

My Roth IRA is basically all in a Vanguard Total Stock Index Admiral (VTSAX) (~11k).

I have a taxable account consisting of Vanguard Total International - it's doing quite poor.

I just feel like I'm "missing out" by not tilting my portfolio I guess, seeing as my whole portfolio is basically US domestic stock. What do you guys think?
I was thinking of making changes perhaps getting rid of my VTSAX and replacing it with like one of the following:
a) Vanguard Extended Market Index (small, mid cap)
b) Vanguard Small Cap Index
c) Vanguard Mid Cap Index
d) Vanguard Emerging Markets Index
e) Vanguard REIT Index
You're also missing out on complexity and higher expense ratios. You should be thinking longer-term. VTSAX is your best bet
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Taylor Larimore
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The enemy of a good plan . .

Post by Taylor Larimore »

American In Korea wrote:
brigboy wrote:I guess I shouldn't feel bad that my 401(k) is all allocated into the S&P500 and Index Bond Fund each with an expense ratio of 0.08 and 0.13 respectively. The rest of the fund options I have are all 0.5-3% (plan to max going forward)

My Roth IRA is basically all in a Vanguard Total Stock Index Admiral (VTSAX) (~11k).

I have a taxable account consisting of Vanguard Total International - it's doing quite poor.

I just feel like I'm "missing out" by not tilting my portfolio I guess, seeing as my whole portfolio is basically US domestic stock. What do you guys think?
I was thinking of making changes perhaps getting rid of my VTSAX and replacing it with like one of the following:
a) Vanguard Extended Market Index (small, mid cap)
b) Vanguard Small Cap Index
c) Vanguard Mid Cap Index
d) Vanguard Emerging Markets Index
e) Vanguard REIT Index
You're also missing out on complexity and higher expense ratios. You should be thinking longer-term. VTSAX is your best bet
Brigboy:

Concentrate on your stock/bond ratio which, more than anything, will determine your expected risk and return. Strive for simplicity, not complexity--then stay-the-course.
"The enemy of a good plan is the dream of a perfect plan." -- Jack Bogle.
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
RunningRad
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Re: Does anyone expect tilts to *under*perform?

Post by RunningRad »

Bracket wrote:
Longtimelurker wrote:Steve - you show up to every small value thread. You admit there Are 1000's of papers show the existence and persistence of these premiums. You ignore real fund results like DFA. Then you basically say "I don't believe it, and you all are stupid if you don't trust me." It's... Odd
I too have noticed this, and find it...annoying.
Really? I find it amusing. :)
Few decisions in life motivated by greed ever have happy outcomes--Peter Bernstein, The 60/40 Solution
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stlutz
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Re: Does anyone expect tilts to *under*perform?

Post by stlutz »

Just to clarify what I was originally asking. My focus is on whether anyone expects various tilts (smalll/value/momentum/profitability etc) to underperform over the long haul.

I read a paper once on the DFA site where Fama stated that over any 15 year period, tilting to value gives you an 85% chance of outperforming the market. Is there anyone who takes the opposite side of that bet--that over any given 15 year period going forward, there is an 85% chance of underperforming the market by doing some type of tilt? To put it succinctly, does anyone consider, say, small/value or high momentum to be the "black hole of investing"? Right now it looks like I have 1 "yes."

I wasn't looking for another pissing match over tilting--just curious if there are people who take the exact opposite side on these debates.
livesoft
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Re: Does anyone expect tilts to *under*perform?

Post by livesoft »

The statistics may not tell the entire story. Typing off the top of my head here …

Suppose Small-cap growth trails Small-cap value by 0.5% over the past 10 years. Then in the next 6 months, Small-Cap value trails small-cap growth by 10%. If one calculates the 10.5 year performances, which one now comes out ahead? I suppose it will depend on the absolute magnitude of the performance to some extent.

Some of this is hinted at in Taylor Larimore's post in this thread showing the 1-year performances of growth funds at the end of June 2000. We all know what happened in the run-up to March 2000, so this is data mining at its finest. I like it alot.
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Trader Joe
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Re: Does anyone expect tilts to *under*perform?

Post by Trader Joe »

No, I do not expect small and value tilts to under perform in a long-term buy and hold porfolio.
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nedsaid
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Re: Does anyone expect tilts to *under*perform?

Post by nedsaid »

StLutz, there is actually a good discussion in the Value and Momentum thread. Berntson and JoMoney are having their usual friendly sparring In that thread. JoMoney believes there is a premium in performance for the stocks that show consistent growth over time. It sounded like he believes in the "quality" premium that Larry Swedroe talks about. You would expect the highest quality stocks to be in the large cap arena and those with the consistent growth year after year to be in the growth category. He also opined that value might be a higher turnover strategy than a classic growth strategy. Not sure I agree, but as usual he gets me to thinking.
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Kevin M
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Re: Does anyone expect tilts to *under*perform?

Post by Kevin M »

stlutz wrote: I wasn't looking for another pissing match over tilting--just curious if there are people who take the exact opposite side on these debates.
So, for example, is anyone tilting to large-cap growth? That would be evidence that someone is taking the opposite side of the small-value bet. I think all someone has to do to answer your question is tell us that they are doing something like this.

I am not. Staying the course with my small-value tilt, but not overconfident about it, so generally recommend going with something like Vanguard LifeStrategy or Target Retirement funds as good starting-point portfolio models. Deviate only if you have done lots and lots of studying, and even then be cautious.

Kevin
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Calm Man
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Re: Does anyone expect tilts to *under*perform?

Post by Calm Man »

I, no expert in these matters, but an expert in using Vanguard's Total Stock Market Index fund Admiral Shares at 5 basis points per year, doubt there will be overperformance going forward. The past overperformance, whatever time period it is said to have happened, could either have been luck or real. If real, the smart people will arbitrage it away. Remember that quote from I think Sinclair Lewis that is referred to often at this site? Something like "never expect a person to accept a fact if his living depends on the contrary? (not exactly). Well there is a huge company with a lot of people who are employed by it (DFA) and an army of investment advisers who these DFA people do not deem worthy of selling their products until DFA certifies them (good lord) who's very livelihood requires tilting to be believed to be of value. Can you blame any one of them for showing you all sorts of proof, evidence, studies, and whatever else they can come up with to justify the higher costs and higher tax costs to boot from using "tilted" funds? Rant over.
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tadamsmar
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Re: Does anyone expect tilts to *under*perform?

Post by tadamsmar »

stlutz wrote:In the incessant back and forth over various tilts/smart beta/active bets (pick your favorite phrase), we have people who:

a) Say that they expect such strategies to outperform, some going so far as to say that there are no circumstances in which they shouldn't be expected to do so;

b) That free lunches are arbitraged away and that such strategies should simply be expected to do no better or worse than that market over the long run.

Is there anyone who will contend for option (C): that such strategies should be expected to underperform the market over the long-haul (e.g. 20 years)?

Included in this list of strategies would be value, small, momentum, quality, and low volatility.
I think there is some increased costs for these strategies even in a tax-deferred account. There must be additional stock trading in a non-cap-weighed fund. And the ERs might be a bit higher. And some funds have hidden soft dollar fees, but no soft dollars on Vanguard index funds that are managed in-house.

If one took a strictly efficient market viewpoint, then increased costs would not be reimbursed, so one could argue the expected risk-adjusted return would be lower.
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stlutz
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Re: Does anyone expect tilts to *under*perform?

Post by stlutz »

So, for example, is anyone tilting to large-cap growth? That would be evidence that someone is taking the opposite side of the small-value bet. I think all someone has to do to answer your question is tell us that they are doing something like this.
Thanks, Kevin. That's a great way to put it.
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nisiprius
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Re: Does anyone expect tilts to *under*perform?

Post by nisiprius »

nedsaid wrote:Nisiprius, your posts are brilliant. I laughed as you poked fun at factor based investing. Humor is a great way to make a point.

I agree with one of your points about investor behavior. "Behavioral shakeout" is an excellent way to describe what I believe will happen.

I am still tilting. I don't think it will hurt me and I have a good chance of getting a bit of a boost in performance. From my reading of your post, you don't think it will hurt these investors either if they stick to their plan. You are skeptical that there will be a performance premium from these tilts.
You read me correctly.

Or, to state it a little more carefully, after 15 or 20 years, the tilted portfolio will either perform better or worse than the market portfolio, but nobody will be able to know for sure whether the better-performing portfolio was intrinsically better, or whether it was just the luck of that particular pair of endpoints.
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ASUGrad
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Re: Does anyone expect tilts to *under*perform?

Post by ASUGrad »

stlutz wrote:Just to clarify what I was originally asking. My focus is on whether anyone expects various tilts (smalll/value/momentum/profitability etc) to underperform over the long haul.

I read a paper once on the DFA site where Fama stated that over any 15 year period, tilting to value gives you an 85% chance of outperforming the market. Is there anyone who takes the opposite side of that bet--that over any given 15 year period going forward, there is an 85% chance of underperforming the market by doing some type of tilt? To put it succinctly, does anyone consider, say, small/value or high momentum to be the "black hole of investing"? Right now it looks like I have 1 "yes."

I wasn't looking for another pissing match over tilting--just curious if there are people who take the exact opposite side on these debates.
"Is there anyone who takes the opposite side of that bet--that over any given 15 year period going forward, there is an 85% chance of underperforming the market by doing some type of tilt?"

You already answered your own question. DFA says that. By definition if they say tilting to value will outperform 85% of the time then they are also saying that tilting to growth will underperform 85% of the time. This is what I got at with my earlier post, and I assume I'm the 1 yes. If not you have at least 2. There are so many strategies some contradict each other. Do a quick google search. There are plenty of articles during previous market cycles where people made arguments you should tilt to growth.

Momentum is the easiest to prove as complete crap. If you were a momentum trader in the late 90s you would have been super heavy in tech stocks that were skyrocketing. They had lots of momentum. You could argue that once they had downward momentum you would have jumped on the shorting bandwagon, but now you are basically a day trading chartist. We know how that normally turns out.

And if everyone 'does' do something that is how you get assets priced wrong in the market. If everyone tilts small value then small value stocks will be overvalued compared to their actual value. Now yes looking at an individual company it would go from value to growth once it had too much invested in it, but looking at the value index vs the growth. If everyone invests in value it will just bring the PE ratios of value and growth closer together.

'Everyone' wanted tech in the late 90s. If everyone wants something... it never ends well. If there was a way to consistently beat the market once enough people started doing it the advantage would be lost. Study up on arbitrage, it only works if you are the first to the table.
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nisiprius
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Re: Does anyone expect tilts to *under*perform?

Post by nisiprius »

stlutz wrote:
So, for example, is anyone tilting to large-cap growth? That would be evidence that someone is taking the opposite side of the small-value bet. I think all someone has to do to answer your question is tell us that they are doing something like this.
Thanks, Kevin. That's a great way to put it.
Well, Fidelity Contrafund (FCNTX), American Growth Fund of America (AGTHX), Vanguard PRIMECAP Core (VPCCX), AQR Momentum Fund (AMOMX), the one-much-lauded Janus Fund (JDGAX) and Fidelity Magellan Fund (FMAGX) are all large growth funds, so the investors in these funds, or at least their fund managers, seem to be taking the opposite side of the bet.

(Or is it widely believed that it is easier to recognize undervalued within the large growth category than within any of the eight others???)

But it's not just active funds. Even if we look at index funds,

the Vanguard [Large-Cap] Growth Index Fund, VIGRX, has $39.5 billion in assets, while
Vanguard Small-Cap Value Index, VISVX, has only $13.3 billion in assets.

In other words, Vanguard-fund indexers, voting with their dollars, have voted 3:1 for large growth over small value.

(Candor compels me to spoil that observation by adding that investors have been able to vote for VIGRX for about 22 years, and for VISVX only for about 16 years, but still.)

What on earth that means, I have no idea. There are nine Vanguard "style box" funds and it would be very very interesting to know what sort of investor buys each of them and why.
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grabiner
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Re: Does anyone expect tilts to *under*perform?

Post by grabiner »

nisiprius wrote:
stlutz wrote:
So, for example, is anyone tilting to large-cap growth? That would be evidence that someone is taking the opposite side of the small-value bet. I think all someone has to do to answer your question is tell us that they are doing something like this.
Even if we look at index funds,
the Vanguard [Large-Cap] Growth Index Fund, VIGRX, has $39.5 billion in assets, while
Vanguard Small-Cap Value Index, VISVX, has only $13.3 billion in assets.
This also reflects the different size of the sectors. If there is six times as much in the large-cap indexes as the small-cap index, there is no overweighting, because the large-cap index (top 85% of the market) has six times the market cap of the small-cap index (85-98%).

Considering large/small and growth/value separately:

Mega-cap (ETF and institutional only): $1.4B growth, $1.0B value
Large-cap: $39.5B growth, $31.6B value
Mid-cap: $4.5B growth, $5.7B value (these indexes are newer)
Small-cap: $15.0B growth, $13.5B value

And among the blend indexes:
Mega-cap (ETF and institutional only): $1.0B
500 and Institutional index: $378.8B (unlike most institutional shares, these are separate funds)
Large-cap: $8.8B (this index is newer than the large-cap growth and value)
TM Capital Appreciation (also a large-cap index): $5.8B
Mid-cap: $50.9B
Small-cap: $46.7B
TM Small-Cap: $3.4B
Totals: $444.5B large, $50.1B small

So Vanguard index investors have a slight bias for growth over value, and for large over small (primarily due to the popularity of the S&P 500).
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tadamsmar
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Re: Does anyone expect tilts to *under*perform?

Post by tadamsmar »

stlutz wrote:Just to clarify what I was originally asking. My focus is on whether anyone expects various tilts (smalll/value/momentum/profitability etc) to underperform over the long haul.

I read a paper once on the DFA site where Fama stated that over any 15 year period, tilting to value gives you an 85% chance of outperforming the market. Is there anyone who takes the opposite side of that bet--that over any given 15 year period going forward, there is an 85% chance of underperforming the market by doing some type of tilt?
You are not clarifying the question in the OP or the title line, you are changing the question.

I don't think you understand the questions you are asking. You have asked two different questions with two different answers: yes to the first and no to the second.

There is the costs argument that tilts have the expected risk-adjusted performance over the next 20 years of non-tilts before costs, but under-perform after costs. So yes, there is reason to expect tilts to under-perform.

This cost argument is true even if the "the other side of the bet" is no better. So no, the other side of the bet is not better.
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Re: Does anyone expect tilts to *under*perform?

Post by richard »

stlutz wrote:<>I read a paper once on the DFA site where Fama stated that over any 15 year period, tilting to value gives you an 85% chance of outperforming the market.<>
Can you (or anyone) provide a link?

Knowing the claimed magnitude would be good. If you outperform by a bit 85% of the time and underperform by a lot 15% of the time, the total could be over, under or equal.

Remember that Fama has said TSM is efficient, but tilt a bit if you want to take more risk with the goal of more return.
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Re: Does anyone expect tilts to *under*perform?

Post by Kevin M »

My first slice and dice portfolio was four corners, so equal amounts in Large-Growth, Large-Value, Small-Growth, Small-Value (and also some in REIT and international). So I wasn't betting one way or the other, but just looking for the diversification effect of multiple asset classes with correlations to each other of less than 1.

Since in aggregate all investors own the market, for everyone who over-weights small-value someone must be under-weighting it. So by definition, yes, there are investors whose behaviors indicate they expect the small and value tilts to under-perform, and ditto for any other tilts. I think I have this right.

I think stlutz was asking if any forum participants are betting against the academic risk factors that we know about.

Another interesting example would be shorting small-value and using the proceeds to buy large-growth, since that would be a pure bet against the small-value factor while eliminating any bet on the market.

Kevin
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