Bridgeway's explanation on BRSIX

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Robert T
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Bridgeway's explanation on BRSIX

Post by Robert T »

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As indicated in some other threads, in 2009 the Bridgeway Ultra-small company market fund (BRSIX) lagged its primary benchmark (CRSP10) by 55%. The respective returns were 25.96% for BRSIX vs. 81.12% for CRSP10.

May be of interest - the lastest Bridgeway report has an analysis of the contributing factors (see pg 37 in attached link).
http://www.bridgewayfund.com/assets/pdf ... .12.31.pdf

Code: Select all

2009

BRSIX variance with CRSP10      Variance in Return        

Rebalancing frequency                 -8%     
Size effect                          -17%
Penny stocks                         -22%
Sidestepping model                    -9%
Other                                  1%
-----------------------------------------
Total           	                  -55%

The main contributors were BRSIX’s larger size and underweight of penny stocks (the latter increased 187% in 2009), relative to CRSP10.

Here's Bridgeway’s explanation of why they deviate from CRSP10 on the above issues:
Why don’t we rebalance our Fund more frequently? First, quarterly rebalancing would significantly increase the transaction costs of our Fund, hurting long-term returns. Related to this, more frequent rebalancing would increase taxes for taxable shareholders. Second, this additional return is sporadic and goes both directions. Over the last 85 years of data, Bridgeway estimates that the average annual return of quarterly versus annual rebalancing has generated approximately 0.40% per year more in return for the asset class of ultra-small companies. However, a huge portion of this was in a single year, 2009. Without last year the difference is only 0.22% annually, making it inappropriate to try to “chase” these extra returns with higher transaction costs. We also looked at the possibility of trying to time capture this effect—with no success. Third, we did, in fact, step up the rate of our rebalancing in the January through June 2009 timeframe, which did serve to dampen the negative impact of quarterly rebalancing. In summary, we don’t see a net advantage to stepping up our rate of rebalancing, and we do not plan to change our strategy with respect to rebalancing.

Why don’t we sell appreciated stocks as soon as they appreciate above the cutoff for ultra-small company size? Similar to the discussion of rebalancing in the paragraph above, we do steadily sell our more highly appreciated stocks to reinvest in ultrasmall ones. However, we do so at a steadier pace in order to reduce transaction costs and “let some winners run,” if one of the quantitative models we use in our more actively managed Ultra-Small Company Fund indicates strong continuing appreciation potential. Our modeling indicates that this adds value over time, but not in all years, and especially not in 2009, which had a rally led by financially distressed companies. Additionally, this problem was exacerbated in 2008 coming into 2009 by the fact that our Fund companies fell less than CRSP 10 in the downturn and much less than the CRSP “breakpoint” or cutoff for ultra-small stocks, which itself exacerbated the problem of too many of our stocks falling outside the CRSP 10 breakpoint. While we did step up the rate of selling highly appreciated stocks in the first half of 2009, we did not “dump” them wholesale, and would not expect to do so in the future. We would not expect this to affect our returns significantly in most decades, as was demonstrated by the fact that the Fund beat the CRSP 10 returns from inception in 1997 through 2008.

Why don’t we invest in penny stocks? Penny stocks accounted for an unusually high 12% of the CRSP 10 Index at the beginning of 2009, relative to 2% for our Fund. But since these risky stocks soared 187% in aggregate, they contributed 22% more return to the CRSP 10 return than to the Fund return. Why wouldn’t we just invest the same percentage of our Fund in these stocks? Over the long haul these risky stocks have been poor investments historically. Indeed, our analysis indicates that ultra-small penny stocks underperformed 63% of all years from 1961 to present and underperformed for the longer period, even when including the remarkable returns of 2009. We also tried a number of methods to time their outperformance with no “hits.” We feel it’s best to stay away from them.

One of our sidestepping models “blew up” in 2009; should we just stop using it? No. It served its purpose well in most years of our Fund and especially in 2008, helping us cushion the worst downturn since the Great Depression. Frequently, when a model is this far out of the historical bounds unfavorably, it makes up some ground coming back the other direction. Thus, we believe that “bailing” after an awful year like 2009 is a particularly poor strategy, which could lead to “whipsawing.” Whipsawing is where you underperform on the way down, trade out of what just hurt you—then change strategies just in time to underperform again on the way back up.

The factors working against us in the previous paragraphs were broad across the Fund, specifically in eight of ten sectors. Only in two sectors, consumer staples and financials, did our Fund stocks significantly beat those of the CRSP 10 Index.
Robert
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Taylor Larimore
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Lessons from BRSIX

Post by Taylor Larimore »

Hi Robert:

The Bridgeway Fund (BRSIX) is a good example of the inherent danger in managed funds:

In 2001 BRSIX was a small fund with only 39M in assets. In the 2002 bear market BRSIX ranked #1 in its category. Investors piled in, primarily for its high return and perceived diversification benefit.

In 2006 BRSIX was a large fund with 1,176M in assets. Unfortunately, in the 2008 bear market BRSIX ranked # 78 in its category. Disappointed investors left in droves. Its assets fell from 1,176M to 324M.

Past performance is no guarantee of future performance.
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ScottW
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Re: Lessons from BRSIX

Post by ScottW »

Taylor Larimore wrote:The Bridgeway Fund (BRSIX) is a good example of the inherent danger in managed funds
I'm not sure how this is a black mark against active funds. To me, the performance shortfall (and Bridgeway's explanation) illustrates the difficulty of investing in microcaps, and raises the question of whether it's a sector worth considering. Nothing more.

While I agree that this fund has attracted its share of performance chasers over the years, I don't see how active management is the primary cause. People flock to and abandon any investment when it outperforms or does poorly for a while, and this includes passively managed funds.
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Post by Ice-9 »

I always thought BRSIX was a passive fund, not an active one.

From Larry Swedroe's Only Guide To A Winning Investment Strategy:

"Passive asset-class funds, while investing only in securities with a specific asset class, have the advantage of not trying to replicate an index. Instead, they focus on acheiving the greatest returns (and, if tax managed, the greatest after tax returns) for a given level of risk... This difference in objective allows passive asset-class funds to maximize the advantages of indexing and minimize the disadvantages of indexing."
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Taylor Larimore
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Re: Lessons from BRSIX

Post by Taylor Larimore »

Hi Scott:
I'm not sure how this is a black mark against active funds. To me, the performance shortfall (and Bridgeway's explanation) illustrates the difficulty of investing in microcaps, and raises the question of whether it's a sector worth considering. Nothing more.
Perhaps you missed this:
in 2009 the Bridgeway Ultra-small company market fund (BRSIX) lagged its primary benchmark (CRSP10) by 55%. The respective returns were 25.96% for BRSIX vs. 81.12% for CRSP10.
The problem was not the sector or index benchmark, they did great. It was the manager's unfortunate stock picks.
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Post by caklim00 »

Ice-9 wrote:I always thought BRSIX was a passive fund, not an active one.

From Larry Swedroe's Only Guide To A Winning Investment Strategy:

"Passive asset-class funds, while investing only in securities with a specific asset class, have the advantage of not trying to replicate an index. Instead, they focus on acheiving the greatest returns (and, if tax managed, the greatest after tax returns) for a given level of risk... This difference in objective allows passive asset-class funds to maximize the advantages of indexing and minimize the disadvantages of indexing."
BRSIX is passive, it uses screens to filter out stocks with certain characteristics, but does not try to pick individual stocks. I don't use BRSIX, but always appreciated the fact that Bridgeway even acknowledged that even though their fund performed better than CRSP 10 since inception (pre last year), that much of it was due to timing.

Personally I wish they had a CRSP 9-10 Value fund...
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Post by Robert T »

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Hi Taylor,
In 2006 BRSIX was a large fund with 1,176M in assets. Unfortunately, in the 2008 bear market BRSIX ranked # 78 in its category. Disappointed investors left in droves. Its assets fell from 1,176M to 324M.
As I understand, a significant part of the decline in fund size was due to one redemption of a very large investor (who closed out their position) – if I recall from one of Rick’s earlier posts.

I don’t think the 2008 bear market is the issue. The Bridgeway fund (BRSIX) did not decline much more than the overall market (all equity asset classes suffered, nothing special about BRSIX). IMO it is the expectation that BRSIX performance could be at least within earshot of CRSP10 performance. And the subsequent 55% lag in 2009 (as in the OP), that is raising some eyebrows, inducing it seems some redemptions (as in earlier posts). IMO it illustrates the difficulty of trying to match CRSP10 performance, but IMO Montgomery has done a better job than anyone else (with his active management of trade costs and tax implications) - there will be tracking error.

I am pleased to see Bridgeway address the tracking error issue in some detail in their quarterly report, with analysis of the sources of the differences. At least this will better align expectations on possible tracking error.

Robert

PS: Have been a BRSIX shareholder since start of 2003, no reason for me to change now.
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Re: Lessons from BRSIX

Post by ScottW »

Taylor Larimore wrote:The problem was not the sector or index benchmark, they did great. It was the manager's unfortunate stock picks.
Again, I feel this is more of a dig against microcaps than active management. Most agree that the microcap arena is difficult to invest in; there is no fund in existence that attempts to precisely replicate Decile 10. Bridgeway has tried to capture the return using a variety of rules and screens to make this area of the market "investable."

Many common indexes follow similar strategies. For years the Russell 2000 was the standard for measuring small cap returns, but as an investment tool it was less than desirable. Companies like S&P and MSCI attempted to create indexes that would track the same area of the market but be more feasible (ie less costly) to use as an actual investment strategy.

In highly liquid areas of the market, similar approaches will generally achieve similar returns. Problems arise when you try to put money into an area of the market that you can't easily invest in. Once you've thrown out the majority of the securities from the sector you're targeting, you have to wonder how bad your tracking error is going to be. Last year's BRSIX divergence was simply astronomical.

Other passively managed microcap funds had similar returns, so again I see this primarily as cautionary tale against investing in "difficult" areas of the market.
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Post by paulob »

Could someone explain the meaning of the "Sidestepping Models"?

I apologize for my ignorance (google didn't help :lol: )
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Post by bradshaw1965 »

Ice-9 wrote:I always thought BRSIX was a passive fund, not an active one.

From Larry Swedroe's Only Guide To A Winning Investment Strategy:

"Passive asset-class funds, while investing only in securities with a specific asset class, have the advantage of not trying to replicate an index. Instead, they focus on acheiving the greatest returns (and, if tax managed, the greatest after tax returns) for a given level of risk... This difference in objective allows passive asset-class funds to maximize the advantages of indexing and minimize the disadvantages of indexing."
BRSIX originally had index in the fund name. Of course, all of the issues presented in this thread indicate that BRSIX is at best a passive fund, but I'd think that perhaps Taylor is a little off in his using this fund as an example of the problems of choosing "active" funds. Full disclosure, I own a bit of BRSIX, don't plan to sell it, but am disappointed in the variations from the index return.
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Post by tfb »

Considering that the microcap index ETF IWC didn't do any better, I'm not sure this is a knock on active management either. It only showed the index is not investable. I sure don't want the fund in penny stocks. Someone else can have those 187% returns.
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Post by matt »

tfb wrote:
Considering that the microcap index ETF IWC didn't do any better, I'm not sure this is a knock on active management either. It only showed the index is not investable. I sure don't want the fund in penny stocks.
But the Russell Microcap Index that IWC tracks was only up 27.5%, not the 81% for CRSP 10. So IWC's gap with its benchmark is much less dramatic; it never claimed to track the really tiny stocks. BRSIX clearly hasn't been able to invest in them very well either, which comes as no shock to me. Total Stock Market indexing is the only type of indexing that works as desired, as far as I'm concerned.
Someone else can have those 187% returns.
Please send them my way.
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Post by White Coat Investor »

paulob wrote:Could someone explain the meaning of the "Sidestepping Models"?

I apologize for my ignorance (google didn't help :lol: )
They try to sidestep stocks that are just passing through the fund (i.e. on their way to zero.) It's a form of active management. It's really a quant fund more than an index fund. Relatively passive, pretty tax efficient for the asset class, but no index fund.
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Re: Lessons from BRSIX

Post by White Coat Investor »

Taylor Larimore wrote:Hi Robert:

The Bridgeway Fund (BRSIX) is a good example of the inherent danger in managed funds:

In 2001 BRSIX was a small fund with only 39M in assets. In the 2002 bear market BRSIX ranked #1 in its category. Investors piled in, primarily for its high return and perceived diversification benefit.

In 2006 BRSIX was a large fund with 1,176M in assets. Unfortunately, in the 2008 bear market BRSIX ranked # 78 in its category. Disappointed investors left in droves. Its assets fell from 1,176M to 324M.

Past performance is no guarantee of future performance.
I wonder if it will perform better at this size. I'm as disappointed as anyone, but I'll stay the course a couple more years anyway.
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Active Management creeping into BRSIX

Post by altruistguy »

Hello Folks,

I was quite concerned when I saw this in the official explanation of BRSIX's big lag:

"... and 'let some winners run,' if one of the quantitative models we use in our more actively managed Ultra-Small Company Fund indicates strong continuing appreciation potential."

When I saw that, I was pretty concerned. Basically, it says that they applied active management to this allegedly passively managed fund.

I contacted Bridgeway directly to inquire about this.

They tried to say (several times) how BRSIX is, indeed, passively managed. But they added that the quote is correct too. They have quant models which they use to manage their similar actively managed fund (here, the Bridgeway Ultra-Small Company Fund (BRUSX)). They said that when the models for BRUSX indicate that a company is a loser -- that they are forecast to do quite poorly -- they apply this "learning" to their passively managed fund too. They tried to spin it as a reasonable, responsible thing to do. They suggested that they felt that it would be unreasonable to invest in a company in (passive) BRSIX that the (active) BRUSX models suggested was a loser. I argued that if an investor wanted the "benefit" of their quant modeling, they would be in BRUSX instead of BRSIX in the first place.

So basically, I expressed my concern and we basically agreed to disagree.

I'm watching Bridgeway closely to see if they can fix this problem of active management "infecting" their allegedly passively managed fund.

Eric E. Haas
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Post by White Coat Investor »

Eric-

I agree. It is a quant fund, more passive than most, but not a passive fund and certainly not an index fund.
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Re: Lessons from BRSIX

Post by wander »

Taylor Larimore wrote:Hi Robert:

The Bridgeway Fund (BRSIX) is a good example of the inherent danger in managed funds:

In 2001 BRSIX was a small fund with only 39M in assets. In the 2002 bear market BRSIX ranked #1 in its category. Investors piled in, primarily for its high return and perceived diversification benefit.

In 2006 BRSIX was a large fund with 1,176M in assets. Unfortunately, in the 2008 bear market BRSIX ranked # 78 in its category. Disappointed investors left in droves. Its assets fell from 1,176M to 324M.

Past performance is no guarantee of future performance.
IWC is a passive fund in the same category with BRSIX and It's not doing any good either. I own PRSVX (T. Rowe Price Small Cap Value fund). Its asset is now 6.1B but I am not going to run away from it. It has been great and big last ten years and was doing fine during 2008 market drop. Size is one big problem of small cap funds, but some managers handle it well.
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Re: Active Management creeping into BRSIX

Post by edge »

altruistguy wrote:Hello Folks,

I was quite concerned when I saw this in the official explanation of BRSIX's big lag:

"... and 'let some winners run,' if one of the quantitative models we use in our more actively managed Ultra-Small Company Fund indicates strong continuing appreciation potential."

When I saw that, I was pretty concerned. Basically, it says that they applied active management to this allegedly passively managed fund.

I contacted Bridgeway directly to inquire about this.

They tried to say (several times) how BRSIX is, indeed, passively managed. But they added that the quote is correct too. They have quant models which they use to manage their similar actively managed fund (here, the Bridgeway Ultra-Small Company Fund (BRUSX)). They said that when the models for BRUSX indicate that a company is a loser -- that they are forecast to do quite poorly -- they apply this "learning" to their passively managed fund too. They tried to spin it as a reasonable, responsible thing to do. They suggested that they felt that it would be unreasonable to invest in a company in (passive) BRSIX that the (active) BRUSX models suggested was a loser. I argued that if an investor wanted the "benefit" of their quant modeling, they would be in BRUSX instead of BRSIX in the first place.

So basically, I expressed my concern and we basically agreed to disagree.

I'm watching Bridgeway closely to see if they can fix this problem of active management "infecting" their allegedly passively managed fund.

Eric E. Haas
I think the main thing you have issue with is something that DFA also employs.
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Post by matt »

edge wrote:
I think the main thing you have issue with is something that DFA also employs.
Indeed, DFA is not truly passive, they have a variety of screens to keep out "bad" stocks and also allow a little momentum to reduce transaction costs and hopefully improve returns. Mr. Haas knows all this. He's disappointed with the outcome of BRSIX, not the strategy. In order to deflect any blame from himself, he appears to be blaming the strategy in hindsight.
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Eric Hass "Reading Room"

Post by Taylor Larimore »

Hi Eric:

I always learn from your posts.

For Bogleheads who do not know, the Eric Haas "Reading Room" links are one of the best sources of information on the web:

Reading Room

Thank you for another insightful contibution.
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Post by subrosa »

He's disappointed with the outcome of BRSIX, not the strategy.
I do not currently invest in BRSIX but I was and am confused about its deviation from its long term tax performance a few years ago.

Rick Ferri said that the fund experienced a huge redemption from a single shareholder causing this problem.

But the fund has (iirc) a provision in its prospectus that if a redemption is likely to disrupt management of the fund, then it can execute a redemption in kind.

If there was ever an opportunity for a supposedly tax sensitive fund invested in the microcap space run by a "good guy" company to ever exercise such a clause, that seems to have been it.

I don't know the details beyond what Rick Ferri posted in 08 but at least for taxable investors this recent inability to manage such an event despite express language in the prospectus seems like a bigger worry than the fund taking on characteristics of the (historically much more successful) BRUSX.
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Passive: index vs. structured strategies

Post by amv »

There is a lesson here: don't invest in strategies you don't fully understand ahead of time. To be questioning the implementation technices of Bridgeway today, over 12 years after the fund first came out, is almost inexcusable.

What posters (excluding Robert) seem to be completely missing here is the difference between primary investment aproaches (active versus passive), and then different approaches to passive investing. Within the non-active camp (ie. "passive"), you have indexed portfolios and structured portfolios.

Passive index strategies are generally designed to represent a subset of a predefined total market universe (ie. Russell 3000 or S&P 1500) according to a specific size or value sort that is dictated by the index committee or rules based guidelines. Portfolios are updated/reconstituted on a calendar basis or when corporate actions dictate, and index risk (from a manager perspective) is defined as "tracking error" or deviation from the underlying index on a day to day basis. To take this to the logical extreme, even if a set index has -0.01% per month, implementation success is measured by the managers ability to deliver that -0.01% monthly return. Some stocks are excluded from the index (such as microcap stocks) due to general illiquidity and pricing pressures that would arise from the reconstitution process.

An index may have a loose affiliation with a particular risk/return dimension (such as size or value), but in most cases, that is a secondary consideration or concern relative to covering a certain subset of stocks in a total market index and tracking that index perfectly on a daily basis. For example, an index manager who has replicated the returns of the Russell 2000 Index over the last 30 years maybe rewarded for tracking the index so closely, with very little if any concern for whether or not he was able to successfully deliver a small cap return premium. Their exclusion rules may actually be at odds with delievering the highest returns possible (again, I point to the example of excluding microcap stocks, which have historically exibited the highest returns in the small cap universe).

Passive structured strategies are instead primarily designed to deliver the returns associated with a given expected risk/return dimension. Because costs associated with expense ratios, turnover, and bid/ask spreads are directly correlated with reduced returns, structured portfolios tend to look very similar to index strategies in terms of broad diversification and low turnover.

Where structured strategies diverge from indexing, however, is in their primary concern with delivering the asset class return as efficiently as possible over long periods of time--even if that includes holding slightly different percentages of companies than a simulated strategy would assume due to pricing issues or general illiquidity. If a company exibits significant negative price momentum or wide bid/ask spreads, it may not be introduced or added to the portfolio until these negative pressures subside. Structured strategies also exclude some stocks that may appear on the surface to share the same characteristics as the asset class as a whole (ie. REITs, utilities, or extreme growth stocks) but are excluded in an attempt to capture the highest returns available. A natural side affect of this goal is that they do not track their universe of stocks perfectly over short or even intermediate periods.

In general, the later is much preferable to the former. if we compare the S&P 500 with 3 different approaches to owning smaller companies, we can isolates the benefits of a focus on investment results. From 1979 through 2009, the S&P 500 compounded at +11.5%. In general, smaller companies outperformed larger ones over this period (as measured by the difference between the CRSP 1-5 Large Cap and CRSP 6-10 Small Cap indexes). Yet the strict index structure of the Russell 2000 resulted in a negative size return over this period: a return of only +11.3%.

Bridgeway, on the other hand, has chosen to focus their Ultra Small Company Market fund on the very smallest decile of companies as defined by CRSP, or decile 10. Over this same period, CRSP 10 compounded at +12.5% per year for a 1% per year advantage. But in order to effectively target the expected returns associated with CRSP 10, Montgomery knows he cannot fully replicate the holdings of these small companies due to significant pricing issues, illiquidity, and the high costs of buying and selling necessary to keep the portfolio in line with CRSP definitions. So he avoids buying or adding to companies with negative momentum, while also patiently selling off companies with larger market caps but positive momentum (which is why the portfolio has larger average market caps than the index itself). Stocks with wide bid/ask spreads might be underweighted or avoided relative to the CRSP index, and those that can be purchased below market values maybe added to in percentages larger than the index would normally call for.

DFA takes an approach similar to this, but goes even further. Their Small Cap strategy is based not on a predefined index, but instead a size based definition (in this case the smallest 8% of the market). From there, they exclude REITs, regulated utilities, and extreme growth stocks--all of which tend to be smaller companies and fall into this 8% metric, but historically have not had the same risk or returns as pure small companies. The companies are not as small as those in the CRSP 10 index (which generally conforms to the smallest 1% or 2% of the market), but it is easier to implement because it is vastly more diversified, and the exclusions increases expected returns. Since 2009, the DFA Small Cap Index (which excludes REITs, Utes, and extreme growth stocks) compounded at +13.3%.

To summarize: investors are probably better off implementing their asset allocations with passive structured strategies if they have the discipline to stay with them over short periods of time when they deviate from an index of companies they are loosely based on.
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Post by amv »

Some may ask what happens when an index provider decided to construct a better definition of an asset class with which to manage a fund, such as Russell developing the Russell Micro Cap Index to provide exposure to lower market cap companies with higher expected returns?

Unfortunately, not much. Since inception in July of 2000, the both the Russell Micro Cap and Russell 2000 indexes have had identical returns despite micro cap stocks outperforming smaller and large cap companies as represented by either DFA US Small, US Micro, or Bridgeway Ultra Small Market.

In the passive world of investment, construction and implementation, while often ignored relative to expense ratios, play a much larger role in relative success.
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Post by Sammy_M »

I'm reading Dr. Bernstein's latest now and he deftly covers index vs. passive funds. He does not use the term 'structured' but, AMV, I think you're covering the same ground.

BRSIX professes to be a passive fund.
The Ultra-Small Company Market Fund is invested in approximately 470 companies of the over 1,337 companies that are in the 10th decile and is passively managed along the following dimensions:
- Roughly match the sector and industry make up of the overall 10th decile,
- Exclude a company from the portfolio if management feels company is on its way to bankruptcy (try to avoid companies “just passing through”),
- Focus on trading efficiency and managing bid/ask spread to shareholders’ advantage.
- [In listing the top holdings, they state...]These are not the "top picks" of the investment management team, rather, they are the companies that have appreciated very significantly since they were purchased.
I had understood about Bridgeway, like DFA, using screens to avoid companies just "passing through" on the way to bankruptcy. However, the quote that Mr. Haas expresses alarm at "...if one of the quantitative models...indicates strong continuing appreciation potential" certainly sounds like something entirely different. Therefore, I see why he is alarmed.

As for me, I wish Bridgeway would knock it off if they are indeed trying to "pick winners", but I am also reminded of something else Dr. Bernstein said in his latest book:
there is nothing magical about passive and index investing; any active manager who charges low fees, is highly diversified and keeps stock turnover to a bare minimum should provide value to his or her investors.
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Post by subrosa »

Hi AMV
What posters (excluding Robert) seem to be completely missing here is the difference between primary investment aproaches (active versus passive), and then different approaches to passive investing.
Actually what I was confused about had nothing to do with this and had to do with questioning what Bridgeway stated would be the implimentation technique of redemption in kind that it said it would use, then seemingly did not use, in 2008.

When I saw your post, I found myself thinking "does this person have clients invested in DFA funds?"
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