GMO High Quality Stocks - Portfolio Allocation/Best Vehicle

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.

GMO High Quality Stocks - Portfolio Allocation/Best Vehicle

Postby Blue » Tue Aug 24, 2010 8:17 pm

GMO predicts the highest returns over the next 7 years to be US High Quality Stocks as outlined in Grantham's recent quarterly newsletter.


Does anybody have a fixed allocation to these stocks?


What is the best passive investment vehicle that fits GMO's definition of US High Quality stocks?
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Re: GMO High Quality Stocks - Portfolio Allocation/Best Vehi

Postby Sammy_M » Tue Aug 24, 2010 9:46 pm

Blue wrote:What is the best passive investment vehicle that fits GMO's definition of US High Quality stocks?

Bridgeway Blue Chip 35 - BRLIX? Not sure.
User avatar
Sammy_M
 
Posts: 1697
Joined: Sun Nov 25, 2007 9:30 am

Postby SteveB3005 » Tue Aug 24, 2010 9:48 pm

GMO has a fund that incorporates the strategy and is available to institutional investors, the GMO Quality III Fund ( GQETX )

The fund in it's seven years since inception has slightly underperformed the S&P 500, which leads me to ask myself if they cannot pick these superior companies how am I supposed too.

edit to add: Blue to answer your question, I know of no passive funds that would fit this strategy. Some active funds that would attempt it would be funds that try for a Growth At Reasonable Prices approach like, T Rowe Price Growth Stock, Jensen J Fund, maybe even Vanguard Primecap Core.
Last edited by SteveB3005 on Tue Aug 24, 2010 10:06 pm, edited 1 time in total.
User avatar
SteveB3005
 
Posts: 1410
Joined: Mon Feb 19, 2007 10:29 pm

Postby bob90245 » Tue Aug 24, 2010 9:54 pm

SteveB3005 wrote:GMO has a fund that incorporates the strategy and is available to institutional investors, the GMO Quality III Fund ( GQETX )

The fund in it's seven years since inception has slightly underperformed the S&P 500, which leads me to ask myself if they cannot pick these superior companies how am I supposed too.

Apparently, not so high quality stocks can do just as well or better as high quality stocks. :D
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
User avatar
bob90245
 
Posts: 6512
Joined: Mon Feb 19, 2007 9:51 pm

Re: GMO High Quality Stocks - Portfolio Allocation/Best Vehi

Postby tibbitts » Tue Aug 24, 2010 10:18 pm

Blue wrote:GMO predicts the highest returns over the next 7 years to be US High Quality Stocks as outlined in Grantham's recent quarterly newsletter.


Does anybody have a fixed allocation to these stocks?


What is the best passive investment vehicle that fits GMO's definition of US High Quality stocks?

Out of curiosity, has GMO ever predicted that US Low Quality Stocks would outperform?

Paul
tibbitts
 
Posts: 4981
Joined: Tue Feb 27, 2007 7:50 pm

Re: GMO High Quality Stocks - Portfolio Allocation/Best Vehi

Postby lazyday » Tue Aug 24, 2010 10:27 pm

Sammy_M wrote:
Blue wrote:What is the best passive investment vehicle that fits GMO's definition of US High Quality stocks?

Bridgeway Blue Chip 35 - BRLIX? Not sure.

Grantham has said that there's a high correlation between quality and megacap. You can see this looking at the top holdings of VTI. So, I'd say that BRLIX is the best passive, that I know about anyway. Another possible could be Diamonds ETF, compare quality overall. Neither BRLIX nor Diamonds are cap weighted, which in megacap U.S. might be a benefit.

I've been a fan of BRLIX a long time, but if you really become a quality believer, you would probably need to roll your own. BRLIX still has some companies with high debt, cyclicality in profits, and probably some with low profits as measured ROA or ROE.

My portfolio includes many companies which can be considered Quality, partly because I think they seem relatively cheap, but also because I think they seem relatively safe, for someone in the withdrawal phase, as part of a well-balanced portfolio.

Doesn't mean they will outperform over the next x years. Actually, perhaps one should expect a little underperformance because of the non-cyclicality of them; one tenet of Quality according to Graham is steady profits, or something like that.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Re: GMO High Quality Stocks - Portfolio Allocation/Best Vehi

Postby lazyday » Tue Aug 24, 2010 10:37 pm

tibbitts wrote:Out of curiosity, has GMO ever predicted that US Low Quality Stocks would outperform? Paul

Paul, not sure, but such a thing could happen. IIRC, they look at several metrics, such as Value, Size, Quality, and others. Easy to be sceptical since Quality sounds vague, but it does have a definition not much more vague than Value, which isn't always taken to just mean high BtM. And it isn't a new thing, at least not very new. Maybe someone knows the history of the word when used this way--did it mostly refer to quality of earnings, and sometimes also dividends, and could GMO or others have extended it to include low/reasonable debt? I guess leverage boosts earnings but at a risk, so that isn't a stretch.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby DaveS » Tue Aug 24, 2010 10:49 pm

Grantham has made some good calls. He said get into Emerging Markets when they were out of favor just before they took off. That said I don't follow hot tips. However if you want a ETF that holds good quality wide moat large blend stocks like Grantham is recommending, look at the Vanguard ETF VIG, Vanguard Dividend Appreciation. The nice thing about it is that it's good in a down market, so if he is wrong you likely won't get killed. Dave
DaveS
 
Posts: 1308
Joined: Fri Jun 15, 2007 10:42 am
Location: Reno, NV

Re: GMO High Quality Stocks - Portfolio Allocation/Best Vehi

Postby yobria » Tue Aug 24, 2010 10:55 pm

Blue wrote:Does anybody have a fixed allocation to these stocks?


No, my days of following the guesses of this or that investment advisor are long (long long) over.

Nick
yobria
 
Posts: 5978
Joined: Tue Feb 20, 2007 12:58 am
Location: SF CA USA

Postby Opponent Process » Tue Aug 24, 2010 11:08 pm

VT
30/30/20/20 | US/International/Bonds/TIPS | Average Age=37
User avatar
Opponent Process
 
Posts: 5159
Joined: Tue Sep 18, 2007 10:19 pm

Re: GMO High Quality Stocks - Portfolio Allocation/Best Vehi

Postby jsnbrnd » Tue Aug 24, 2010 11:13 pm

Blue wrote:GMO predicts the highest returns over the next 7 years to be US High Quality Stocks as outlined in Grantham's recent quarterly newsletter.

Does anybody have a fixed allocation to these stocks?

What is the best passive investment vehicle that fits GMO's definition of US High Quality stocks?


I have VDAIX, the Vanguard Dividend Appreciation Fund. There's is a sibling ETF, namely VIG.
jsnbrnd
 
Posts: 417
Joined: Tue Dec 11, 2007 5:25 pm

Postby lazyday » Tue Aug 24, 2010 11:50 pm

DaveS wrote:look at the Vanguard ETF VIG, Vanguard Dividend Appreciation.

A better Quality list than I expected. I own 21 of the first 50 companies. A few names I wanted to buy, but found too pricey, such as Avon, Colgate, and Clorox. GMO doesn't always agree with me though. :)

Of the first 35 companies: Target and IBM have lots of debt. Others might be too cyclical or have unsteady earnings, like Caterpillar, maybe Lowes? I haven't looked at McDonalds, Emerson Electric, EOG, Praxair, Illinois Tool Works, Franklin, Aflac, Air products, Nucor, though some sound cyclical.

Blue, if you really want to invest this way, you can find GMO fund reports on Edgar, to see which fund is closest to the Quality fund, and if any is close enough. Don't forget about the $ weighting of each fund. And make sure you're committed before doing it, since it could underperform a long while; but if you believe in it and either have good reason to invest in Quality (such as safety in economic downturns) or don't put too much % there, you have a better chance of riding out any long big underperformance period.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby Blue » Wed Aug 25, 2010 7:32 am

A really useful and intriguing set of comments/thoughts so far.

I had always assumed that my large cap TSM would be a good correlate to Grantham's "U.S. High Quality", but with a prediction by Grantham of future real returns of 7.3% for High Quality vs 2.9% (U.S. Large Cap) and 1.1% (U.S. Small Cap) it left me wondering a bit as to how much exposure I really have to "High Quality" if Grantham is correct.

That High Quality could diverge so significantly from Large Cap is not intuitive to me. Grantham seems to have a level of respect on this board and has made a few good calls in the past so I wanted to better understand the ramifications of what he is predicting relative to my portfolio.

http://www.gmo.com/websitecontent/JGLetter_SummerEssays_2Q10.pdf
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Postby Gekko » Wed Aug 25, 2010 8:28 am

S&P 500
VFINX
VFIAX
User avatar
Gekko
 
Posts: 3773
Joined: Fri May 11, 2007 6:00 pm
Location: USA

Postby lazyday » Wed Aug 25, 2010 10:48 am

Blue wrote:Grantham seems to have a level of respect on this board and has made a few good calls in the past so I wanted to better understand the ramifications of what he is predicting relative to my portfolio.

Respect--not from everybody, for sure.

Ramifications--if your portfolio is well diversified, such as Swensen's typical listed in Unconventional Success, or William Bernstein's, or some other sample AAs, then only 20-35% or so of the portfolio will be in U.S. stocks other than REITS. If 25% U.S. stocks and GMO prediction is exactly right, you could have made 7.3 instead of 2.9 for 7 years, on just that fraction, not that large a difference.

If you do follow GMO, there's all the risks Bogleheads teach you, plus the risk that GMO will stop reporting on valuations before Quality becomes relatively expensive, if they are right.

Sorry to be somewhat hypocritical; I do lean towards Quality today with my own money, but wouldn't really see myself suggesting others do so in today's market, unless they have strong convictions built over time, and maybe also don't have any history with other asset classes of selling low. Much research shows that people with normal personalities will usually buy high sell low. At least that's my way of thinking of it. :)
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby dave.d » Wed Aug 25, 2010 1:54 pm

Here is a description of research by Rob Arnott suggesting that the very largest companies underperform, which I think is consistent with Fama/French:
http://www.mebanefaber.com/2010/08/12/too-big-to-succeed-stocks-to-avoid-mon-jnj-pg-mcd-xom-jpm-ge-msft-exc/

How many of these would Grantham recommend as "quality"?
User avatar
dave.d
 
Posts: 935
Joined: Mon Mar 19, 2007 11:30 pm
Location: Richmond, VA

Postby Multifactor Advisor » Wed Aug 25, 2010 2:02 pm

Blue: it should be noted that a basic review of the book to market data on Ken French's website reveals that large neutral/growth stocks do not trade at any meaningful discount to their long term (70-09) averages. The most steeply discounted of the 2X3 grid is large value (with a book to market ratio 50% below its long term average) followed by small value (20% below its long term average).

This data is probably of limited use, and using current valuations to make allocation decisions is unwise in my opinion, just wanted to pass the data along.

MA
Multifactor Advisor
 
Posts: 266
Joined: Wed Aug 18, 2010 1:42 pm

Postby jeffyscott » Wed Aug 25, 2010 3:29 pm

SteveB3005 wrote:GMO has a fund that incorporates the strategy and is available to institutional investors, the GMO Quality III Fund ( GQETX )

The fund in it's seven years since inception has slightly underperformed the S&P 500, which leads me to ask myself if they cannot pick these superior companies how am I supposed too.


I don't think they were calling high quality under valued 7 years ago. Their forecasts from that time do not have a separate figure for high quality. 7 years ago the highest expected returns, according to GMO's published forecast was for emerging market stocks.

By June 30, 2005, the forecast was +2.5% real for high quality compared to -1% for the S&P 500. GQETX has a slight lead on the S&P over the last 5 years (about 1% annualized) and has been much less volatile (SD 13% vs. 17%).
press on, regardless - John C. Bogle
User avatar
jeffyscott
 
Posts: 5966
Joined: Tue Feb 27, 2007 10:12 am
Location: Wisconsin

Postby Blue » Wed Aug 25, 2010 9:06 pm

In consideration of the above comments, I spent a little time comparing portfolios of GMO's quality fund and Vanguards TSM.

The top 25 holdings of GMO Quality GQETX represent roughly 69% of GQETX. These same stocks make up roughly 21% of Vanguard's TSM VTSAX.

Extrapolating, the totality of GMO High Quality fund portfolio likely represents about 30% of Vanguard TSM.

It seems then, that by having a primary holding of TSM or SP500, that an investor is likely to have reasonably high allocation to Grantham's favored High Quality Stocks.
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Postby jeffyscott » Thu Aug 26, 2010 1:21 pm

I was able to go a little farther by playing with the "stock intersection" portfolio feature at m*, found the top 50 holdings of GQETX, representing 89% of assets amounted to 27% of assets in VTSMX. So the 30% figure does appear to hold.
press on, regardless - John C. Bogle
User avatar
jeffyscott
 
Posts: 5966
Joined: Tue Feb 27, 2007 10:12 am
Location: Wisconsin

Postby lazyday » Thu Aug 26, 2010 4:43 pm

dave.d wrote:How many of these would Grantham recommend as "quality"?

Probably many of them.


http://researchaffiliates.com/ideas/pdf ... 201006.pdf

The first page is amusing to me compared to a decade ago, when it was a given that larger companies were superior and would do better.
Several reasons were given then why large=good, valid reasons even today, not included in Arnott's argument. People were too enamoured with largecaps. Today, I wonder if too many seek small and value premia. And overlearned the lesson "good company=bad stock" without checking valuations to see if it's still a good rule.

The second page uses data, but over a relatively short period and ending at a time some people think megacaps or leaders are underpriced, so one might complain that it's period specific, maybe even data mining. If the study ended 1/2000, would results be the same?

For someone attempting TAA, it all depends on price. Generally, I'd expect megacaps, especially the largest in an industry to have less risk and lower return. Even more so for Quality. But I believe relative valuations change, and sometimes I even change my AA because of them. (Not very Bogleheady, not for everyone, and most wouldn't even call Quality an asset class.)
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby lazyday » Thu Aug 26, 2010 5:15 pm

Multifactor Advisor wrote:The most steeply discounted of the 2X3 grid is large value (with a book to market ratio 50% below its long term average) followed by small value (20% below its long term average).

That's surprising to me, not sure what to make of it.

Though in my very amateurish look at valuations, I look at other multiples than just BtM, and with Quality stocks that have a history of steady earnings, I usually ignore book value except perhaps growth of it over time. For example, if a megacap like JNJ, PnG, Pepsi, etc not long ago and maybe today is trading at P/E of 12 or 14, has long history of very steady and maybe nicely growing earnings, while having P/E, P/CF only a bit more expensive than their sector and competitive with the market, I'm very interested.

I've even seen a few Quality stocks that appear to be cheaper than the lower quality stocks in the same sector. When Quality should be safer, lower risk, lower return, more expensive.

Again--amateur here. And Quality being cheap now isn't even my idea, of course got it from Grantham.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby citydweller00 » Sat Oct 30, 2010 1:53 pm

When GMO makes their asset class forecasts for international (developed international and emerging markets), are those 7 year forecast returns their expected returns in dollars? In other words, do their international forecasts account for expected fluctuations in the dollar and foreign currencies, or are the forecasts just how they expect the foreign equity markets by themselves to perform (not considering dollar or other currency fluctuations)?

If they're taking currency fluctuations into account, how can they forecast next 7 year currency fluctuations?
citydweller00
 
Posts: 76
Joined: Thu Oct 14, 2010 8:03 pm
Location: Denver, CO

Postby fishnskiguy » Sat Oct 30, 2010 2:24 pm

I just went over to the Vanguard web site and looked at the top 100 companies in TSM. They all sure looked high quality to me. :)

Chris
Trident D-5 SLBM- "When you care enough to send the very best."
User avatar
fishnskiguy
Moderator
 
Posts: 2538
Joined: Tue Feb 27, 2007 2:27 pm
Location: Eagle, CO

Postby Blue » Sat Oct 30, 2010 6:16 pm

Blue wrote:I had always assumed that my large cap TSM would be a good correlate to Grantham's "U.S. High Quality", but with a prediction by Grantham of future real returns of 7.3% for High Quality vs 2.9% (U.S. Large Cap) and 1.1% (U.S. Small Cap) it left me wondering a bit as to how much exposure I really have to "High Quality" if Grantham is correct.



If Grantham is correct, next 7 years could be challenging for those that tilt away from TSM.

If we take TSM as ~30% Grantham HQ, ~10% Small Cap, and remaining 60% as large cap, then TSM would be expected to return a weighted real 4.04%.

An investor splitting domestic equity 50:50 with SCV (1.1% expected return), would have an expected real return of 2.57%.

At 7 years, a TSM investor would have 10% more wealth than a 50:50 TSM:SCV and 22% more wealth than a pure SCV investor seven years from now if GMO predictions hold.

IIRC, Grantham indicated his personal view was high quality would be realize more out-performance than indicated in the GMO numbers which would of course amplify the wealth difference in 7 years.

If Grantham's predictions are on target.... there will be more talk of SP500 funds than SCV tilting in 7 years on this board.
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Postby citydweller00 » Sat Oct 30, 2010 6:42 pm

Blue wrote:
Blue wrote:I had always assumed that my large cap TSM would be a good correlate to Grantham's "U.S. High Quality", but with a prediction by Grantham of future real returns of 7.3% for High Quality vs 2.9% (U.S. Large Cap) and 1.1% (U.S. Small Cap) it left me wondering a bit as to how much exposure I really have to "High Quality" if Grantham is correct.



If Grantham is correct, next 7 years could be challenging for those that tilt away from TSM.

If we take TSM as ~30% Grantham HQ, ~10% Small Cap, and remaining 60% as large cap, then TSM would be expected to return a weighted real 4.04%.

An investor splitting domestic equity 50:50 with SCV (1.1% expected return), would have an expected real return of 2.57%.

At 7 years, a TSM investor would have 10% more wealth than a 50:50 TSM:SCV and 22% more wealth than a pure SCV investor seven years from now if GMO predictions hold.

IIRC, Grantham indicated his personal view was high quality would be realize more out-performance than indicated in the GMO numbers which would of course amplify the wealth difference in 7 years.

If Grantham's predictions are on target.... there will be more talk of SP500 funds than SCV tilting in 7 years on this board.


To be fair, the 1.1% is GMO's forecast for small cap (SCV + SCG), not SCV specifically. I'm not sure what GMO's forecast is for SCV specifically. Anyone know?

And anyone know an answer to my question a few posts above? :D
citydweller00
 
Posts: 76
Joined: Thu Oct 14, 2010 8:03 pm
Location: Denver, CO

Postby SteveB3005 » Sat Oct 30, 2010 6:54 pm

If Grantham's predictions are on target.... there will be more talk of SP500 funds than SCV tilting in 7 years on this board.


If my predictions are on target we will be talking about something or another on this board in 7 years.

and...If the Mayan predictions are right, nobody will be talking at all, anywhere.
User avatar
SteveB3005
 
Posts: 1410
Joined: Mon Feb 19, 2007 10:29 pm

List of GMO's High Quality Stocks

Postby StoneReader » Sun Oct 31, 2010 5:00 pm

For the curious, here are some examples of GMO's High-Quality stocks from their fund by the same name (the top 60% of the fund). GMO says that they start out by screening for high Return on Equity that is not produced by debt leveraging. They then screen by Valuation and its deviation from historic averages. GMO also avoids companies with bad balance sheets and lots of debt, e.g. GE, so you can not just choose stocks based on their size or name or presence in the Dow30 or the S&P500. Most of these companies incidentally have a large international presence so you get a good dose of foreign stock exposure too.

GMO High-Quality Stocks As of 9/30/2010
Oracle Corp. 6.9%
Microsoft Corp. 6.0%
Johnson & Johnson 5.5%
Wal-Mart Stores Inc. 4.8%
Pfizer Inc. 4.7%
Coca-Cola Co. 4.2%
Exxon Mobil Corp. 3.6%
Google Inc. (Cl A) 3.5%
PepsiCo Inc. 3.2%
Procter & Gamble Co. 3.2%
Nestle S.A. 2.9%
Merck & Co Inc 2.8%
Apple Inc. 2.8%
Cisco Systems Inc. 2.6%
Abbott Laboratories 2.4%

Total 59.1%
User avatar
StoneReader
 
Posts: 394
Joined: Tue Feb 27, 2007 8:42 pm

Postby lazyday » Mon Nov 01, 2010 4:49 am

Blue wrote:If we take TSM as ~30% Grantham HQ, ~10% Small Cap, and remaining 60% as large cap, then TSM would be expected to return a weighted real 4.04%.

Does anyone recall if "Large Cap" in GMO predictions means S&P 500?

If so, then Blue, I'm very sorry, but TSM would be more like 70% or 75% Large Cap, and perhaps 10%small cap (blend), the rest midcaps not in S&P500
OR 70 to 75% Large Cap, and 25-30% S&P Completion Index.

Or for those of you who insist that TSM is the same as Largecap, TSM would just be Largecap. :)

Even if LargeCap isn't S&P500, you're including the HQ, but not the LQ that is in TSM.

Of course, GMO could be very wrong this time.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby Blue » Mon Nov 01, 2010 7:27 am

lazyday wrote:
Blue wrote:If we take TSM as ~30% Grantham HQ, ~10% Small Cap, and remaining 60% as large cap, then TSM would be expected to return a weighted real 4.04%.

Does anyone recall if "Large Cap" in GMO predictions means S&P 500?

If so, then Blue, I'm very sorry, but TSM would be more like 70% or 75% Large Cap, and perhaps 10%small cap (blend), the rest midcaps not in S&P500
OR 70 to 75% Large Cap, and 25-30% S&P Completion Index.

Or for those of you who insist that TSM is the same as Largecap, TSM would just be Largecap. :)

Even if LargeCap isn't S&P500, you're including the HQ, but not the LQ that is in TSM.

Of course, GMO could be very wrong this time.


A few thoughts.

We established above in this thread that TSM is ~30% HQ (which are also large caps)
We know that TSM is 70% LC, 20% Mid Cap, 10% SC
Grantham only provides projections for HQ, LC (presumably LC ex HQ?), and SC

So, for estimation purposes, I lumped Mid caps into LC (ex HQ) to get TSM = 30% HQ, 60% LC (40% LC ex HQ + 20% Mid Cap), with 10% SC.

I agree you could take a number of different reasonable alternative approaches but since Granthams predictions for LC (2.9%) and SC (1.1%) are reasonably close vs prediction for HQ (7.3%), I think where you stick mid caps is probably less important.

As an aside, I noticed Ed Tower's collection of work on this topic mentioned in summary document of Bogleheads 9. When I get some time this evening, I am hoping to dig through his work a bit.


2. E. Tower, “Are GMO’s Predictions Prescient? Using Them to Predict Vanguard’s Mutual Fund Returns”
http://econ.duke.edu/Papers/Other/Tower ... r_2010.doc
3. E. Tower, “Strategic Asset Allocation in Practice: Using Vanguard Funds toClone GMO’s Benchmark-Free Allocation Fund.”
http://econ.duke.edu/Papers/Other/Tower ... ctice.docx
4. E. Tower, “GMO’s Predictions as Pilots for Vanguard Portfolios: Are They a Useful Guide for Strategic Asset Allocation?” Not available on line yet. Will be shortly.
http://econ.duke.edu/Papers/Other/Tower/Strategic_GMO’s_Predictions_as_Pilots.docx .
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Postby Blue » Mon Nov 01, 2010 8:03 am

The GMO predictions are prescient enough to be a useful input into investment decisions. Investors should be grateful to GMO for providing them at no charge.


Ed Tower,
Are GMO’s Predictions Prescient?
Using them to predict Vanguard’s Mutual Fund Returns
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Postby lazyday » Mon Nov 01, 2010 1:40 pm

Blue wrote:We established above in this thread that TSM is ~30% HQ (which are also large caps)

I don't know how good that estimate is, but if you're going to include HQ in your estimate, then you also need to include LQ.
What % of TSM is LQ?

Or, keep it simple, and just estimate that TSM = 75% Largecap, 10% Smallcap, and 15% other. Maybe to keep things simple, "other" could be lumped in with Largecap or split between the two.

You're cheating if you take some of the HQ estimate, but none of the LQ estimate.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby lazyday » Mon Nov 01, 2010 1:47 pm

Not sure if Tower would apply his earlier work to Quality or not. Not everyone even considers it an asset class. (I haven't looked at his stuff lately.)

Also don't forget a couple months ago, we discussed the implications if GMO is right. If U.S. LC and SC is a reasonable % of portfolio, because you are diversified globally into several asset classes like in Swensen's book or other sample AA's, then the result would be relatively small. You can even calculate it as you have been doing in recent posts, multiplied by % held. I hope few people are all U.S. with 50% SC and no bonds, unless they are really prepared for massive underperformance.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby maj » Mon Nov 01, 2010 2:51 pm

Normally, I index but to focus only on high quality stocks such as those held by Vanguard Dividend Apprecation Index Fund, I find the managed Vanguard Dividend Growth Fund a better choice.
Frist, Dividend Growth has the ability to be most widely diversified;
Second, Dividend Appreciation's requirement that a company has raised the dividend for at least 10 consecutive years means excluding a company's stock for a very long time. The failure to raise the dividend (or even to reduce it modestly) could have been a temporary slow down in earnings from which the company recovered quickly.

peace
maj
maj
 
Posts: 304
Joined: Wed Jun 25, 2008 3:58 pm

Postby lazyday » Mon Nov 01, 2010 3:18 pm

This seems to be the issue:
Blue wrote:Grantham only provides projections for HQ, LC (presumably LC ex HQ?), and SC

I take LC to be all of LC, not LC-HQ.

Also, GMO used to provide estimates of LQ for free, some here might still have these in their download folders. It was very low, maybe slightly negative.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby Roy » Mon Nov 01, 2010 3:33 pm

The GMO predictions are prescient enough to be a useful input into investment decisions. Investors should be grateful to GMO for providing them at no charge.


http://moneywatch.bnet.com/investing/bl ... oited/498/
Roy
 
Posts: 967
Joined: Wed Sep 10, 2008 10:34 am

Postby Houston101 » Mon Nov 01, 2010 4:46 pm

SteveB3005 wrote:The fund in it's seven years since inception has slightly underperformed the S&P 500, which leads me to ask myself if they cannot pick these superior companies how am I supposed too.


The commentary they publish sounds intellectual, none of the usual CNBC stuff.

But if you look at there funds performance they have hardly beaten the respective benchmarks, however there funds do show notable out-performance in the International equities section (but not always).

Leaves me to wonder the same question, if they are so smart why can't they beat the market by a wide margin?
User avatar
Houston101
 
Posts: 96
Joined: Fri Feb 26, 2010 4:15 pm

Postby Blue » Mon Nov 01, 2010 5:36 pm

lazyday wrote:This seems to be the issue:
Blue wrote:Grantham only provides projections for HQ, LC (presumably LC ex HQ?), and SC

I take LC to be all of LC, not LC-HQ.

Also, GMO used to provide estimates of LQ for free, some here might still have these in their download folders. It was very low, maybe slightly negative.


You are correct, this is the issue for discordance.

If LC is 2.9% estimate inclusive of HQ (estimated at 7.3%), then that implies a ex-HQ LC estimate of 0.4% (if LC is 70% of TSM, with 30/70 of HQ and 40/70 ex-HQ).

I assumed since Grantham broke out LC vs HQ he meant them as separate and distinct units.... but if you are correct and the LC estimate is inclusive of very high HQ estimate then the implications are much worse for us as TSM/S&D investors.
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Postby Roy » Mon Nov 01, 2010 5:38 pm

Houston101 wrote:
The commentary they publish sounds intellectual, none of the usual CNBC stuff.

But if you look at there funds performance they have hardly beaten the respective benchmarks, however there funds do show notable out-performance in the International equities section (but not always).

Leaves me to wonder the same question, if they are so smart why can't they beat the market by a wide margin?


Same questions, same answers. And investors in their funds have to identify these guys prior to their outperformance, and for reasonable cost, then hope the deluge of hot money doesn't dilute future success, which so often seems to follow.

But I agree that his level of discourse far exceeds that demonstrated in the CNBC "Looney Tunes" arena. (Love your avatar—the very symbol of outperformance!).
Roy
 
Posts: 967
Joined: Wed Sep 10, 2008 10:34 am

Postby Blue » Mon Nov 01, 2010 5:40 pm

Roy wrote:
The GMO predictions are prescient enough to be a useful input into investment decisions. Investors should be grateful to GMO for providing them at no charge.


http://moneywatch.bnet.com/investing/bl ... oited/498/


Fair points.

To play devil's advocate a bit, selecting individual securities and tactical asset allocation seem to be two different skill sets only partially correlated I suspect. History is favorable to Grantham on the latter point but not the former.
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Postby Blue » Mon Nov 01, 2010 8:00 pm

maj wrote:Normally, I index but to focus only on high quality stocks such as those held by Vanguard Dividend Apprecation Index Fund, I find the managed Vanguard Dividend Growth Fund a better choice.
Frist, Dividend Growth has the ability to be most widely diversified;
Second, Dividend Appreciation's requirement that a company has raised the dividend for at least 10 consecutive years means excluding a company's stock for a very long time. The failure to raise the dividend (or even to reduce it modestly) could have been a temporary slow down in earnings from which the company recovered quickly.

peace
maj


Maj, It looks like Ed Tower agrees with your assessment.

From his GMO Strategic Allocation paper,

Dividend growth, VDIGX, a clone of GMO’s Quality fund
....................
GMO on its web page has been recently been predicting high returns from investing in quality stocks. Thus it seemed likely that GBMFX would invest in part in assets which are held in the GQETX portfolio. VDIGX is the Vanguard mutual fund whose returns best explain GQETX, using Sharpe’s method of style analysis. Thus, it seemed likely that one component of the return of GBMFX would be explained by that of VDIGX.



Fascinating conclusions at the end of the paper,



My first take away from this is that the gains from strategic asset allocation as exhibited by GMO are substantial, but they are not consistent. My second take away is that GMO does not use its 7 year asset class return predictions to guide the asset allocation of its Benchmark Free Asset Allocation Fund III.
User avatar
Blue
 
Posts: 1017
Joined: Sat Jul 12, 2008 11:18 pm

Postby Robert T » Mon Nov 01, 2010 9:25 pm

My second take away is that GMO does not use its 7 year asset class return predictions to guide the asset allocation of its Benchmark Free Asset Allocation Fund III.

Here's a comparison of the GMO Benchmark Free portfolio with the historical backtest to 2004 of the portfolio I set up in M* that uses GMO's 7-year asset class forecast to guide annual assest allocation among 10 mostly Vanguard index funds.

Code: Select all
Annual returns, %

               GMO                Back-test 
          Benchmark-Free    GMO 7yr Forecast Portfolio   

2004           18.2                  18.4
2005           16.4                  18.4
2006           12.9                  14.9
2007           11.3                  12.6
2008          -11.2                - 10.4
2009           20.7                  37.8


Looks fairly correlated. Based on this (and the GMO prospectus) I come to a slightly different conclusion to Ed Tower. FWIW here the current portfolio tracked in M*: http://socialize.morningstar.com/NewSoc ... 6C583905A6
.
User avatar
Robert T
 
Posts: 1824
Joined: Tue Feb 27, 2007 10:40 pm
Location: 1, 0.2, 0.4, 0.5

Postby jeffyscott » Tue Nov 02, 2010 8:23 am



Larry's conclusion that: There certainly doesn’t seem to be any evidence of Grantham’s ability to exploit the supposed inefficiencies he is railing about., misses the point that the inefficiencies that Mr. Grantham "rails" about are not at all related to the selection of individual securities within funds that are limited to a specific asset class, instead they are related to the selection of asset classes in which to invest. If, for example, their forecast says foreign is a better value than US, this is not proven wrong by pointing out that their small cap value fund under-performed a small cap value index fund.
press on, regardless - John C. Bogle
User avatar
jeffyscott
 
Posts: 5966
Joined: Tue Feb 27, 2007 10:12 am
Location: Wisconsin

Postby ladders11 » Tue Nov 02, 2010 10:29 pm

Blue wrote:To play devil's advocate a bit, selecting individual securities and tactical asset allocation seem to be two different skill sets only partially correlated I suspect. History is favorable to Grantham on the latter point but not the former.


I agree. Yet his distinction of "high quality" seems elusive, and it may require skill to corral stocks that fit this class.

Look at his "Quality" fund. Why ORCL, and not HP, ADBE, IBM, etc? Why CSCO and not INTC or WDC? Why is ORCL double weighted in comparison to PEP? And there are many companies with earnings growth, low debt, fair valuation, multinational business, and other signs of "quality" that are not included. It is so difficult to pin down specifics, that "quality" is really whatever GMO says it is - not an asset class, of course, but their own prediction of their own skill.

I agree with his general thesis. But doesn't it seem like a tall order for this category to outperform large cap US equities by 3-4% per the next 7 years? This seems possible, given very low or nonexistent returns from all broad equity indexes - in sync with GMO's prediction, Hussman's forecast and other forecasts based on the Shiller PE/10. It does follow that JNJ, KO, PEP would beat a down market - these are unlevered, low beta, low volatility offerings. You may think of it as collecting dividends while the market muddles through.

The opposite would be something like Arnott's RAFI index (PRF) which has outperformed in recent decades (Arnott sees the trees, rather than the forest) because it tilts toward value, small, and levered companies. Grantham predicts mean reversion.
User avatar
ladders11
 
Posts: 639
Joined: Fri Nov 14, 2008 5:20 pm

Postby Noobvestor » Wed Nov 10, 2010 12:50 pm

Blue wrote:If Grantham's predictions are on target.... there will be more talk of SP500 funds than SCV tilting in 7 years on this board.


I really hope not - at that point, I'll have been buying into SCV on the cheap for seven years - I'm all for it :)
User avatar
Noobvestor
 
Posts: 3919
Joined: Mon Aug 23, 2010 2:09 am

Postby lazyday » Thu Nov 11, 2010 8:31 am

http://news.morningstar.com/articlenet/ ... ?id=359359
Risk of quality

Click link at start of article for October article on international revenue, and benefit of quality.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Postby ladders11 » Thu Nov 11, 2010 2:59 pm

^ Good article.

Quality fails to outperform when a the overall market succeeds. In market declines, quality declines less, and that is where outperformance occurs.
User avatar
ladders11
 
Posts: 639
Joined: Fri Nov 14, 2008 5:20 pm

Postby Noobvestor » Thu Nov 25, 2010 4:51 am

I guess I'm curious to know how 'quality' on the GMO definition compares/contracts to 'value' as an FF risk factor and 'wide moat' as M* talks about - and if 'value' and 'quality' are strongly correlated, does the GMO prediction suggest we're in for some troubled times ahead? :)
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe
User avatar
Noobvestor
 
Posts: 3919
Joined: Mon Aug 23, 2010 2:09 am

Postby ladders11 » Mon Nov 29, 2010 12:15 pm

noobvester wrote:I guess I'm curious to know how 'quality' on the GMO definition compares/contracts to 'value' as an FF risk factor and 'wide moat' as M* talks about - and if 'value' and 'quality' are strongly correlated, does the GMO prediction suggest we're in for some troubled times ahead? :)


Quality is more oriented towards growth stocks. Value would pretty much be the opposite. That said, part of the prediction comes from the idea that quality is now cheap. (Today JNJ has a PE of 12.65; WMT has a PE of 13.29.)

In the forecast dated 10/31/10, GMO predicts a real return of 1.2% for large-cap US equities. This is a dismal forecast. I would argue that this is an important factor in their prediction for the outperformance of quality.
User avatar
ladders11
 
Posts: 639
Joined: Fri Nov 14, 2008 5:20 pm

Postby lazyday » Tue Nov 30, 2010 4:35 pm

newb,

I'd guess that years ago quality and value were negatively correlated, and today that correlation is close to zero.

A wide moat helps to make a quality company, but alone isn't enough according to GMO's definition of quality.

For those who have diversified portfolios, I don't see the predictions as especially dire, nor do I think this is a bad time to have a diversified Boglehead TSM+international incl EM+FI portfolio. Earnings yield of the markets look ok, in spite of the bad economy.

My opinion is that it might be a very risky time to have extreme tilts to small and value, which might not be treated kindly if we have a double dip. My perspective is from someone in withdrawal phase.
lazyday
 
Posts: 1961
Joined: Wed Mar 14, 2007 11:27 pm

Next

Return to Investing - Theory, News & General

Who is online

Users browsing this forum: baddriver, Blazak, Bonhomie, cfs, dgdevil, jchris, JTJjr, Kevin M, retiredjg, TurnitinBot [Bot], wcmFun and 80 guests