Small cap tilt - value vs. growth

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radstar
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Small cap tilt - value vs. growth

Post by radstar » Fri Aug 17, 2018 3:01 am

I'm thinking of tilting my asset allocation to small cap by 5%. Currently, it is with standard 3 fund portfolio with US stocks at 65%.

Is it better to choose small cap value or growth, or just simply have small cap index fund without further dividing into value and growth? Which is the best Vanguard small cap fund for that?

Thanks!
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Re: Small cap tilt - value vs. growth

Post by vineviz » Fri Aug 17, 2018 5:36 am

radstar wrote:
Fri Aug 17, 2018 3:01 am
I'm thinking of tilting my asset allocation to small cap by 5%. Currently, it is with standard 3 fund portfolio with US stocks at 65%.

Is it better to choose small cap value or growth, or just simply have small cap index fund without further dividing into value and growth? Which is the best Vanguard small cap fund for that?

Thanks!
I’d rethink the tilt. 5% isn’t big enough to make a measurable impact on a portfolio, so probably doesn’t justify the additional complexity.

I’m a big proponent of tilting toward small cap value (its about half of my US stock position), but I’d say do at least 10% of your total portfolio or don’t bother.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Small cap tilt - value vs. growth

Post by UpperNwGuy » Fri Aug 17, 2018 8:18 am

Why do the tilters favor value over growth? Seems like growth has done better recently. (I am not a tilter nor considering tilting, just curious.)

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Re: Small cap tilt - value vs. growth

Post by ruralavalon » Fri Aug 17, 2018 8:41 am

radstar wrote:
Fri Aug 17, 2018 3:01 am
I'm thinking of tilting my asset allocation to small cap by 5%. Currently, it is with standard 3 fund portfolio with US stocks at 65%.

Is it better to choose small cap value or growth, or just simply have small cap index fund without further dividing into value and growth? Which is the best Vanguard small cap fund for that?

Thanks!
I think its better to use a small-cap value fund.

If you want a small-cap value tilt, then Rick Ferri has suggested using a small-cap value index fund at around 25% of domestic stocks. “My preference is 75 percent to a total market index fund and 25 percent allocation to a small-value index fund“, Rick Ferri, etf.com, "To Tilt Or Not To Tilt?".

I use 25% in Vanguard Small-cap Value Index Fund Admiral Shares (VSIAX) ER 0.07%. An alternative is Vanguard S&P Small-Cap 600 Value ETF (VIOV) ER 0.20%

I would not use a small-cap growth fund. Larry Swedroe, etf.com, "The 'Black hole of Investing' ". That article shows both the annualized returns and the annual standard deviations for the period 1927-2012 (75 years).

UpperNwGuy wrote:
Fri Aug 17, 2018 8:18 am
Why do the tilters favor value over growth? Seems like growth has done better recently. (I am not a tilter nor considering tilting, just curious.)
Because it is not a good idea to base an allocation decision on what has happened "recently".
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Re: Small cap tilt - value vs. growth

Post by wolf359 » Fri Aug 17, 2018 8:51 am

UpperNwGuy wrote:
Fri Aug 17, 2018 8:18 am
Why do the tilters favor value over growth? Seems like growth has done better recently. (I am not a tilter nor considering tilting, just curious.)
The terms "small cap value" and "small cap growth" sound very clinical and mask some of the emotions that are involved in actually selecting some of the stocks. By investing in an index, what it means to invest in these specific companies is masked even further.

Back in the 1990's, I used to invest in small companies that I thought were going to hit it big. Maybe it will be the next Apple, Cisco, Dell, or Amazon. The idea is that you buy them when they're small, and hold onto them until they grow big. You may do more than double your money. You could get a 20 bagger, or 30 bagger (making 30X the money invested). That is known as a small cap growth stock. Many investors who believe that they can pick a stock already try for these "lottery stocks." A lot of the talk on CNBC highlights these types of companies. Some of them hit big, but most do not. There were online stores that sold books, music, furniture, groceries, shoes, pet supplies, etc. Who knew that the book seller (Amazon) would hit bigger than the others? Or that pet supply company (pets.com) would bomb so badly?

A value stock is another way to refer to a company that is having problems. Nobody wants to buy it, because they have stumbled, or are having problems. They are losers, and their stock is down in the dumps because of that. One way of identifying them is that their price to book value is low. They're unpopular stocks. Small company stocks are generally more volatile, because they have fewer reserves and fewer resources to draw on. If they get a loan, they'll get unfavorable terms due to their size and whatever their issue is. So a small cap value stock is really beat down.

The theory is that people tend to overdo it. When they're optimistic about a stock, they get over-optimistic and bid the price up. When they are pessimistic about a stock and are losing money, everybody bails out and it may get oversold. So when you are systematically buying small cap value, you are systematically buying losers, and hoping that the market will eventually adjust to reflect their actual value.

The biggest problem with factor investing is that you have to be willing to suffer through years of underperformance before the factor pays off. Most people cannot do this. For example, small cap value may lag the market for years or even decades before it comes back on top. Would you hold on that long? Small cap growth soared in the 90's until it hit the tech crash of early 2000. Investing in the general total market index is a lot more consistent.

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Re: Small cap tilt - value vs. growth

Post by radstar » Fri Aug 17, 2018 8:58 am

wolf359 wrote:
Fri Aug 17, 2018 8:51 am
UpperNwGuy wrote:
Fri Aug 17, 2018 8:18 am
Why do the tilters favor value over growth? Seems like growth has done better recently. (I am not a tilter nor considering tilting, just curious.)
The terms "small cap value" and "small cap growth" sound very clinical and mask some of the emotions that are involved in actually selecting some of the stocks. By investing in an index, what it means to invest in these specific companies is masked even further.

Back in the 1990's, I used to invest in small companies that I thought were going to hit it big. Maybe it will be the next Apple, Cisco, Dell, or Amazon. The idea is that you buy them when they're small, and hold onto them until they grow big. You may do more than double your money. You could get a 20 bagger, or 30 bagger (making 30X the money invested). That is known as a small cap growth stock. Many investors who believe that they can pick a stock already try for these "lottery stocks." A lot of the talk on CNBC highlights these types of companies. Some of them hit big, but most do not. There were online stores that sold books, music, furniture, groceries, shoes, pet supplies, etc. Who knew that the book seller (Amazon) would hit bigger than the others? Or that pet supply company (pets.com) would bomb so badly?

A value stock is another way to refer to a company that is having problems. Nobody wants to buy it, because they have stumbled, or are having problems. They are losers, and their stock is down in the dumps because of that. One way of identifying them is that their price to book value is low. They're unpopular stocks. Small company stocks are generally more volatile, because they have fewer reserves and fewer resources to draw on. If they get a loan, they'll get unfavorable terms due to their size and whatever their issue is. So a small cap value stock is really beat down.

The theory is that people tend to overdo it. When they're optimistic about a stock, they get over-optimistic and bid the price up. When they are pessimistic about a stock and are losing money, everybody bails out and it may get oversold. So when you are systematically buying small cap value, you are systematically buying losers, and hoping that the market will eventually adjust to reflect their actual value.

The biggest problem with factor investing is that you have to be willing to suffer through years of underperformance before the factor pays off. Most people cannot do this. For example, small cap value may lag the market for years or even decades before it comes back on top. Would you hold on that long? Small cap growth soared in the 90's until it hit the tech crash of early 2000. Investing in the general total market index is a lot more consistent.
So, what do you recommend on small value tilt?
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Re: Small cap tilt - value vs. growth

Post by g2morrow » Fri Aug 17, 2018 9:23 am

if you can't decide - small cap blend

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Re: Small cap tilt - value vs. growth

Post by nisiprius » Fri Aug 17, 2018 9:27 am

This is a fascinating question, because the original Fama-French study--and virtually all people recommending factor tilts--say that small-cap value is far preferable. It's just about unanimous.

In fact, there's surprisingly little evidence for any strong benefit from small-caps alone (i.e. small-cap blend). Skeptics have wondered if the size effect even exists. Small-caps have had higher returns, but they have had considerably higher risk, and it's much less clear that they have ever had higher risk-adjusted return. Some of the cognoscenti have started to use language like "rescuing" or "resurrecting" the size factor by combining it with other factors. For example, it's often said that you get most of the benefit by combining it with a value tilt. Larry Swedroe has even referred to small-cap growth as "the black hole of investing," and people have said that the only reason the size factor hasn't seemed to amount to much is that it has been poisoned by the inclusion of small-cap growth stocks.

So in theory that's perfectly clear.

And yet,

...it has been frequently noted in this forum that the Vanguard Small-Cap Value index fund, VISVX, blue, has conspicuously failed to do much better than the Vanguard Small-Cap Growth index fund, VISGX, orange, during their lifetime:
Source

Image

And, perhaps even more surprisingly given that Fama and French are both advisors to DFA, during the relatively short period of time DFA has offered a small-cap growth fund, that fund, DFSGX, orange, has actually outperformed the DFA US Small-Cap Value Portfolio, DFSVX, blue.

Source

Image

The factor mavens have explanations for all of this. But, my mind most of them amount to saying "small-cap value did about the same or worse than small-cap growth over this time period because small-cap value did about the same or worse than small-cap growth over this time period."
Last edited by nisiprius on Fri Aug 17, 2018 9:34 am, edited 1 time in total.
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Re: Small cap tilt - value vs. growth

Post by Alexa9 » Fri Aug 17, 2018 9:33 am

The small value premium for a long term investor is a solid choice. Lots of research behind it.
If anything, it's good to diversify away from the mega cap heavy market cap index funds that are not too big to fail.

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Re: Small cap tilt - value vs. growth

Post by dcabler » Fri Aug 17, 2018 9:37 am

Being a topic that comes up all the time here, I wonder if this thread will go as many pages as the current "international stock is a disaster" thread. Maybe it's time to bring up factors again. :D

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Re: Small cap tilt - value vs. growth

Post by wolf359 » Fri Aug 17, 2018 9:44 am

radstar wrote:
Fri Aug 17, 2018 8:58 am
So, what do you recommend on small value tilt?
When someone is asking me what I recommend on small value tilt, I usually recommend staying with the Boglehead 3-Fund portfolio and not tilting. That strategy will reliably get you market returns, and is tough enough to stick with over the long term.

The reason that is my response is that by asking the question, you demonstrate that you do not have the conviction that the theory may be correct. If you don't have that conviction, then small cap value is probably not for you. If you watch your portfolio and wonder why you are underperforming year after year, then you probably won't stick with it. Better to not invest in the first place -- you'll end up selling while it's still down.

The strength of your conviction in the theory should dictate how much risk you're willing to accept. If you have a 30-50 year plus timeframe and you are absolutely convinced that small cap value will work, then go 100/0 SCV. (That, by the way, is insane. Don't do that!)

If you want to just slightly tilt, then put 5% in SCV. That probably won't move the bar much, and won't make much of a difference.

10-20% will have a noticeable impact on your portfolio, but that will be positive or negative over time. Most formal portfolio recommendations from literature that promote tilting are around this level.

Personally, I left percentages behind. I made sure that I'm contributing enough to the general market indices to meet my goals, and I'm throwing extra money at small cap value (in Roth) for my longest term money. It's a long-term bet for legacy (estate) money. If it works out, my heirs will be happy. By thinking of it this way, I don't have any stress over whether or not the theory is correct. If I don't have extra money, I don't add to it. I also don't rebalance it to increase or decrease its size. I consider it outside my primary portfolio.

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Re: Small cap tilt - value vs. growth

Post by pkcrafter » Fri Aug 17, 2018 9:49 am

UpperNwGuy wrote:
Fri Aug 17, 2018 8:18 am
Why do the tilters favor value over growth? Seems like growth has done better recently. (I am not a tilter nor considering tilting, just curious.)
This:
Seems like growth has done better recently.
Recently is never a good idea when considering a plan. Over the long term small value has beaten growth. Uh, or it used to. :confused "Recently" is part of the problem investors must overcome when trying to capture the small premium, or any other premium for that matter. You have to hold through the sometimes long periods of underperformance. This holds true when over weighting total small--it doesn't always beat large, and the market can remain stubborn longer than investors can remain patient (to paraphrase John Maynard Keynes).



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Re: Small cap tilt - value vs. growth

Post by UpperNwGuy » Fri Aug 17, 2018 1:29 pm

Thanks! You guys have successfully reconfirmed my inclination to avoid tilting towards small cap, small cap growth, or small cap value. I’ll stick to the Total Stock Market Index Fund.

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Re: Small cap tilt - value vs. growth

Post by MotoTrojan » Fri Aug 17, 2018 1:44 pm

UpperNwGuy wrote:
Fri Aug 17, 2018 1:29 pm
Thanks! You guys have successfully reconfirmed my inclination to avoid tilting towards small cap, small cap growth, or small cap value. I’ll stick to the Total Stock Market Index Fund.
Sound choice. If one does tilt I suggest using an S&P600 based fund like VIOV/IJS. Vanguards offering is more of a 50/50 mid/small index.

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Re: Small cap tilt - value vs. growth

Post by nisiprius » Fri Aug 17, 2018 4:56 pm

pkcrafter wrote:
Fri Aug 17, 2018 9:49 am
...Over the long term small value has beaten growth. Uh, or it used to. :confused
Jared Kizer wrote the following. Note point #7 in particular.
6. Any transparent strategy, which applies to everything outlined in this piece, is capable of extended periods of underperformance. There is nothing that preordains these strategies to work over any period of any length. Investors should either commit to these strategies over an extremely long time horizon or not tilt toward these factors at all.

7. A corollary to the sixth point is that it is virtually impossible to determine whether a given factor premium no longer exists precisely because each is capable of extended periods of underperformance. The period of underperformance could either be because “the world has changed” or simply a reasonable point on the distribution of possible outcomes.
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Re: Small cap tilt - value vs. growth

Post by stlutz » Fri Aug 17, 2018 6:53 pm

It probably won't make that much of a difference. Or at least is hasn't. Comparison

Theoretically, small/value probably makes the most sense. If you're doing to deviate from the overall market, you might as well deviate in a way that looks different. If you had a lot in the total market and were talking of adding a technology and a financials sector fund, one would of course say that this makes no sense as those are already the largest two sectors of the market. On the other hand, adding a materials fund could make sense as that sector is only 2.5% of the market. Perhaps it "should" be more?

Smallcap value companies look less like the market overall than does generic smallcap. As such, adding 5 or 10% of that will give you something that is at least kind of different.

Now some advocate for crazy things like investing only in small/value stocks. I'd stay away from that as one really doesn't want to bet their financial future on the performance of 2 or 3% of the market. As a small bet, go for it.

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Re: Small cap tilt - value vs. growth

Post by HEDGEFUNDIE » Fri Aug 17, 2018 7:01 pm

I used to tilt small value, but last year I switched to small blend. IJR instead of IJS.

The value factor premium is notorious for disappearing for a decade at a time. Small blend (based on S&P 600) is the more BH move, you're taking advantage of the quality screen and not counting on value to go your way.

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Re: Small cap tilt - value vs. growth

Post by nisiprius » Fri Aug 17, 2018 7:31 pm

HEDGEFUNDIE wrote:
Fri Aug 17, 2018 7:01 pm
I used to tilt small value, but last year I switched to small blend. IJR instead of IJS.

The value factor premium is notorious for disappearing for a decade at a time. Small blend (based on S&P 600) is the more BH move, you're taking advantage of the quality screen and not counting on value to go your way.
You are, however, counting on the size factor to go your way.

The academic paper bringing the size factor to the attention of investors was published in March of 1981. The DFA US Micro Cap Portfolio, DFSCX in December of 1981. An investor who invested $10,000 into DFSCX at launch (blue) would have been ahead of a Vanguard 500 Index investor (orange) unti 6/30/1986, four-and-a-half years, and would then have fallen behind and stayed behind for seventeen years.

Source

Image
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Re: Small cap tilt - value vs. growth

Post by spdoublebass » Fri Aug 17, 2018 8:07 pm

I really shouldn't be commenting because I do not know enough and hold market weight....
But,

I read so much about small value being the better choice, but if I were going to tilt I would use the Extended Market index. I know it's not the point of the fund.
Portfolio Vis. goes back to 1988, it comes out a little ahead of SP500 (I don't know how to upload graphs). Same with the small cap blend fund, which I guess you could use instead. I just sometimes feel so top heavy with the market weight numbers.
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Re: Small cap tilt - value vs. growth

Post by cheezit » Fri Aug 17, 2018 9:24 pm

nisiprius wrote:
Fri Aug 17, 2018 7:31 pm
HEDGEFUNDIE wrote:
Fri Aug 17, 2018 7:01 pm
I used to tilt small value, but last year I switched to small blend. IJR instead of IJS.

The value factor premium is notorious for disappearing for a decade at a time. Small blend (based on S&P 600) is the more BH move, you're taking advantage of the quality screen and not counting on value to go your way.
You are, however, counting on the size factor to go your way.

The academic paper bringing the size factor to the attention of investors was published in March of 1981. The DFA US Micro Cap Portfolio, DFSCX in December of 1981. An investor who invested $10,000 into DFSCX at launch (blue) would have been ahead of a Vanguard 500 Index investor (orange) unti 6/30/1986, four-and-a-half years, and would then have fallen behind and stayed behind for seventeen years.

Source

Image
I'm curious why the graph there stops at 2003? If you go for the whole period of 1981-2018, you get the following results:

Code: Select all

Class             Start$           End$         CAGR
Total_Mkt	    $10,000	    $482,868 	10.87%
US_LgCap	    $10,000	    $518,405 	11.08%
US_SmCap	    $10,000	    $614,720 	11.58%

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Re: Small cap tilt - value vs. growth

Post by HEDGEFUNDIE » Fri Aug 17, 2018 9:24 pm

nisiprius wrote:
Fri Aug 17, 2018 7:31 pm
HEDGEFUNDIE wrote:
Fri Aug 17, 2018 7:01 pm
I used to tilt small value, but last year I switched to small blend. IJR instead of IJS.

The value factor premium is notorious for disappearing for a decade at a time. Small blend (based on S&P 600) is the more BH move, you're taking advantage of the quality screen and not counting on value to go your way.
You are, however, counting on the size factor to go your way.

The academic paper bringing the size factor to the attention of investors was published in March of 1981. The DFA US Micro Cap Portfolio, DFSCX in December of 1981. An investor who invested $10,000 into DFSCX at launch (blue) would have been ahead of a Vanguard 500 Index investor (orange) unti 6/30/1986, four-and-a-half years, and would then have fallen behind and stayed behind for seventeen years.

Source

Image
Show me a comparison using the S&P 600 index (small without junk) and we can have a proper debate.

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Re: Small cap tilt - value vs. growth

Post by HEDGEFUNDIE » Sat Aug 18, 2018 12:16 am

Image

The S&P 600 index was created in late 1994. It closely tracked the S&P 500 for the first two years, then fell behind for five years.

But ever since 2002 it has been a rocket ship. 16 years of sustained outperformance.

If this keeps up I'm going to have to start a thread titled "It's not enough to mumble "Stay the Course"... Large-Cap Investing has been a disaster!"

:wink:

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Re: Small cap tilt - value vs. growth

Post by heyyou » Sat Aug 18, 2018 12:45 am

by spdoublebass » Fri Aug 17, 2018 8:07 pm
I ........hold market weight....

but if I were going to tilt I would use the Extended Market index. I know it's not the point of the fund.
I just sometimes feel so top heavy with the market weight numbers.
My underlining of the above.
I agree and my tilt is away from Large Growth and Large Blend. I haven't forgotten the 2000 Crash.
Others are welcome to allocate to whatever suits them. There is an entire spectrum of good enough allocations.

Another datum for retirees is McClung ran each of the equity sub-asset classes separately in a retirement spending calculator. Small Growth was the worst, and Large Growth was second worst, so he left both of them out of his suggested retirement allocation. Please note that the differences are only lower positive growth rates, not negative growth.

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Re: Small cap tilt - value vs. growth

Post by HEDGEFUNDIE » Sat Aug 18, 2018 1:02 am

HEDGEFUNDIE wrote:
Sat Aug 18, 2018 12:16 am
Image

The S&P 600 index was created in late 1994. It closely tracked the S&P 500 for the first two years, then fell behind for five years.

But ever since 2002 it has been a rocket ship. 16 years of sustained outperformance.

If this keeps up I'm going to have to start a thread titled "It's not enough to mumble "Stay the Course"... Large-Cap Investing has been a disaster!"

:wink:
I thought the picture might change if we included dividends, but it doesn’t!

On a total return basis the S&P 600 has gone up 469% since Aug 2001 (as far back as the data shows) while the S&P 500 has only returned a paltry 237%.

(source: TR6GSPC vs. SPXTR on investing.com)

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Re: Small cap tilt - value vs. growth

Post by footballbazzer » Sat Aug 18, 2018 4:24 am

There are stocks that are both Growth and Value. Look at $MSFT with 14 Years of Dividend and Price Growth

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Re: Small cap tilt - value vs. growth

Post by whodidntante » Sat Aug 18, 2018 5:01 am

Growth (aka expensive) tends to lag value over a long period of time. This phenomenon is called the value premium. However, the S&P 600 growth index doesn't have the lottery ticket stocks that some financial writers correctly tell you to avoid. But I would still expect it to lag SCV over a lifetime of investing.

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