Vericimetry is an interesting startup. They've filed for a small-cap multi-factor value fund. From their website:
We believe there is not a single measure of value. Instead, we believe in a multifactor approach, using metrics such as:
Book to market
Earnings to price
Sales to price
Cash flow to price
Each of these metrics corresponds to varying degrees with different measures of risk. In our view, using a multifactor approach provides a deeper and truer exposure to value.
I think their take on single-factor versus multi-factor value has merit. Each value factor has it's day in the sunshine and day in the doghouse. A multi-factor approach smooths this out.
CEO Gleen Freed used to be DFA's tax guy. He Dr. Freed received a Ph.D. in Philosophy from the Graduate School of Business at USC and holds a B.S. degree in Accounting from the University of Florida.
CIO Andrew Berkin was a director at First Quadrant. B.S. with honors in physics from the California Institute of Technology in 1983, and his Ph.D. in general relativity from the University of Texas at Austin in 1989. He is literally a rocket scientist, having worked at the Jet Propulsion Laboratory in the 1990s.
The expense ratio in the filing is 0.60%.
This is another example of competition for DFA, along with RAFI funds, Bridgeway funds, M*, Vanguard, traditional value index funds such as S&P and Russell, and a growing variety of factor-based value stock offerings that are on the market or on the way.
BTW, for an excellent reveiw of various value factors and their effect on large and small cap portfolios, see the newly released 4th edition of What Works on Wall Street by Jim O'Shaughnessy. It's a wonderful source of factor data going back many decades.
Rick Ferri
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.
A Devout Indexer wrote:Bridgeway Ultra Small Co Market = +8.1%
Vanguard Small Cap Index Institutional = 6.8%
While the REIT index comparison might be fair, this is comparing apples and oranges, as the small-factor loading is much larger in BRSIX. In fact, the MSCI index that Vanguard tracks has an average market cap 8x has large as the BRSIX fund.
ftrobin
yes that is true, and what investors need to understand are two key points
First, the higher loadings mean higher expected return. So you really should look not an ER (plus other expenses and revenues like from securities lending, typically higher the lower the market cap) but the cost per unit of risk (or expected return).
Second, the higher expected return allows one to hold less equity risk for the same expected return with two benefits--the FI side is or can be cheaper than the equity side, lowering total portfolio expenses and you cut the potential dispersion of returns.
Best
Larry
Rick Ferri wrote:Vericimetry is an interesting startup. They've filed for a small-cap multi-factor value fund. From their website:
We believe there is not a single measure of value. Instead, we believe in a multifactor approach, using metrics such as:
Book to market
Earnings to price
Sales to price
Cash flow to price
Each of these metrics corresponds to varying degrees with different measures of risk. In our view, using a multifactor approach provides a deeper and truer exposure to value.
I think their take on single-factor versus multi-factor value has merit. Each value factor has it's day in the sunshine and day in the doghouse. A multi-factor approach smooths this out.
If I recall correctly, MSCI value indexes use Book to Market, Earnings to Price, and dividends to price, equally weighted. Does Vericimetry plan on having deeper value, or is it another 50/50 market split?
I'm curious as to whether their weighting system is algorithmic or subjective, and if algorithmic, why wouldn't they create an ETF...
Rick Ferri wrote:I agree in general with Larry's remarks. However, I believe when we see Allan's follow up article that the evidence will be pretty clear that advisors are among the worst performance chasers of any group of investors. I have not seen his article, but that's what I'm expecting the evidence to show.
Rick Ferri
Rick - thanks for posting this piece - fascinating discussion. I've written on how "fee-only advisors" timed the market poorly, when TD Ameritrade released some data on their advisor platform.
Tomorrow's piece will look at the dollar weighted (investor) returns vs. fund returns for the largest five DFA funds over the past five years. I agree with you that the key word is "good" in Bill Schultheis statement "Good advisors are incredibly valuable to the vast majority of investors." 99% of advisors I've met claim they buy low and sell high, but there is substantial evidence that, as a whole, advisors performance chase as well. Yes - we advisors are human too.
Rick Ferri wrote:This is another example of competition for DFA, along with RAFI funds, Bridgeway funds, M*, Vanguard, traditional value index funds such as S&P and Russell, and a growing variety of factor-based value stock offerings that are on the market or on the way.
I'm not convinced that RAFI is a viable option at this time. While I have nothing against their products in theory, their execution by Schwab has been less than stellar, with a tracking error that would pretty much wipe out any "benefits" you would get from tilting in the first place. Their domestic tracking error hasn't been that bad, but their international funds are, in my view, shameful: http://www.bogleheads.org/forum/viewtop ... t#p1275216
But I agree that competition for DFA is a good thing (particularly when I have no access to DFA and couldn't buy their products if I wanted to).
Rick Ferri wrote:The MSCI value indexes that Vanguard uses are capitalization weighted.
I meant that the application of the value factors were equally weighted to determine which stocks were value and which weren't. E.g., 1/3 P/B, 1/3 P/E, and 1/3 P/dividends. Yes, within the MSCI value universe it is capitalization weighted.
Growth no Value
Value no Growth
Value and Growth
No Growth and No Value
The problem with MSCI style methodology is the "no-growth, no-value' category that's split equally between growth and value. That dilutes the value weight in Vanguard funds. Value fund investors don't want "no-value" in the portfolio. I have made this point several times with Vanguard. It seems to have fallen on deaf ears. They think the value/growth indexes together should be "complete". They're missing the point.
Also, I'd like to see equal weighted value indexes. I'm not trying to capture cap weighing in a value tilted fund, I'm trying to capture the value aspect of it. This is why RAFI, DFA and S&P pure value makes sense. They're not cap weighted. They're not as cheap either, so there's a trade-off, as Larry noted above (what is the cost per unit of risk?).
Rick Ferri
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.
psteinx wrote:Here is a quick scenario and some questions for the advisors and their supporters out there:
Let's say that you have a relatively high income individual with above average intelligence. A college professor or an engineer or a small business owner or whatever.
They're somewhere in the 25 to 35ish age and have dabbled in various savings vehicles, had some ups and downs, and are now getting more serious about both savings rate and appropriate savings/investment vehicles.
They're not financially illiterate or incompetent, but they're not the type who is willing to spend many hours reading the Bogleheads forum or reading 6 different books on investing.
i.e. I would consider this person a near-ideal case for help from a GOOD advisor. But also, a candidate to perhaps get mediocre results from an average or worse advisor (depending, I suppose, on how we feel about the results developed by the average or even the 25th percentile advisor).
Why does following the Boglehead strategy require hours of reading the Boglehead forum or reading 6 books on investing? Most of the posts from long time posters on here are either helping new investors set things up or some discussion that has little or no impact on their investment plan. Obviously you probably want to read at least 1 book on index investing. But if you understand the basics, you don't have to make it more complicated. You don't even have to read a book... you could read the Wiki, but a book might help you crystallize a gameplan.
If the person does not want to spend the 1 week it requires to read a book on index investing, then chances are they won't know much about what kind of advisor to look for.
3CT - I guess the basic question is the relatively likelihood that an individual with relatively low interest/knowledge in financial issues will end up with good results with a somewhat haphazardly chosen advisor vs. a somewhat haphazardly chosen DIY path.
Of course, one can hope that such individuals will follow best practices in either case, do good research from a variety of sources and so on. But I suspect that only a limited number of people actually do that.
So, comparisons between best case DIY vs. average advisor or average case DIY vs. best case advisor are both misleading, IMO, when trying to think of how a typical average or below average investor might fare.
Also note that even among those who spend a lot of time thinking and reading about these issues, and perhaps reading this forum or a similar one, there may be disagreement about the best case plan for either a DIYer or someone selecting and using an advisor.
psteinx wrote:3CT - I guess the basic question is the relatively likelihood that an individual with relatively low interest/knowledge in financial issues will end up with good results with a somewhat haphazardly chosen advisor vs. a somewhat haphazardly chosen DIY path.
Of course, one can hope that such individuals will follow best practices in either case, do good research from a variety of sources and so on. But I suspect that only a limited number of people actually do that.
So, comparisons between best case DIY vs. average advisor or average case DIY vs. best case advisor are both misleading, IMO, when trying to think of how a typical average or below average investor might fare.
In your prior post, you said...
They're not financially illiterate or incompetent, but they're not the type who is willing to spend many hours reading the Bogleheads forum or reading 6 different books on investing.
I interpreted that to mean... they are intelligent enough to read and understand a book like The Four Pillars of Investing or The Little Book of Common Sense Investing, but they don't want to spend extensive time constantly researching on this forum or by reading more books.
I would argue that it doesn't require anything beyond 1 week of reading a book, and a day setting up your portfolio. It is this simple: 1) Set up a simple portfolio consisting of anywhere from 2-5 funds, 2) that you will adjust once every 5 or 10 years as you age to be more conservative, and finally 3) ignore the market noise. The less you think about your portfolio the better off you will be. Maybe someone like Larry Swedroe or Rick Ferri would be worth it if that is too much or you know you will bail on your plan at the worst time.
If that was the only book you'd read on the topic, do you think your investment strategy today would be a good one?
My point is not that everyone is going to stumble on the Boglehead way. My point is that once you are exposed to and convinced of the Boglehead way, it doesn't require any more effort. Once the investment plan is set in place, less is more.
1210sda wrote:I believe (?) that DFA's Core Equity 1 or Core Equity 2 funds are supposed to be a "one fund" approach for an investors equity portfolio needs.
1210
I'm assuming you're talking about US Core Equity 1 or US Core Equity 2 Funds which are NOT meant to be a "one fund" approach. (You might want to add Int'l SC, Int'l Core Equity, addt'l SC Value if you want that tilt, perhaps DFREX- real estate) Not sure why the advisors posting in this topic aren't responding to this question.
Rick Ferri wrote:I agree in general with Larry's remarks. However, I believe when we see Allan's follow up article that the evidence will be pretty clear that advisors are among the worst performance chasers of any group of investors. I have not seen his article, but that's what I'm expecting the evidence to show.
Rick Ferri
Rick - thanks for posting this piece - fascinating discussion. I've written on how "fee-only advisors" timed the market poorly, when TD Ameritrade released some data on their advisor platform.
Tomorrow's piece will look at the dollar weighted (investor) returns vs. fund returns for the largest five DFA funds over the past five years. I agree with you that the key word is "good" in Bill Schultheis statement "Good advisors are incredibly valuable to the vast majority of investors." 99% of advisors I've met claim they buy low and sell high, but there is substantial evidence that, as a whole, advisors performance chase as well. Yes - we advisors are human too.
Alan, disappointed to hear your case will rest on Morningstar dollar weighted returns over a 5 year period. They of course are unable to account for $s that move from one fund to another for tax reasons or simplification purposes. For example, are we to believe investors were terrible timers (as if DFA would allow this) in US Small Value with returns of 2% less than the fund returned, but had terrific timing with the US Core 2 fund, with returns of 2% more than the fund returned?
Also, the choice of star ratings was a let down as the basis of performance attribution, but that's been covered extensively already so I won't pile on.
A note from Jim Davis on why "investor returns" are misleading (see bold):
In an effort to determine the returns earned by a typical investor, analysts sometimes estimate the dollar-weighted returns of mutual funds. They reason that a return calculation that explicitly accounts for flows in and out of portfolios should give a clearer picture of investors' effective returns than just looking at average portfolio returns over time. Some of these studies report that the effective returns earned by investors are substantially below the compound average returns reported by the funds in which they invest. By moving in and out of funds, investors appear to hurt themselves on average, and the damage is, by some accounts, substantial.
Do these dollar-weighted return calculations give a reasonable estimate of the actual returns earned by a typical investor? Consider a hypothetical example of a mutual fund that has two investors, Frank and Julia. Frank moves his wealth back and forth between the mutual fund and a bank account. Each year he observes a signal from a trading model. If the signal is positive, he puts everything in the equity mutual fund. If the signal is negative, he puts everything in a bank account that earns 3% per annum. In contrast, Julia leaves her funds fully invested in the equity mutual fund. She makes no attempt to switch back and forth between stocks and other investments. Both investors start with $1,000.00.
I draw 50 annual fund returns from a normal distribution with a mean of 9% and a standard deviation of 16%.1 I then draw 50 trading signals at random for Frank, so that he is in the mutual fund 50% of the time. The rest of the time, he is invested in the bank account.
The following results summarize the simulation:
Equity fund arithmetic average return 9.0%
Equity fund compound average return 7.8%
Equity fund dollar-weighted average return 7.5%
Julia's compound average return 7.8%
Frank's compound average return 5.0%
Since Julia remained in the mutual fund, her compound average return is the same as that of the fund. In contrast, being out of the market half of the time had a noticeable impact on Frank's return. Since the trading signals are drawn at random, it is no surprise that Frank has a lower compound average return than the all-equity mutual fund. Trading signals drawn at random would add value only by chance, and Frank's expected return should be somewhere between the expected return of the fund and the rate on his bank account.
The main issue is not whether investors can find successful trading rules. I want to know whether the fund's dollar-weighted return is an accurate representation of the returns earned by the fund shareholders. The answer here is no. The fund's dollar-weighted return is 7.5%, but the weighted average compound return of Julia and Frank is 6.9% (using average wealth as the weights). The simple average of their compound returns is 6.4%. The fund's dollar-weighted return is below its compound average return, but it is still above the effective return of the fund's investors.2
Why do we see this result? The dollar-weighted return is essentially an internal rate of return (IRR). The IRR is the discount rate that sets the present value of all the periodic cash flows equal to the initial value of the fund. An implicit assumption of the IRR calculation is that intermediate cash flows are reinvested at the IRR. In this simulation, since the fund's dollar-weighted return is 7.5%, the IRR calculation assumes that yearly cash flows are invested at this 7.5% rate. We know that is not the case; Frank's cash flows out of the fund are reinvested in a bank account that pays 3%. The reinvestment assumption is too high, and that is why the dollar-weighted return of the fund is higher than the effective return of the fund shareholders.
This example shows that a fund's dollar-weighted return does not necessarily reflect the performance achieved by the fund's investors. It also shows why trading models that switch between equities and money market instruments have the potential to earn effective rates of return even lower than the dollar-weighted returns of the equity funds they are trading. The implication should be sobering: The low dollar-weighted returns reported in some studies might actually overstate the effective returns of fund shareholders, due to the reinvestment rate assumption.
The foregoing discussion ignores the impact on fund returns of investors who trade frequently. In the example, the fund returns were drawn randomly from a probability distribution, and it was assumed that the flows in and out of the fund had no impact on the return realizations. In fact, shareholders who trade frequently in and out of funds can have a detrimental effect on the fund's performance. This is especially true if the fund invests in illiquid securities. Consequently, frequently trading investors may not just harm themselves; they may also negatively impact the investment experience of others.
Another aspect of dollar-weighted returns deserves mention. Suppose a particular mutual fund experiences positive cash flow throughout most of its history. The fund shareholders are not trying to time the market; instead, they simply put their savings into the fund each period. In this case, the dollar-weighted returns of the fund will be heavily influenced by the returns of more recent periods. The returns earned in the early years of the fund will have a lower impact than those from the later years. Funds with good recent performance and consistent inflows will report attractive dollar-weighted returns, possibly above their compound average returns. On the other hand, funds with consistent inflows and low recent returns will not compare favorably on a dollar-weighted basis, since the recent poor returns receive a heavier weight than the early returns that may have been higher. This shows that poor dollar-weighted returns do not always reflect frequent trading.
This discussion might lead some to conclude that dollar-weighted returns are meaningless. I do not believe that to be the case. However, I believe there are other factors that are at least as important in judging the relative merits of mutual funds. These other factors include asset class definition, style consistency, portfolio turnover, and expenses, to name a few.
There is another question about DWRs that need an explanation. What do people do with their money when it's not invested in a fund? That's never talked about. The money is someplace earning something. The investors TOTAL return over the period isn't accounted for in DWR numbers.
Rick Ferri
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.
The problem with MSCI style methodology is the "no-growth, no-value' category that's split equally between growth and value. That dilutes the value weight in Vanguard funds. Value fund investors don't want "no-value" in the portfolio. I have made this point several times with Vanguard. It seems to have fallen on deaf ears. They think the value/growth indexes together should be "complete". They're missing the point.
Rick, I personally agree with you (for different reasons) but I think Vanguard is up to something different than what you are. You tilt to value because you think you can get better returns that way, arguably with more risk. In contrast, Vanguard is trying to essentially replicate the average value or growth fund, just at a much lower cost. The no-growth, no-value companies are owned by *somebody*. Logically, it's probably a mix of growth and value investors. Hence the index splits those companies 50/50 between the two indexes.
Fwiw, here is an article from about 1 month ago indicating DFAs worst performing equity fund last year (-25%), and a laggard in the fall upswing, continued to see industry leading inflows: http://blogs.barrons.com/focusonfunds/2 ... hoobarrons
Since this time, it's jumped almost 11% and about 250bps more than the average EM fund. DFA may be good or bad depending on your views (or your stance on M* star ratings), but one thing they are not is poorly timed.